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The Doctrine of Ultimate Effect and Unfair Preference Payments - the Doctrine is alive and well

02 Sep 2010

In June 2010, the Western Australian Supreme Court had to consider the operation of the doctrine of ultimate effect and whether it still applied in relation to actions for recovery of what are alleged to constitute preference payments within the meaning of section 588FA of the Corporations Act 2001 (the Act).

Section 588FA provides that an unfair preference will be given by a company to a creditor of a company if and only if:

  1. the company and the creditor of parties to the transaction;
  2. either:
    1. the company is insolvent at the time of the transaction of the giving of the effect to it; or
    2. the transaction of the giving of the effect to it results in the company becoming insolvent; and
  3. the transaction results in the creditor receiving from the company in respect of a debt which the company owes to the creditor, more than the creditor would receive from the company in respect of the debt if the transaction was set aside and the creditor were to prove the debt in the winding up of the company.

The doctrine of ultimate effect is one where the court has regard to the ultimate effect of a transaction on the other creditors in assessing whether the particular transaction in question constituted a preference, priority of advantage to the debtor of the creditors.

The case has brought to light potential tensions between the operation of section 588FA and the doctrine of ultimate effect and clarified that it has survived.

Facts

The Centaur companies (Centaur Mining & Exploration Ltd and Centaur Nickel Pty Ltd) leased mining tenements in Western Australia upon which they conducted mining operations. The minister was responsible for collecting rental royalties and other revenues associated with mining tenements in Western Australia.

Between October 2000 and August 2002 there were a number of payments of rent and royalties to the minister by the Centaur companies. The rental payments were paid in advance while royalties were paid in arrears.

During this period, numerous letters were sent to the Minister from the Centaur companies requesting extensions for payment of the royalties due and owing. The minister sought advice from the Crown Solicitors Office as to how to protect themselves in relation to outstanding royalties if the Centaur companies were to be placed into voluntary administration. The following facts were not disputed:

  1. that the payments were made by Centaur Mining to the minister;
  2. that the payments resulted in Centaur Mining and the minister becoming parties to the transaction involving payments totalling $1.6 million to the minister; and
  3. that Centaur Mining was insolvent from and or 31 December 2000.

The first decision

The court found that the doctrine of ultimate effect had not been revoked by section 588FA and the 1992 amendments to the unfair preference laws were not intended to make any significantly different provision for identifying what is an unfair preference.

The court found that the doctrine of ultimate effect applies to the construction of section 588FA. That meant that the court looked to the totality of the transaction, not just the payment itself.

The appeal

The liquidators appealed. They had two contentions:

  • The supreme court erred in applying the doctrine of ultimate effect by concluding that each of the payments was not an unfair preference within the meaning of section 588FA.

    The liquidators‘ primary contention was that the words in section 588FA being ’if and only if‘ showed that Parliament intended to exclusively set out the only conditions required to establish that a transaction was an unfair preference, relevantly that the transaction resulted in the creditor receiving more for an unsecured debt and the creditor would receive in the winding up. Their argument was that the phrase ’if and only if‘ made it an exclusive definition and that therefore the previous common law doctrine of ultimate effect was excluded.

    Furthermore, the liquidators argued that earlier decisions which were made in accordance with the doctrine of ultimate effect(1), were not authority to contradict their contention that the plain language of 588FA left no room for the application of the doctrine of ultimate effect.

    The court found that this is somewhat of a strict approach to the wording of the legislation. If constructed strictly in accordance with the way the liquidators were submitting then a transaction would become an unfair preference if an unsecured creditor received more then it would have received if it had to prove its debt in a winding up in any situation.

    The court found that if the section (588FA) was construed literally, as the liquidators contended then it would apply indiscriminately to transactions that could not, would not and never were conceived as being voidable preference including cash on delivery transaction.
  • Even if section 588FA did not operate to exclude the ultimate effect doctrine then the supreme court had made an error in concluding that the doctrine applied to the payment of the royalties.

    The liquidators contended that if the rent payments were not unfair preferences, then the royalties, which were paid in arrears not in advance (unlike the rental payments), were in respect of a past debt and were therefore unfair preference payments.

    The liquidators argued that in relation to the doctrine of ultimate effect the royalties were not included in that category for the following:

    (a) because the payment was made in respect of a past debt; and

    (b) it was not made to secure the continuing provision of goods or servicesor the acquisition of assets of a value corresponding with the payment made .

    The court of appeal found that in respect to the royalty payments, the doctrine of ultimate effect not extend to circumstances where the payment was made in respect of a past debt and is not made to securing the continuing provision of services or the acquisition of assets of a value corresponding with the payment made(2).

The appeal was unanimously allowed in respect of the recovery of the royalty payments, but was denied in respect of the rental payments.

Conclusion

The decision makes it clear that the Doctrine of Ultimate Effect has survived and needs to be considered when any claim for a preference payment is brought or defended.

The doctrine can have a substantial effect upon the commerciality of any unfair preference proceedings and substantially expand the issues to be considered in any such proceedings.

Hynes Legal regularly advises clients on recovery proceedings including consideration of the Doctrine of Ultimate Effect. 

(1) Eg VR Dye & Co v Peninsula Hotels Pty Ltd (in liq) [1999] 3 VR 201

(2) In Air Services Australia v Ferrier (1996) 185 CLR 482 the court held that a
     payment to secure ongoing supply was not a preference