Do ‘I’ really ‘O.U.’? Going behind court judgments in bankruptcy proceedings

The Federal Court has recently considered an appeal relating to the circumstances in which a court of bankruptcy can and should ‘go behind’ a judgment made against a debtor in order to ascertain whether a party facing bankruptcy in fact owes a debt being pursued.

The decision in Compton v Ramsay Health Care Australia Pty Ltd[1] clarifies the circumstances in which a court’s discretion to ‘go behind’ should be enlivened, and draws a sharp distinction between the conduct of parties to bankruptcy proceedings and the underlying merits of their arguments about the debt. The Court’s decision concerns a history of litigation in which the debtor could have disputed the debt at trial but did not, and as such raises matters useful to debtors and creditors alike.

The facts

Ramsay Health Care (RHC) sought and obtained judgment against Mr Compton in the Supreme Court of New South Wales for money owed under a pharmaceutical distribution contract. Mr Compton was guarantor of a business, MediChoice, which was a party to the contract.

Upon succeeding in the Supreme Court, RHC issued a bankruptcy notice to Mr Compton requiring payment of the judgment debt. When Mr Compton failed to comply, RHC filed a creditor’s petition in the Federal Court seeking a sequestration order.

Mr Compton issued an interim application in the Federal Court, asking the Court to determine whether it should ‘go behind’ the Supreme Court judgment and scrutinise the debt said to be owing. Mr Compton submitted affidavit evidence in support of his application which went beyond that filed in the Supreme Court proceeding and which painted a different picture regarding the issue of indebtedness; Mr Compton’s evidence suggested that, rather than MediChoice owing RHC money, it had been quite the contrary.

At the interim hearing, RHC did not wholly dispute Mr Compton’s material but submitted there was an ‘open question’ as to whether the calculations that Mr Compton had provided were factually correct.

In his decision, the Federal Court judge declined to go behind the Supreme Court judgment. The judge held that because Mr Compton had decided not to provide evidence in the Supreme Court to dispute the quantum of debt the Federal Court’s ‘go behind’ discretion was not enlivened. The judge also observed that, even if the discretion were enlivened, he would have chosen not to exercise such discretion. The primary judge concluded that, in the circumstances, there would be no injustice in bankrupting Mr Compton.

Mr Compton sought leave to appeal this decision to the Full Court.

On appeal

Applicable law

In a joint decision, Siopis, Katzmann and Moshinsky JJ looked to the case law on the question of the ‘go behind’ discretion, including the decision of Fullagar J in Corney v Brien.[2] His Honour held in that case:

‘If the judgment in question followed a full investigation at a trial on which both parties appeared, the court will not reopen the matter unless a prima-facie case of fraud or collusion or miscarriage of justice is made out’.[3]

Their Honours considered this statement should not be seen as ‘an exhaustive statement of the circumstances in which a court of bankruptcy may or should “go behind” a judgment’, and instead ‘must be applied flexibly’ in light of the facts of the particular case at hand.[4]

Their Honours also looked to the decision of Barwick CJ in Wren v Mahoney[5] — a decision their Honours considered to be consistent with the comments of Fullagar J — where the Chief Justice held:

‘The Court’s discretion in my opinion is a discretion to accept the judgment as satisfactory proof of that debt. That discretion is not well exercised where substantial reasons are given for questioning whether behind that judgment there was in truth and reality a debt due to the petitioner’.[6]

Their Honours rejected the primary judge’s two-stage approach — involving first the enlivening of a court’s discretion and secondly whether or not that discretion ought be exercised — and stated that ‘if there is a preliminary investigation into whether or not to “go behind” a judgment … there is but one issue to be addressed, namely whether or not the Court should “go behind” the judgment’.[7]

Focus on evidence rather than conduct

Having articulated the applicable ‘go behind’ test, the Full Court held that the primary judge had erred in focusing on Mr Compton’s conduct in the Supreme Court — and, in particular, Mr Compton’s decision not to dispute the quantum of the debt — rather than the ‘central issue’, namely ‘whether reason was shown for questioning whether behind the judgment there was in truth and reality a debt due to the petitioning creditor’.[8] Their Honours found that the evidence presented to the primary judge ‘disclosed substantial reasons for questioning whether Mr Compton was indebted to [RHC]’.[9] It was for this reason that their Honours ultimately allowed the appeal.

The Full Court was mindful of the fact that Mr Compton had the opportunity to challenge the debt in the Supreme Court and had failed to do so. Nonetheless, the Full Court held:

‘[T]he focus for the bankruptcy court is not on the forensic choices made by the parties in the litigation which resulted in the judgment, but on the requirement that there be satisfactory proof of the petitioning creditor’s debt’.[10]

For the Full Court, the consideration of whether there would be ‘injustice’ in bankrupting the debtor in the present case should have been informed by the credentials of the debt being claimed rather than the debtor’s conduct at trial. The fact that RHC had conceded before the primary judge that there was an ‘open question’ about the indebtedness was apposite; had the primary judge focused on this, the Full Court held, ‘he would have come up with a different answer’ about the justice of the matter.[11]

Conclusion

In Compton v Ramsay Health Care Australia Pty Ltd, the Federal Court sharpened the focus of the test when ascertaining whether to ‘go behind’ a court judgment to scrutinise a debt. The case is authority for the view that, in determining whether to go behind a court judgment, a court should concern itself primarily with the merits of the debt being claimed and not the conduct of the parties in the proceeding.


[1]: [2016] FCAFC 106.

[2]: (1951) 84 CLR 343.

[3]: Ibid 356–7.

[4]: [2016] FCAFC 106 [60].

[5]: (1972) 126 CLR 212.

[6]: Ibid 224–5.

[7]: [2016] FCAFC 106 [68].

[8]: Ibid [69].

[9]: Ibid.

[10]: Ibid [70].

[11]: Ibid [77].