The High Court has dismissed an appeal against a decision of the Full Federal Court on the circumstances in which a bankruptcy court may ‘go behind’ an earlier debt judgment. In a 2015 judgment, the NSW Supreme Court held that Compton, who had guaranteed the Ramsay’s debts, now owed almost $10 million to the company, and rejected his contention that he was not aware of the debts as they were not attached to the guarantee papers he had signed. When Compton himself went bankrupt, Ramsay presented a creditor’s petition to the Federal Court to sequester the debt to preserve it from the demands of other creditors, and Compton, in response, submitted new evidence that he contended showed he never actually owed anything to the company. Section 51(1)(c) of the Bankruptcy Act 1966 (Cth) provides that

At the hearing of a creditor’s petition, the Court shall require proof of: …
(c) the fact that the debt or debts on which the petitioning creditor relies is or are still owing;
and, if it is satisfied with the proof of those matters, may make a sequestration order against the estate of the debtor.

The FCAFC unanimously held that the primary judge should have inquired into whether the debt was owed, holding that the primary judge erred in focusing on Compton’s NSWSC proceedings (namely, failing to challenge the amount in those proceedings), rather than examining the central issue of whether a reason existed for questioning whether behind the NSWSC judgment was a real debt due to the company prior to making the sequestration order.

A majority of the High Court (Kiefel CJ, Keane and Nettle JJ, and Edelman J, Gageler J dissenting) held that the FCAFC was correct to conclude that there was a substantial question as to whether the debt was owing, and that the Bankruptcy Court should proceed to investigate the question before making the sequestration order.

The joint judges (Kiefel CJ, Keane and Nettle JJ) held that both earlier authorities and principle supported Compton’s arguments on the application of s 52(1)(c); that a Bankruptcy Court should go behind a judgment where there is sufficient reason for questioning whether behind that judgment is in truth a reality a debt owing to the petitioning creditor, and that in this case a sufficient reason did exist. Corney v Brien [1951] HCA 31 stood as authority for the proposition that a Bankruptcy Court has ‘undoubted jurisdiction’ to go behind a judgment in cases of fraud, collusion or miscarriage of justice, but contrary to Ramsay’s arguments, did not limit that jurisdiction to only those circumstances (at [39]ff). Wren v Mahony [1972] HCA 5 stood as authority against Ramsay’s argument that the circumstance of obtaining a judgment without collusion or fraud after a contested hearing precludes the possibility of any sufficient reason to go behind that judgment (at [47] and see [42]ff). The joint judges then rejected Ramsay’s argument that a ‘miscarriage of justice’ here only relates to the kind of miscarriage that would suffice to impeach the obtaining of the judgment: scrutiny by a Bankruptcy Court is not an attempt to impeach the judgment, or some process analogous to an appeal, but instead to examine whether the debt is truly a basis for the making of a sequestration order, which in turn is aimed at protecting the rights of third parties (see [53]ff). Finally, turning to the question of finality in litigation, the joint judges held that while Compton’s failure to bring evidence in the NSW proceedings that he did not owe any debt to Ramsay may raise a real question as to whether he failed to present his case on the merits at trial, he is not bound by the conduct of that case for the purposes of this question (at [65]ff, [67]):

the notion that a party is bound by the conduct of his or her case has never been a sufficient reason not to look behind a consent judgment or a default judgment. That is because a Bankruptcy Court is concerned, not to discipline litigants or to protect finality in the administration of justice as between parties to litigation, but to protect the interests of third parties who were not participants in the litigation which led to the judgment in question.

The joint judges concluded by ordering that the Bankruptcy Court proceed to investigate the question of whether the debt was owing and decide whether it was open to it to make a sequestration order (at [72]).

Edelman J agreed with the conclusions and reasoning of the plurality (at [97] and [110]ff), and added that the power to go behind a judgment has a long history in the Court of Chancery: that history supports the view that the power was not and is not restrained to any particular category (see [99]ff), and that while since the nineteenth century it has been rarely exercised outside the categories of fraud, collusion or miscarriage of justice, it does continue to exist outside of those categories (see [103]ff).

Gageler J dissented, holding that the FCAFC’s identification of the ‘central issue’ was incorrect, and that the primary judge was correct in focusing on whether there had been a failure of legal process in the NSW proceedings, and correct to conclude that Compton had failed to make any prima facie case for the exercise of the discretion (at [94]). For Gageler J, it was significant that Compton had not put quantum in issue in the original proceedings but would, following the sequestration order, now be able to do so (at [78]–[80]), unlike in Wren v Mahony, where the petitioning creditor relied on an antecedent contractual liability, rather than, as here, a final judgment entered after a trial on the merits (at [87]). While the rule in Corney v Brien that a Bankruptcy Court will not exercise its discretion to ‘go behind’ a judgment absent a prima facie case of fraud, collusion or miscarriage of justice is not an absolute proposition (at [90]), this ‘guiding principle’ should not be disregarded ‘merely because substantial reasons might be shown to that court for considering that the determination of another court after a trial on the merits might have been wrong on the evidence presented to that other court’, let alone where the debtor failed to do so in earlier proceedings (at [91]). For Gageler J, to do otherwise would risk injustice to other honest and bona fide creditors (at [92]):

The foundational consideration remains that stated by Cotton LJ in Ex parte Lennox;In re Lennox: ‘that, under whatever circumstances a judgment may have been obtained against the bankrupt, yet no act of his — collusion, compromise improperly entered into, or anything else — ought to prejudice the rights of the other creditors, because the assets ought to be distributed in the bankruptcy only amongst the honest bonâ fide creditors of the bankrupt’. Those other honest and bona fide creditors are not to be made the victims of a failure of legal process. Hence the acknowledged ability of a court exercising bankruptcy jurisdiction to go behind a judgment entered after a trial on the merits where a prima facie case of miscarriage of justice can be shown. But those other creditors are not to be protected by an exercise of judicial discretion from what might be shown in retrospect to have been poor forensic choices which the debtor made in the course of contesting proceedings which have resulted in a judgment on the merits against the debtor any more than they are to be protected from poor business decisions of the debtor which have resulted in other debts being incurred. Each creditor takes the debtor’s estate for what it is.

Here, contrary to the FCAFC’s conclusion, the correct focus remained on this failure of legal process in the NSW proceedings (at [93]ff).