Many readers will be aware of claims made by liquidators and bankruptcy trustees to recover preferential payments. These claims are made when certain creditors are paid in preference to other creditors before the commencement of the liquidation or bankruptcy.

Readers may also be aware that the amount of these claims may be limited or reduced under what has been known as a ‘running account’. The concept of the running account has been around for some time, and is set out in the Corporations Act as the Continuing Business Relationship.

A running account and its effect was described in the 1952 case of Richardson v Commercial Banking Co of Sydney Ltd as “… where the payment forms an integral and inseparable part of an entire transaction, its effect as a preference involves consideration of the whole transaction“. This and other decisions describe the position of allowing subsequent advances of credit granted by a creditor to reduce the amount of any preference claim made against them.

Section 588FA(3) of the Corporations Act sets out this principle:

Where:
(a) a transaction is, for commercial purposes, an integral part of a continuing business relationship (for example, a running account) between a company and a creditor of the company (including such a relationship to which other persons are parties); and
(b) in the course of the relationship, the level of the company’s net indebtedness to the creditor is increased and reduced from time to time as the result of a series of transactions forming part of the relationship;
then:
(c) subsection (1) applies in relation to all the transactions forming part of the relationship as if they together constituted a single transaction; and
(d) the transaction referred to in paragraph (a) may only be taken to be an unfair preference given by the company to the creditor if, because of subsection (1) as applying because of paragraph (c) of this subsection, the single transaction referred to in the last-mentioned paragraph is taken to be such an unfair preference.

The Explanatory Memorandum explains the purpose of this section as:

“.. embodying in legislation the principles reflected in the cases of Queensland Bacon Pty Ltd v Rees (1967) 115 CLR 266 and Petagna Nominees Pty Ltd & Anor v AE Ledger 1 ACSR 547. The effect of these principles is that it is implicit in the circumstances in which payments are made to reduce the outstanding balance in a running account between purchaser and supplier that there is a mutual assumption that the relationship of purchaser and supplier would continue as would the relationship of debtor and creditor.”

The application of this principle has been considered in preferential payments claims against the Australian Taxation Office. The question in these cases was whether the principle of ‘subsequent advances of credit’ applied to debts that accrued due to taxation legislation, and not from sales under a debtor creditor relationship. In particular, the 1998 case of Sands & McDougall Wholesale Pty Ltd (in Liq) & Anor v The Commissioner of Taxation dealt with preferential payments made in relation to sales tax.

The three judges of the Victorian Supreme Court of Appeal noted that:

“The liability of a taxpayer to pay sales tax to the Commissioner does not .. lead either to a running account or to the situation contemplated by s588FA(3)(b), nor do [we] think one could draw the conclusion that the parties conducted their relationship on the basis that any sort of service would be provided and paid for on credit terms ordinarily applicable, leading to the mutual assumption that each payment was connected with the subsequent provision of such services (see Airservices Australia v Ferrier at 505)”.

The Court noted that a tax liability was not a trading debt that fluctuated, but was a debt that automatically arose by operation of a statute upon certain events. The Court therefore said for all of those reasons that a company did not have a continuing business relationship with the Commissioner of Taxation.

In particular the Court stated that a continuing business relationship did not exist because:

• no contract existed between the parties;
• the supply of goods and services were not involved;
• the payments were not made in connection with subsequent supply; and
• payments were generally for particular debts.

We are about to commence an action against a state taxing authority and will be using the same principles applied in the Sands case to remove any application of a ‘running account’ defence. We will advise the outcome of that action and whether that principle was upheld.

Sands & McDougall Wholesale Pty Ltd (in Liq) & Anor v The Commissioner of Taxation [1998] VSCA 76