INSOLVENCY – LECTURE 1
EXTERNAL ADMINISTRATION OF CORPORATIONS
Insolvency law is statute based – not a lot of common law.
When a company can’t pay its’ debts the control of a Company is handed from the
Directors to someone independent to administer the Company. The administration
of the company is done to assist repayment of unsecured creditors who are otherwise
just going to miss out.
External administration occurs when the Company is insolvent and the Liquidator is
not running the Company in the interests of the shareholders any more but is running
the Company purely doing the best they can to pay the unsecured creditors. There
can also be external administration of a solvent Company in certain circumstances.
Insolvency laws have these aims in relation to a Company:
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What you want is an orderly and rateable distribution of property in favour of
creditors so that one person doesn’t rush in and take everything. By rateable
we mean that everyone gets treated equally e.g. every creditor gets paid 10
cents in a dollar.
An impartial liquidator is appointed to carry that out, they collect Company
property, they challenge certain past dispositions of the Company, they deal
with the people making claims, they deal with the priority of creditors and once
they’ve done all they can to pay the unsecured creditors the Company is wound
up.
Insolvent winding up is what we are interested in – governed by Part 5.4B of
the Corporations Act.
Mcpherson – “liquidation is a process whereby the assets of a Company are
collected and realised, the resulting proceeds are applied in discharging all
debts and liabilities and any balance which remains after paying the costs and
expenses of winding up is distributed among the members or otherwise
distributed as to the constitution…”
Social purpose in winding up insolvent companies and that is they should be
stopped trading. So the general commercial world is not continuing to lose
money dealing with a Company that is never going to pay them.
The liquidator can investigate the companies affairs and will try and challenge
some past distributions of property by the Company.
In Company liquidation there is no fresh start it goes out of existence after
winding up.
By mindful that the laws about winding up companies is different from the
bankruptcy laws – have to have clear in your head which principles apply to
individual v corporate insolvency.
Definition of Insolvency
95A(1) declares that a person (that means a legal person which includes a Company)
is solvent if and only if the person is able to pay all the persons debts as and when
they become due and payable.
95A(2) provides that a person who is not solvent is insolvent.
The definition is the same in the bankruptcy act – so older bankruptcy cases on the
meaning of insolvent are authoritive even in corporate insolvency cases.
Judges have said that the test is a commercial or cash flow test not a balance sheet test.
Sets out what income is coming in month by month and into the future and sets out
debts on the same basis.
Judges have said the basic question is whether the business is viable and they have
also said is the Company suffering from a temporary lack of liquidity or an endemic
shortage of working capital.
Sandell v Porter (1966) 115 CLR 666
“Insolvency is ….. an inability to pay debts as they fall due out of the debtor's own
money. But the debtor's own moneys are not limited to his cash resources immediately
available. They extend to moneys which he can procure by realization by sale or by
mortgage or pledge of his assets within a relatively short time - relative to the nature
and amount of the debts and to the circumstances, including the nature of the
business, of the debtor. The conclusion of insolvency ought to be clear from a
consideration of the debtor's financial position in its entirety and generally speaking
ought not to be drawn simply from evidence of a temporary lack of liquidity. It is the
debtor's inability, utilizing such cash resources as he has or can command through the
use of his assets, to meet his debts as they fall due which indicates insolvency. Whether
that state of his affairs has arrived is a question for the Court and not one as to which
expert evidence may be given in terms though no doubt experts may speak as to the
likelihood of any of the debtor's assets or capacities yielding ready cash in sufficient
time to meet the debts as they fall due.”
It doesn’t just mean what have you got in your pocket it means what could you raise
within a relatively short period of time to pay your debts.
This definition of solvent and insolvent is not just relevant when you are determining
as a Judge should I wind this Company up, is this Company insolvent – they become
relevant down the track – for the liquidator once he gets in power and he trys to
unwind certain transactions from years ago and there are certain defences that if the
Company was solvent when the transfer was made then there is a defence to what
would otherwise be a voidable transaction.
Compulsory Winding Up
Compulsory Winding Up is where a person applies to the Court for an order to wind
up a Company in insolvency, that is, to have a liquidator appointed. Under Section
459P Corporations Act 2001 (C’th) the following may apply to the court for a
company to be wound up in insolvency:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
the company;
a creditor;
a contributory;
a director;
a liquidator or provisional liquidator of the company;
ASIC;
a prescribed agency.
(b) is the one you will most often strike in practice and the one we focus on for this
course. It occurs where the creditor is sick of not being paid and makes an application
to wind up the insolvent Company.
Certain of those categories need the leave of the Court but a creditor doesn’t they have
a statutory right.
If you are the creditor who wants to wind up the Company – how do you prove that
the Company is insolvent – cause all you know is that you are owed say $10K and the
Company keeps putting off paying me well that’s interesting but does it satisfy the
statutory definition of can the Company satisfy it’s debts as and when they fall due.
A creditor is almost obliged to start up one of these proceedings blind in that they
hope to prove insolvency but they know nothing about the financial state of the
Company when they embark upon the process. So, it would just be a waste of public
resources if people brought winding up applications all the time and the Company
proved to be solvent. So, the statute provides that there are 6 factual scenarios where
if any one of them is proven by the creditor a presumption of insolvency will arise.
Statutory demand is the main one the other 5 scenarios are there but they are rarely
used.
Statutory Demand – s459C(2)(a)
A Court must presume a Company is insolvent if during or after the 3 months ending
on the day the application was made the Company failed as defined in s459F to
comply with a statutory demand.
If the presumptions are invoked the Company is regarded as insolvent unless the
Company proves to the contrary at the hearing of the winding up application –
459C(3).The onus of proof is shifted back to the Company to prove solvency – all the
creditor has to prove is non-compliance with a statutory demand.
Statutory demands are written demands created by the statute. They are almost
magical pieces of paper because if you create one in accordance with the Act and you
serve it and it requires the Company to pay the debt within 21 days or else, if the
Company doesn’t pay they are presumed to be insolvent and you can fearlessly go
ahead and bring that application.
The Court has said the demands must be expressed in clear, unambiguous terms.
Topfelt says the demand must tell the debtor Company in clear terms what amounts
are due, whether they include interest or not and if so, the amount. So, the statute
provides what has to be in a stat demand – if it relates to a single debt it has to specify
the debt if there are two or more debts it has to specify the total of the amounts of the
debts. (c) is important it must require the Company to pay the amount of the debt or
the total amount of the debts or to secure a compound for that amount or total to the
creditors reasonable satisfaction within 21 days after demand is served on the
Company. Has to be in writing, in a prescribed form and signed by or on behalf of
the creditors. Back to (c) what it means is that the stat demand has to provide that the
Company has to do one or more things within 21 days of service of the demand
otherwise the Company is going to be deemed to be insolvent. The first thing the
Company could do is pay the amount due – to be blunt stat demands are debt
collecting documents, if the Company owes you money the first thing you will do is
serve a stat demand on the Company and 9 times out of 10 the Company will get a bit
of legal advice and pay up, you won’t even get to Court. Or the Company can secure
or compound that amount to the creditors reasonable satisfaction – that means instead
of paying you might go to the creditor and give them a mortgage over the Company’s
assets to secure the debt – most creditors would take it as they will become secured
creditors rather than unsecured creditors. Or it can compound the debt to the
creditors satisfaction which means doing a deal – coming to an agreement between
debtor and creditor as to how the debt is going to be satisfied – e.g. payment plan, or
delayed payment with interest – whatever the parties agree. There is a prescribed
form for a statutory demand– 509H.
Characteristics of the types of debt where you can issue a stat demand: can only be
issued by a creditor who has got a debt which is already due and payable which is
recoverable by enforcement action – meaning if you chose to you could sue for
recovery of that debt – so the debt can’t be contingent or prospective or unliquidated
– which means that the parties do have an obligation to each other but the size of that
debt is yet to be quantified. The debt must total at least the statutory minimum of
$2K. A creditor may not serve a demand at the same time as taking proceedings
against the directors in relation to the same debt as that is an abuse of process. Any
statutory right is provided to people for prescribed purposes – yes you can use a stat
right given to you for the intended purpose but you can’t use it for a collateral purpose
because that is an abuse of the process. So for example, if you already have
proceedings on foot. The demand doesn’t have to be based on a money judgment –
so a stat demand is just created in a solicitor’s office and it is merely an assertion that
this money is owed – the demand has to be accompanied by an affidavit verifying the
debt is due and payable from the creditor.
Service is an important concept – because when you look back at the section that
creates the presumption of insolvency you see that there is a presumption if there has
been no payment after service. You can serve a document in any way you like if it
brings it to the attention of the person served – classic means being personal service –
best form but you can’t always effect personal service – 109X provides alternative
means of service: you can leave it at or post it to the registered office, you can leave it
at or deliver it personally to a director of the Company who resides in Australia. If
you comply with 109X service will be presumed to be effective.
The Company may come along at some hearing and say well he says it has been
delivered to the registered office but our Company hasn’t been at that office for the
last 3 years – here is an ASIC search that says we’ve moved. 109X doesn’t mean that
you’ve definitely served the document but it means that you have some evidence that
you have served the document. Whether a document is effectively served or not is a
matter to be determined by a judge on the evidence. The general principle is any
means of service which brings a document to the attention of a Company will be valid.
Leaving it on the building site is a bit of a classic. Serving it on a director at home by
serving it on a family member. If the evidence shows it brought it to the attention of
the Company that’s all well and good even though it is very informal type service.
Time for compliance with the demand can be complicated but probably not, first of all
the demand itself gives the Company 21 days to pay after service or else – the first
way in which that time might be extended is if the Company applies within that 21
days for an order setting aside the demand then time will expire 7 days after such
application is determined. In Aussie Vic Plant Hire v Esanda Finance the HC said
that the extension of time order must be made before time has expired meaning you’ve
got to do something and get your extension of time within the 21 days – if you let the
21 days run out then there is no point in trying to get an extension of time after that
because the presumed act of insolvency has occurred.
Grounds for setting aside a Statutory Demand
As a protection the statute gives companies the right to go to Court to seek to set aside
a statutory demand. You want to do this so you don’t have to get to a final hearing
and have to prove that you are not insolvent. If there is something wrong with the
statutory demand and you can challenge it, it doesn’t matter whether you are solvent
or not, you live to fight another day. It is the Company under 459G given the right to
apply to set aside the statutory demand – says you must apply within 21 days of
service, that is you have to get your application filed in court while time is still ticking
and the application has to be supported by a filed affidavit and be served together
with the affidavit back on the creditor – service of same must be effected within 21
days of service of the stat demand.
On what basis can you set aside a statutory demand, 4 basis:
(i)
If there is a genuine dispute about the existence of the debt;
(ii)
If the Company has an offsetting claim;
(iii)
(iv)
If there is a defect in the demand and substantial injustice will occur if the
demand is not set aside – problem with the formalities; and
If there is some other reason why the demand should be set aside.
When you see a provision like (iv) then you know parliament is saying it is up to the
judges to set out what adequate reasons for setting aside a statutory demand would
be.
(i)
Genuine Dispute
Because of the wording of the section must relate to the existence or amount of the
debt. Most of the disputes are about the existence of the debt, I don’t owe this money,
you haven’t done the work to entitle you to payment etc. If you apply to set aside a
stat demand what happens is that you need to satisfy the court not that you are right
about not owing the money, but that there is a genuine dispute that the money is
owing. Then that genuine dispute can go to someone else. You don’t need a lot of
evidence just need enough to be satisfied that there is a genuine dispute.
The prescribed case of Eyota v Hanave says “the expression genuine dispute connotes
a plausible contention requiring investigation and raises much the same sort of
considerations as the serious question to be tried criterion which arises on an
application for an interlocutory injunction.”
As the Court is only embarking on this limited process, cross examination of affidavits
isn’t really allowed. If the Company puts forward full and complete evidence,
annexing documents, telling the story about conversations, etc the Judge hearing that
is not going to allow cross examination because to do so would allow the parties to
start litigating their dispute in your Court, and the judge hearing this is probably
hearing several in a day and will decide this within half an hour.
(ii)
Offsetting claim
This is defined in 459H to mean a genuine claim the Company has as opposed to will
have against the person serving the demand by way of counterclaim or cross demand.
E.g. building co builds a wall, then the wall falls down – then the person who
commissioned the wall may then be sued and will therefore have an offsetting claim.
If a judge is satisfied that there is an offsetting claim that will wipe out the so called
debt then that is a good reason for setting aside the stat demand.
The offsetting claim must exist at the date of the hearing of the app to set aside the stat
demand. A claim for unliquidated damages may constitute an offsetting claim.
The offsetting claim has to be genuine in the sense of being authentic or bona fide.
The offsetting claim must reduce the debt below the statutory minimum of $2K.
The Courts have said the Company doesn’t have to adduce all of its’ evidence but
must identify the appropriate evidence showing the genuineness of the offsetting
claim – but generally you would just include all the evidence to make sure you prove
your offsetting claim.
(iii)
Defect in the Demand
It has got to be not only a defect in the demand but there must be substantial injustice
caused by the defect.
Topfelt v State Bank is a prescribed case for this purpose because it defined defect to
mean “a lack or absence of something necessary or essential for completeness, a
shortcoming or deficiency, an imperfection.”
Further, the statute goes on to define what is a defect in a statutory demand. It
includes, an irregularity, a misstatement of an amount or total, misstatement of a debt
or other matter, a misdescription of an entity – this comes from the definition of defect
in s9 of the Corp Act.
Minor defects won’t justify the setting aside of a statutory demand because they won’t
constitute a substantial injustice. However it has been said a demand which is likely
to mislead and confuse or fail to properly inform a debtor would cause substantial
injustice, and in the prescribed case of Main Camp v Australian Rural there was a
statutory demand which showed two completely different amounts payable by the
debtor and that was said to be defective because the debtor could be said to say on
page 1 you’re claiming $10K and on page 2 you’re claiming $20K how do I comply
with this demand.
(iv)
Any other reason
It is judge made law – all of these propositions come from cases but you don’t need to
know the authority:
(a) If you have failed to accompany the stat demand with an affidavit as required
by 459E – that is the affidavit verifying the debt is due.
(b) Any other failure by the creditor to provide proper evidence failing to verify
the debt is due and payable – essentially the same as (a).
(c) Where the accompanying affidavit is not sworn contemporaneously with the
stat demand – that is a bit of a trap people fall into – can’t have an affidavit that
has been sworn prior to the stat demand.
Evidence required pursuant to s.459G(3)(a) for Setting Aside a Statutory Demand
Have to have an affidavit stating the grounds that you are putting forward for setting
aside the stat demand – that is, you have to make it plain which of those 4 grounds
you are relying on.
You also have to set out your evidence for those 4 grounds. An important prescribed
case is Graywinter – it has become the gold standard for the quality of evidence you
need to set aside a statutory demand. It stands for two propositions: a bare claim or
mere assertion that the debt is disputed is not sufficient – because the statute requires
not just an affidavit and grounds but evidence. The second one is the supporting
affidavit must at least raise all of the contentions that you want to raise in opposition
to the stat demand even if it doesn’t set out all the evidence. So if you’re grounds for
setting aside the stat demand are genuine dispute and offsetting claims – if you’re
affidavit only covers genuine dispute evidence and not offsetting claims evidence then
Graywinter is authority for this, that because you haven’t raised those matters in your
first affidavit you cannot file a supplementary affidavit later on to raise them at a later
stage. You have to raise everything you want to raise first up and if for example,
someone from your Company was overseas at the time and you didn’t have their
direct evidence you put on hearsay evidence or you get them to put on a statement or
your transcribe a statement they have given over the phone and annex it so at least
you have raised it and when the person comes back you can put on a supplementary
affidavit.
Statute says the affidavit should have annexed to it a copy of the statutory demand.
As this is the first application coming before the judge and he knows nothing about
the stat demand so you have to put it before a judge.
Putting on an application to set aside a statutory demand
Have to file an originating process e.g. Summons or SoC and file an Affidavit in
support at the same time.
Both have to be filed and served on the creditor who served the stat demand within
21 days after the service of the stat demand. 21 day time limit cannot be extended
David Grant v Westpac.
Jurisdiction to deal with Corp Act matters vests in 2 Courts: the first is the Federal
Court of Australia which has Australia wide jurisdiction. The Courts that do most of
the work in relation to Corp Act are the state Supreme Courts because they are
invested with Federal jurisdiction in relation to most type of claims under the Corp
Act. SC runs every day a winding up list. If you go to the SC the prescribed form is
Form 2 – has to state each section of the Corp Act under which the proceedings are
sought. Must also state the relief sought.
UCPR – the Corp Rules have not yet been put into the UCPR so the Corp Rules still
apply in the SC(Corp) Rules.
Summary
Winding Up Proceedings
Once Statutory Demand has been served, there has been non-compliance, the 21 days
has passed and therefore there is a presumed act of insolvency then what…
Winding Up is governed by Part 5.4B of the Corp Act.
The Winding Up Application has to be served within 14 days of filing – they have no
be served no later than 5 days within the date fixed for hearing.
Application has to set out particulars of the service of the demand and noncompliance and attach a copy of the stat demand.
The application has to be accompanied by an affidavit verifying the debt is due and
payable.
The application has to be determined by the Court within 6 months of being made.
The period of time can however be extended by the Court.
The aim of a winding up application is to have the judge order that control of the
Company be taken away from the Company directors and invested in an insolvency
practitioner who is an official liquidator. In Australia they are people who are by
training Accountants with even more experience than that.
Because the creditor wants a liquidator appointed they have to approach a liquidator
from the panel and get their consent to be appointed by order of the Court. Creditors
who are regular liquidators will have 2 or 3 they regularly appoint.
You have to publish notice of the application in relevant newspapers. Notice of the
application has to be published with ASIC and there has been a change in recent times
from newspaper advertising to web based publication of these notices.
See Federal Court Winding Up Guide – plain English explanation of what you need
to do. Federal Court Winding Up Checklist – also very useful to have – the registrar
will do this with the Court file prior to the hearing before the Judge.
Opposition to the Winding Up – s465C Corp Act
If there is a person who wants to support or oppose the application to wind up they
have to file what is called a Notice of Intention to Appear and that document must
contain any grounds in opposition to the winding up and be accompanied by an
Affidavit.
So, if the Company wants to oppose the application then they have to file the Notice
of Intention to Appear and an Affidavit setting out the evidence to show their
grounds. It is the Directors who will oppose the application for winding up.
You can go to the equity judge and seek an injunction to prevent the filing and/or
advertising of an application to wind up and that is to prevent damage to the
reputation of the Company. If the debt is genuinely disputed and you haven’t
bothered to try and set aside the stat demand then you can go and try and get an
injunction to prevent the filing or advertising of the winding up application as the
application would never succeed as there is a genuine dispute about the debt. So,
because it is an injunction proceeding you have to show there is a serious question to
be tried on the balance of convenience is going to be considered.
Once you get to the hearing of the winding up application the courts powers are to:
grant the winding up order, dismiss the application, adjourn the hearing or make an
interim or other order. So the Court has this discretion not to wind up the Company
even though the creditor can prove all the technical things they are required to prove
in order to get such an order.
Cases have said even though on the face of it the creditors are entitled to their order if
there is proved to the Court to be a bona fide dispute based on substantial grounds
concerning the debt then the Company can argue that the order should not be made
for winding up however, you need the leave of the Court to do so. Because you should
have done something sooner – when you could have set aside the stat demand. The
leave of the Court requires for you to prove you have a good case, for you to provide
some explanation for why you didn’t do it in the first place. If the explanation is you
as the lawyer missed the time frame say so, no judge will punish the client if the lawyer
missed the time limit. The worst thing you can do is cover it up and hope it goes away
cause it never does.
The Court also has a discretion if there has been an abuse of process. If these
proceedings are bound to fail that is an abuse of process, if you have an object other
than securing the winding up order for example because you are a spouse in a
marriage breakdown family court proceeding and you have a family Company and
you are trying to gain some forensic advantage in the family law litigation then that is
an abuse of process – as it should all be dealt with in the family court. If there is a
substantial contest in relation to the existence of the debt or if you are already making
a parallel claim in another court then that would be an abuse of process – even though
technically the winding up order could be made they won’t make it.
The Court can also decide not to wind up if there has been tender of payment at the
hearing but the creditor says I’ve had enough of you I’m just going to wind you up.
There is in the statute there is a provision for opposition by the general body of
creditors, that is, if they want to argue and say please don’t wind this Company up,
we think it can be salvaged, we want to do a deal with it, don’t just let one Company
wind it up the Court will take that into account because of the public interest nature.
S459S says if the Company is unable without the leave of the Court to oppose the
application on a ground which could have been raised to apply set aside the demand.
You should have done it earlier when you had a right to apply to set aside the demand
– you can raise it here with the leave of the court.
The prescribed case of Switz v Glowblind says that if you come along to a winding
up judge and say look exercise your discretion not to wind me up then it is not enough
to simply show that this debt is genuinely in dispute you have to also show that this
debt would make the difference between a finding of solvency and a finding of
insolvency. Say, this is the only debt that the company owes, say this debt is a $1m
well that’s a classic example of if that debt is genuinely in dispute and shouldn’t form
the basis for a winding up application then this company is solvent and therefore the
Judge will exercise his discretion to dismiss the winding up application. If on the
other hand, unsecured creditors fund me $1m but this company owes 99 other
creditors $1m each and has assets of $2 well what’s the point of dismissing the
winding up application even though the million dollar debt of the creditors is in
dispute if there is really $99m worth of undisputed debt out there.
Substituting creditor
If the Company pays out the applicant’s debt, and often this happens on the Court
room steps, then the Court has power to order the substitution of another creditor as
the applicant for a winding up. After that person is substituted the application
proceeds as if the person who is substituted was the original applicant. A substituted
creditor might do this because they have done nothing to enforce the debt and
effectively they can ride on the coat tails of the original creditor. They can use the
presumed insolvency and walk in and say I’m the new plaintiff and the Judge will
allow that. The Court will usually on the first occasion only make an order that a
person be substituted and then stand it over for 2-4 weeks to enable the parties to work
out what happens – Court will give directions with respect to filing of affidavits etc.
Order for Winding Up
If the Court makes an order for winding up the Court will appoint a liquidator
nominated by the creditor – it gets an order for costs out of the assets of the Company.
The day on which the winding up order is made is usually the day of the
commencement of the winding up.
After the liquidator is appointed they are then authorised to get in the Company’s
property. That property doesn’t vest in the liquidator, it is still owned by the
Company but the liquidator is the agent of the company and now controls the
property to be administered for the benefit of the unsecured creditors.