A company’s non-compliance with a statutory demand is the most common method of proving its insolvency in any winding up proceedings. Generally, if it does not make good the debt under the statutory demand within 21 days of service, the company will be presumed to be insolvent. What can a company do if it disputes the legitimacy of the debt?

The basics – compulsory winding up and statutory demands

The last few years have seen the Commonwealth increasingly crack down on misuse of the Fair Entitlements Guarantee, or FEG, program. The cases that have resulted have led to various disputes in insolvency law about the priorities of different creditors. The priorities to be applied in insolvent trading trusts have been one issue recently puzzling lawyers and insolvency practitioners alike. Relief may well be around the corner, however, as the High Court is set to weigh in.

What the FEG?

Prior to March 2017, any right to sue that comprised an asset of a bankrupt’s estate could only be litigated by the trustee of the bankrupt. The inability of a trustee to assign a bankrupt’s cause of action resulted in many such actions not being litigated due to factors such as a lack of resources. This position changed through the insertion into the Bankruptcy Act 1966 (Cth) in Schedule 2 of the Insolvency Practice Schedule (Bankruptcy), which expressly permits a trustee to assign to a third party any right to sue that is held by of a bankrupt estate (see section 100-5).

The Limitations Act 1969 (NSW) (Limitations Act) establishes time limits within which plaintiffs must commence civil proceedings, including for the recovery of a debt. A failure to bring a claim within the relevant time period results in the claim lapsing, and the creditor losing its rights to enforce its debt. Accordingly, it is critical that creditors understand how the law restricts their ability to collect debts and any exceptions that they may rely upon as the limitation date approaches.

The question in Pleash (Liquidator) v Tucker [2018] FCAFC 144 (29 August 2018) was whether financial documents of a discretionary trust ought to be produced for the purpose of a liquidator investigating the ability of an examinee (and former director of the company) to satisfy any judgment debt that may be obtained against him.

The global M&A market has remained strong from the end of 2017 into 2018, with the total deals announced in the first half of 2018 making it the best period for global M&A yet. With stockholders pressuring larger companies to grow their revenues and the strong liquidity position of many companies, it is a sellers’ market.

A recent Ninth Circuit Court of Appeals decision provides insight into “bad faith” claims-buying activity; specifically whether a creditor’s purchase of claims for the express purpose of blocking plan confirmation is permissible. In In re Fagerdala USA-Lompoc, Inc., the Court found it was—the secured creditor did not act in bad faith when it purchased a subset of all general unsecured claims and voted those claims against confirmation because it was acting to further its own economic interest as a creditor, without some extrinsic ulterior motive.

It is not unusual for a creditor of a debtor to cry foul that a non-debtor affiliate has substantial assets, but has not joined the bankruptcy. In some cases, the creditor may assert that even though its claim, on its face, is solely against the debtor, the debtor and the non-debtor conducted business as a single unit, or that the debtor indicated that the assets of the non-debtor were available to satisfy claims. In these circumstances, the creditor would like nothing more than to drag that asset-rich non-debtor into the bankruptcy to satisfy its claims. Is that possible?

Ordinarily, a company entering liquidation is considered the commercial equivalent of “game over”, “checkmate”, “the end”, “K.O” or whatever other synonyms creditors can conjure up. This would be true for the most part because, at the end of the liquidation process, the company is usually deregistered and ceases to exist.

However, in some cases it is possible for the liquidator, a creditor or a “contributory” (member) of the company to apply to the Court for an order terminating the winding up. If made, this would return control of the company to the directors.

The statutory demand is a formidable card up a creditor’s sleeve that can result in a company being deemed to be insolvent if it does not pay the creditor’s debt within 21 days of service of the demand. Whether a statutory demand served on an incorporated body other than an Australian company will be effective largely depends on the State or Territory in which the incorporated body is based and whether it is served pursuant to the correct section of the Corporations Act 2001 (Cth) (Corporations Act).

What is a statutory demand?