The Creditor’s Petition: what all CFOs need to know30-May-2017 Commercial Disputes,Fraud and Insolvency By Mel Collins
This article details the use of Bankruptcy Notices, Creditor’s Petitions and the impact these have on the estate of the debtor and, particularly, the recovery of a Judgment Debt.
Chief Financial Officers and small to medium-sized enterprises also need to understand how this recovery process impacts their personal guarantees in their terms and conditions of trade with corporate entities.
Involuntary Personal Insolvency
The Bankruptcy Notice is the mechanism by which creditors petition the court that an act of bankruptcy has occurred. This can then lead the Court to make an order for sequestration (personal insolvency).
Why file a Creditor’s Petition?
Creditors will often proceed to file a Creditor’s Petition after there has been a failure by a debtor to satisfy a Bankruptcy Notice within the prescribed 21-day period. The creditor has often considered other mechanisms for the recovery of a debt or the creditor may believe that this is the most effective method of recovery.
The Creditor’s Petition seeks to satisfy the Court that the debtor is unable to pay his or her debts and that there is sufficient cause to make an order for sequestration.
One key point to understand is that it is up to the debtor to provide reasons, backed up by evidence, for the Sequestration Order not to be made.
The majority of Creditor’s Petitions emerge from the Debtor’s failure to comply with the requirements of a Bankruptcy Notice. Debtors often challenge the validity of the Bankruptcy Notice, however, failing to challenge the notice before a Creditor’s Petition is served (ie. within the 21-day period) risks the debtor facing financial penalties.
These defects, which are focused on by the Debtor, will need to be more than mere formal defects or irregularities to the extent that they are capable of reasonably misleading the debtor; MacDonald v Official Trustee & Bankruptcy (2001) (FCA140). For example, failing to show a date on the petition was found not to be a failure; Joan Freedom Rodgers Pty Ltd v Prasad (2000) (FCA1049).
Circumstances where a Creditor’s Petition is dismissed
Section 52(2) of the Bankruptcy Act says that the Court may choose to dismiss a Creditor’s Petition and not make a Sequestration Order if it is satisfied that the Debtor:
a) is able to pay his or her debts; or
b) That for other sufficient causes, the Sequestration Order ought not to be made;
Streeterlaw Senior Solicitor Evatt Styles said the Courts are careful when deciding to impose a Sequestration Order due its potential long-term impact. “The serious financial restrictions and future consequences of bankruptcy upon the debtor and his/her company, not to mention the emotion devastation, means the Courts do not make orders for sequestration lightly. However, the onus is on the debtor to prove that there is sufficient reason for a Sequestration Order not to be made,” he explained.
The Trustee’s role
Upon the filing of a Creditor’s Petition, the Creditor needs the consent of the Trustee to act.
The Trustee is usually an accountant/insolvency practitioner with experience in dealing with the estates of bankrupts. The Trustee conducts investigations into the financial affairs of the sequestered person, the bankrupt, and his/her role is to find property/assets and then provide a return to creditors. Importantly, this return usually involves a return to creditors who may not be the applicant of the Creditor’s Petition.
In short, there are two types of creditors:
- Secured (financial institutions with a mortgage over a property or a security interest which has been “perfected” pursuant to the Personal Property Security Act.
- Unsecured Creditors – with no charge, no mortgage and no security interest.
Creditors need to understand that security interests have a priority over unsecured interests and the recovery of unsecured creditors will be paid out after secured creditors. The method for payment of unsecured creditors is usually in accordance with the Pari-Passu principle – each on an equal footing and ranking.
Substitution of Creditors
The applicant considering a Creditor’s Petition (which is usually the petitioning creditor) needs to be aware that in the event that his amount is satisfied, another creditor may apply to the Court to be substituted as the petitioning creditor. This means that in the event that the debtor pays one of the creditors (namely the applicant creditor), he may still be open to being made bankrupt on the basis that another creditor owed money steps into the proceedings brought by the other applicant creditor. In other words, a debtor should be aware that paying the petitioning creditor may not be the end of the Creditor’s Petition as other creditors could be “waiting in the wings” who are also unpaid.
Importantly, Sequestration Orders (or insolvency events) will prompt action being taken by financial institutions, secured creditors or holders of other financial agreements, which have clauses that relate to an act of default coming from an insolvency event. Creditors and debtors are strongly encouraged to obtain advice regarding those provisions. These are predominantly drafted to ensure a secured creditor receives notice of a potential act of insolvency to assist in the recovery of property and the reservation of their rights to mitigate the risks of lending.
Protecting the estate – how to stop the dissipation of assets by the debtor
Occasionally, a debtor may seek to dissipate assets either out of the jurisdiction or within the jurisdiction.
Streeterlaw’s Mr Styles recently brought proceedings on behalf of a client in the Federal Court of Australia to appoint a controlling Trustee over a debtor’s property in circumstances where there was a significant risk of dissipation.
The debtor, through investigations, was found to be selling his property to allegedly defeat the recovery of creditors in the estate. The creditor believed that it was an attempt to defraud and prevent payment and recovery of monies that were owed as a result of a Judgment Debt. In a short time, evidence was collated and affidavits-in-support were drafted with the relevant evidence. An application was made on an ex parte basis (without the debtor) to the Federal Court and an order was made for a controlling Trustee to be appointed to take control over the property, which was the subject of the concern.
Tips for CFOS:
- If there is a risk of the debtor dissipating any assets – seek advice immediately. It may be possible to appoint a controlling Trustee over the subject property or over the estate of the debtor if an act of bankruptcy has occurred.
- Creditors and debtors must both remember that paying the Applicant Creditor of a Creditor’s Petition is only part of the picture and that a substituting creditor may be appointed to continue the Creditor’s Petition.
- The onus of satisfying the Court that a Sequestration Order should not be made falls upon the debtor. This means there has to be sufficient reason for the order not to be made.
- Debtors who dispute a claim should not delay challenging a Bankruptcy Notice until the Creditor’s Petition is issued. Any challenge needs to have specific grounds and more than a formal defect or irregularity to satisfy the Court to set it aside.