16 minute read
Revenge of the zombie company?
By Chris Hadley MICM, Andrew Tanna MICM and Jessica Georges*
Revenge of the Zombies is a 1943 horror film in which zombies exact revenge on their mad scientist creator. Although there are not many mad scientists on the scene in 2020, there are many zombie companies which, if subject to liquidation, are likely to create an influx of preference claims being brought by liquidators and which will cause grief to credit managers in the coming months and years.
For those unacquainted with the term, a ‘zombie company’ refers to a business which exists but which is largely artificially sustained by external and artificial sources and factors, including the recent massive Government spending (including via the JobKeeper program) and deferrals of liabilities (including BAS, payroll tax, and rent commitments).
Those zombie companies, which continue to accumulate liabilities and rely on outside assistance for survival would, but for changes brought about by COVID-19, ordinarily have failed and be placed into administration or liquidation much sooner.
Disruption and change
By all measures the outbreak of COVID-19 has resulted in significant disruption to large parts of the economy and has impacted the credit function of many businesses.
The latest ABS statistics show that Australia’s GDP fell 0.3% in the March quarter and 7% in the June quarter (which was the largest quarterly drop since records began). Two consecutive quarters of negative growth means that Australia is officially in a recession.
By now all credit managers will know that, in response to the impacts of COVID-19 on the economy, in March 2020 the Federal Government introduced “temporary” changes to rules affecting common insolvency and bankruptcy processes which have typically been used by credit managers in recovery action.
The measures increased the minimum amount of debt required to be owed before a creditor could issue a Bankruptcy Notice (from $5,000 to $20,000) or a Statutory Demand (from $2,000 to $20,000) and significantly increased the time
in which a debtor has to respond to a Bankruptcy Notice or a Statutory Demand from 21 days to 6 months. The measures also provided temporary relief for directors from personal liability for trading whilst insolvent.
The temporary measures were scheduled to expire on 24 September 2020. However, in early September 2020, the Government announced it would be extending the measures until at least 31 December 2020.
As part of the announcement of the extension of the measures the Treasurer said that the extension would lessen the threat of actions that could unnecessarily push businesses into insolvency at a time when they continue to be impacted by health restrictions and that the change would help to prevent a further wave of failures before businesses have had the opportunity to recover.
Between a rock and a hard place?
In the context of a commercial leasing example, the Government introduced a code of practice which included a number of enforceable elements adopted into legislation.
The Code says that parties should agree to tailored, bespoke and appropriate temporary arrangements, taking into account the particular circumstances on a case by case basis and that the parties should negotiate appropriate temporary arrangements.
Landlord creditors might find themselves in a position whereby, adopting the spirit of the Code, they negotiate with a tenant/debtor a payment arrangement with respect to arrears only to be confronted with a preference claim brought by a liquidator should the tenant/debtor enter into liquidation.
Similar scenarios are likely in other sectors, where credit managers assisting customers through the “tough times” when supplying goods or services, will be at risk of having the existence of such assistance and accommodation returning as evidence to be used by a liquidator of “suspicion” of insolvency.
Although it is the case that debts are not always paid on time by solvent traders and the mere failure to pay debts on time does not by itself constitute grounds for suspecting insolvency, any experienced credit manager will know, entering into a payment arrangement (particularly with whole number payments not directly attributable to particular invoices) is one of the matters which liquidators will rely upon in support of a claim that the creditor had the requisite “suspicion”.
Does the case law assist?
The Supreme Court of NSW decision of Hamilton v BHP Steel (JLA) Ltd from 1995 provides some interesting analysis which might assist credit managers navigating the postrecession landscape.
Prior to 2020, the last time Australia was in recession was in the early part of the 1990’s. Following the end of the recession, a liquidator brought a preference claim against a creditor with respect to payments made in November 1993. The liquidator was ultimately unsuccessful and the claim was dismissed.
Relevantly in the context of a recession, the Judge found that when considering questions of insolvency in the 1990s one should take into account common happenings in the commercial community and such practices as a matter of the Court’s own knowledge from commercial activities that come before the Court.
The Judge opined on a number ➤
of relevant matters including whether suspicious circumstances arise in the context of late payment of business debt in a recessionary environment (he indicated that such suspicion will not necessarily be so engendered) and the relevance of “common knowledge” in that “many debtors in a time of recession seek to delay payments to their creditors for as long as they possibly can.”
It seems likely that similar considerations will be argued by creditors in the current environment in opposition to preference claims occurring during the 2020 recession.
What defensive tools are available to creditors?
Unfortunately for the credit managers, none of the measures introduced by the Government have any impact whatsoever on the preference regime under Part 5.7B of the Corporations Act 2001 (Cth).
A preference claim can be brought by a liquidator within 3 years from the relation-back day. Accordingly, unless there are changes to the preference payment regime, preference claims arising from zombie companies will be an inevitable consequence for credit managers in the years to come.
As an example, if a zombie company was placed into a creditors voluntary liquidation in say January 2021, the liquidator could commence proceedings against the creditor for the recovery of preference payments at any period up-to January 2024.
Experience unfortunately indicates that liquidators sometimes, belatedly, commence proceedings towards the end of the 3 year period of the relation-back date.
It is also available to liquidators to seek an order from the Court under s 588FF(3)(b) of the Corporations Act 2001 (Cth) that the time for bringing any such proceedings be extended beyond the usual 3 year period.
Preference claims are an inevitable part of the credit function. Most credit managers are aware of the various defences available against a preference claim including the good faith defence, the security/PPSA defence, the running account, and setoff.
In time, COVID-19 will be all but a distant memory to the world. However, the harsh reality for credit managers is that even when the world returns to a “new normal” in the coming years, an influx of preference claim actions will likely occur within 3 years or longer from the relevant relation-back date and such claims will need to be responded to.
In an environment in which credit managers should rightly be on alert as to possibly insolvent customers, there are measures that can adopted to mitigate the risk of a liquidator being successful in a preference claim. These include: 1. ensuring that PPS Registrations are properly made within the prescribed time and in accordance with the applicable regulations and rules. This is relevant to the
“security” defence. 2. regular monitoring of customer accounts and moving quickly to manage exposure (including by limiting credit limits, trade, and payment terms). This may also include obtaining legal advice to devise a more secure repayment regime with the debtor, such as the preparation of a Deed. 3. requiring personal guarantees and other alternate forms of security where possible. For example: — personal guarantees from directors of customer companies may be of assistance to a creditor in seeking recovery against a director in the event that the creditor is forced to pay back any preferential payment to a liquidator; — obtaining bank guarantees for larger projects which a creditor may draw on in the event of default; and — lodging caveats over any real estate owned by the customer/ guarantor as a condition to continuing trade.
The Commercial Recovery and Insolvency Team at Holman Webb understands that implementing strong cost effective recovery strategies is crucial, particularly in these uncertain times. Our leading recovery specialists are on stand-by should you wish to discuss ways in which this can be best achieved.
*Chris Hadley MICM Partner – Sydney Holman Webb T: +61 2 9390 8303 E: christopher.hadley@holmanwebb.com.au
*Andrew Tanna MICM Special Counsel – Sydney Holman Webb T: +61 2 9390 8309 E: andrew.tanna@holmanwebb.com.au
*Jessica Georges Special Counsel – Melbourne Holman Webb T: +61 3 9691 1223 E: jessica.georges@holmanwebb.com.au
By Stephen Mullette MICM and Darrin Mitchell MICM*
Stephen Mullette MICM
In the time of COVID-19 and when the Federal Government has enacted legislation to significantly constrain the use and benefit bankruptcy notices, what is a frustrated creditor to do?
Obviously there are other means of enforcement of a judgment debt against a debtor’s property or assets; however the mere fact that a bankruptcy notice may not be as useful a tool in these COVID-19 times does not mean that bankruptcy is not an option for recalcitrant debtors.
So what other paths are available to establish a proper basis for the issue of a creditor’s petition?
Background
Since ancient times bankruptcy has led to enslavement or imprisonment. In the late eighteenth century Lord Kenyon CJ noted that “Bankruptcy is considered as a crime and the bankrupt in the old laws is called an offender…” 1
The term “bankrupt” come from the Italian “banka rotta” or “broken bench”, a reference to a moneylender’s place of business. Systems of bankruptcy have evolved over the centuries to be both punitive, and also protective – allowing not only creditor’s petitions but also for any person unable to pay their debts, to file a debtor’s petition and become bankrupt.
Bankruptcy Notices and Creditors Petitions
It should be noted of course that the purpose of bankruptcy proceedings is not debt recovery; it is to allow for the administration of the property of insolvent persons. His Honour Justice Emmett of the Federal Court put it this way:
“… I take it to be undisputed that if it is apparent that the purpose of the bankruptcy notice is to put pressure on a debtor to pay a debt rather than to invoke the Court’s jurisdiction in relation to insolvency, then the filing of a bankruptcy notice is an abuse of process.” 2
Nevertheless, a creditor seeking to file a creditor’s petition against a debtor will usually take three steps: l Firstly, the creditor will commence proceedings and obtain a final judgment for a fixed sum from a
Court. l Secondly, the creditor, relying on the final judgment, will request the Official Receiver to issue a Bankruptcy Notice and will arrange for it to be served on the debtor. l Finally, should the Bankruptcy
Notice not be complied with by ➤
the debtor, an act of bankruptcy is committed and the creditor can rely upon that act of bankruptcy to file a Creditor’s Petition seeking a sequestration order against the debtor.
To comply with the provisions of a Bankruptcy Notice, the debtor has 21 days to either pay the debt, make a satisfactory arrangement with the creditor, or to satisfy a Court that the debtor has a counterclaim, setoff or cross demand equal to or exceeding the amount of the judgment debt.
Along comes a Virus
On 23 March 2020 the Federal Government passed the Coronavirus Economic Response Package Omnibus Act 2020 which included changes to various pieces of legislation designed to assist Australians in coping with the COVID-19 pandemic.
One of the changes introduced by the legislation was in respect of the use of Bankruptcy Notices, a document prescribed under section
40(1)(g) of the Bankruptcy Act 1966 (Cth)(“the Act”). The COVID-19 amendments inserted a new regulation 4.02AA in the Bankruptcy Regulations 1996 which temporarily amends the definitions of “statutory minimum” and “default period” in section 5(1) of the Act. The changes: l Extended the time for compliance with a Bankruptcy Notice from 21 days to 6 months; and l Increased the minimum debt amount from $5,000 to $20,000.
The requirement for a creditor to wait six months after service of the Bankruptcy Notice for the debtor to commit an act of bankruptcy is too long for some creditors as it may significantly reduce cashflow and cause financial difficulties.
The amendments were initially introduced for six months only and were set to expire in September 2020. The amendments have however recently been extended by the Federal Government until 31 December 2020.
Alternative Acts of Bankruptcy
Notwithstanding the COVID-19 legislative amendments, the Government has not put a halt on the filing of Creditor’s Petitions generally, or the pursuit of sequestration orders. Those creditors, who are owed in excess of $20,000 and are not prepared to wait for six months to obtain an act of bankruptcy, may wish to look at possible alternative acts of bankruptcy.
Unfortunately this will not assist
creditors whose debts are less than $20,000, since regulation 4.02AA prevents the filing of a Creditor’s Petition for less than this sum.
Section 40 of the Act provides for a total of 21 different acts of bankruptcy which may be relied upon by a creditor to issue a Creditor’s Petition. Some of the acts of bankruptcy include: l Taking certain steps with intent to
l
l defeat or delay creditors, including leaving the country, or a dwellinghouse or usual place of business; or alternatively, beginning to ‘keep house’ (subsection 40(1) (c)). It has been held that to satisfy this subsection, it is sufficient if this was one of a number of intentions3 . A court will draw an inference about the intention if it is satisfied that the debtor “must have known that the likely result of his absenting himself would be to delay creditors”4; If a Sheriff is sent to execute a judgment at a debtor’s property, and the Sheriff does not recover goods sufficient to pay the judgment debt (subsection 40(1) (d)). It is “only necessary to show proof that execution had issued and that it had been returned unsatisfied in whole or in part. The High Court said that the truth or falsity of the return was not a relevant matter. This was because the legislature had considered that the return should be treated as correct.”5 However if the writ is materially defective, it has been held that no act of bankruptcy will have occurred, and these requirements will be interpreted strictly6; At a meeting of any creditors, the debtor admits he/she “is in insolvent circumstances”, and if requested to file a Debtor’s Petition or take steps to appoint a controlling trustee (under Part X of the Act), fails to do so within seven days (subsection 40(1)(f)); Notice is given by the debtor
to his/her creditors that he/she has suspended, or is about to suspend payment to creditors (subsection 40(1)(h)). It has been held that “… to constitute this act of bankruptcy two things are requisite: first, an intention residing in the mind of the debtor that he will, in a sense voluntarily, that is, as his own act, refuse to pay his debts as they become due, and secondly, a communication of that intention to one of his creditors”7;
l An authority is signed under section 188 of the Act (a
Personal Insolvency Agreement) (subsection 40(1)(i)). The signing of an authority, even if it is not effective for the purposes of the Act, will still be an act of bankruptcy8 . l A debtor becomes insolvent as a result of transfers of property under a family law financial agreement (subsection 40(1) (o)). The aim of this subsection is to deter persons from using family law proceedings, including financial agreements, to frustrate creditors.
A full list of the available acts of bankruptcy can be found in section 40(1) of the Act. Whilst many of these may not be applicable or convenient, there are some which may be relevant in particular circumstances.
So despite the bankruptcy process changing in these trying times with the changes to the operation of a Bankruptcy Notice, a creditor may still be able to issue a Creditor’s Petition against a debtor by relying on alternative acts of bankruptcy as prescribed in the Act.
It might seem counterintuitive that the COVID-19 amendments would primarily target one act of bankruptcy only. However, given the Government’s focus on improving the flow of funds throughout the economy, it is also somewhat counterintuitive to lock up the ability of creditors to collect properly owing debts for (at least) six months.
At least for those creditors with debts above $20,000, exploring alternative acts of bankruptcy might provide some opportunity to continue collecting debts and dealing with insolvent customers in an efficient manner.
*Stephen Mullette MICM Principal Matthews Folbigg E: stephenm@matthewsfolbigg.com.au T: +61 2 9806 7549
*Darrin Mitchell MICM Senior Associate Matthews Folbigg E: darrinm@matthewsfolbigg.com.au T: +61 2 9806 7428
FOOTNOTES: 1 2
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8 Fowler v. Padget (1798) 7 TR 509 at 514 In Brunninghausen v Glavanics [1998] FCA 230 Barton v DCT (Cth) (1974) 131 CLR 370 Re Smith; Ex parte Kern Corporation Ltd. (unreported, 19 June 1985), per Pincus J; quoted in Vassis, Re B.W. Ex Parte Leo Leung [1986] FCA 19 per Burchett J at [16] Helfenbaum v St George Bank Ltd [2001] FCA 1392 per Finkelstein J (with whom Wilcox and von Doussa JJ agreed), at [19]; referring to the High Court’s decision in King v Commercial Bank of Australia Ltd (1921) 29 CLR 141 Lewis v. Lamb [2012] FMCA 392, per Smith FM, where the judgment debt was materially overstated Cropley’s Ltd v Vickery (1920) 27 CLR 321 per Knox CJ at 325 Re Donovan; Ex parte ANZ Banking Group Ltd [1972–73] ALR 313
