Creditor’s Petitions – Some Practical Considerations

Introduction

The law of bankruptcy dates back to the 1800’s (or possibly earlier).  Learned academics and practitioners have spent years researching and writing about development of the law in this area. To comprehensively deal with all aspects of the law relating to creditors’ petitions in bankruptcy would be impractical, take considerably more time than is available and more importantly completely boring.  The purpose of this paper is to consider some of the situations that regularly arise before the Federal Court and the Federal Magistrates Court when creditors’ petitions are argued.

Jurisdiction to make sequestration orders — s.43

The Federal Court or the Federal Magistrates Court has jurisdiction to make a sequestration order where:-

(a) a debtor has committed an act of bankruptcy; and

(b) at the time when the act of bankruptcy was committed the debtor:-

There is usually no argument about whether an act of bankruptcy has occurred by the time a creditor’s petition comes on for argument. However unsuccessfully attempting to have the bankruptcy notice set aside does not create an issue estoppel thus allowing a debtor to argue that a bankruptcy notice is invalid.¹ Furthermore the subsequent setting aside of the judgment on which the bankruptcy notice was founded does not invalidate the act of bankruptcy. Similarly the debtor is not assisted by payment of the debt referred to in the bankruptcy notice after the stipulated time.  There still remains a valid act of bankruptcy.

The second part of s.43 namely whether the debtor was personally present or otherwise within Australia when the act of bankruptcy was committed are questions of fact. They are not usually contentious issues on creditors’ petitions. The Court has jurisdiction if at the time of the act of bankruptcy was committed the debtor was connected with Australia in one of the ways mentioned in s.43(1)(b).²

Ordinarily Resident

If Australia is a debtor’s’ “settled and usual place of abode” the Court will have jurisdiction to make a sequestration order.³ There must be “an element of permanence” about the debtor’s presence in Australia as “contrasted with temporary or occasional residence”.⁴ However a person can be ordinarily resident in more than one place or country at the same time.⁵

Dwelling house or place of business

It is probably insufficient that a debtor merely owns or leases a dwelling, house or place of business.  He or she must actually have used the relevant premises for those purposes.⁶ On the other hand a debtor probably does not need to have a legal or equitable interest in the premises provided they were being used for that purpose by the debtor at the time the act of bankruptcy was committed.⁷ The Courts have taken a wide view of what constitutes carrying on business and will depend on the particular circumstances of each case. Carrying on business includes the collection of debts and the winding up of the business that has ceased to trade.⁸

Conditions on which creditor may petition — s.44

The conditions on which a creditor may petition are:-

(a) the creditor is owed at least $2,000.00;

(b) the amount owing is a liquidated sum payable either immediately or at a certain future time; and

(c) the act of bankruptcy on which the petition is founded was committed within six months before presentation of the petition.

Who is a creditor?

The creditor must be owed a liquidated sum of at least $2,000.00 payable either immediately or at a certain future time. However the debt must have accrued before the act of bankruptcy on which it is intended to found the petition. It is insufficient if the debt became liquidated after the act of bankruptcy and before the petition. For example where a costs order had not been taxed before the act of bankruptcy.⁹ An assignee of a debt may present a petition provided the debt has been legally assigned. If the assignment is only effectual in equity the assignee must be a party to the petition.¹⁰
 
Secured Creditor

A secured creditor:-

(a) can only petition for the amount for which his or her debt exceeds the value of the security.¹¹;

(b) may petition for his or her entire debt provided the petition contains a statement that the security will be surrendered for the benefit of creditors generally in the event of a sequestration order being made.¹²; and

(c) must set out particulars of the security in the petition.¹³

Where a sequestration order is made upon the application of the secured creditor the security shall be surrendered upon request in writing within three months of the order being made.¹⁴ Failure to comply with the request constitutes contempt of Court.¹⁵

A secured creditor is defined in s.5 as someone “holding a mortgage, charge or lien on property of the debtor as a security for debt due to him from the debtor”. This includes statutory charges.¹⁶ However a creditor who has obtained a Mareva injunction is not, because of the granting of such order, a secured creditor.¹⁷

Proceedings and orders on creditor’s petition — s.52

At the hearing of a creditor’s petition the Court shall require proof of:-

(a) the matters stated in the petition;

(b) service of the petition; and

(c) the debt on which the petitioning creditor relies is still owing.
 
Sufficient proof of the matters stated in the petition can be an affidavit by a person who knows the relevant facts verifying those matters.¹⁸ In any event these are formal matters about which there is usually no argument. On a contested hearing the debtor usually contends that the petition ought to be dismissed as the debtor is able to pay his or her debts or there is other sufficient cause for an order not being made.¹⁹ Another common argument is that the debtor wishes to go behind the judgment and show there is no debt to found the petition.

Going behind judgment

Where a creditor is relying upon an unsatisfied judgment as the basis for its standing to present a
petition the Court has power to look behind the judgment to ascertain if in truth a debt really exists.  The Court does so because it can only make a sequestration order if there is proof of the fact that the debt on which the petitioning creditor relies is still owing.  It has been said that the rationale for this approach is the making of a sequestration order effects not only parties to the proceeding but the rights of all creditors.²⁰

Usually special circumstances must exist before a Court will go behind a judgment. Put simply, if the Court is not satisfied that a debt exists the creditor will have failed to prove it has standing and the petition will be dismissed.²¹ A Court will more readily look behind a judgment if it has been obtained by default without a trial of the issues.²² The Court may also choose to treat the enquiry as a two stage process. First whether there is sufficient reason to question the existence of the debt and secondly, if it is appropriately satisfied, a full determination of the issues.

There are numerous examples of circumstances in which the Courts have found there is in truth no debt.²³ Examples include where the judgment was obtained by fraud or fresh, previously unavailable evidence has been discovered. Other cases involve an error of law resulting in a miscarriage of justice. The question however does arise why the original judgment was not the subject of an appeal in those circumstances. Where there has been a trial of all issues the Court will be less ready to go behind the judgment.²⁴

A Court will not go behind the judgment if it is satisfied there is a debt that arose on the same general basis as the judgment was obtained.²⁵ On the other hand where a Court does go behind a judgment it is not sufficient for a creditor to show the existence of a debt based on a cause of action other than that which gave rise to the judgment.²⁶ It will never be enough for a creditor seeking to prove the matters required by s.52(1)(c) to show that the debtor owes an amount equal to the debt upon which the petition is founded but on an entirely different basis. The Act requires proof that “the” debt on which the petitioning creditor relies is still owing.²⁷

Able to pay his/her debts — s.52(2)(a)

Frequently debtors contend that notwithstanding the creditor’s unsatisfied judgment they are able
to pay all of their debts and accordingly a sequestration order, in the discretion of the Court, should not be made. It has been held that a debtor who is in the position to pay all his or her debts within a reasonable time would not be subject to a sequestration order.²⁸ Sarina²⁹ was an unusual case where a wealthy land owner fell into dispute with his shire council resulting in Court proceedings and a judgment debt slightly in excess of $2,000.00. There was no dispute the debtor committed an act of bankruptcy by failing to comply with the bankruptcy notice served upon him. Upon the hearing of its petition the debtor argued merely he had sufficient assets to pay the judgment debt many times over but simply refused to do so. The debtor had also paid the amount claimed in the bankruptcy notice into Court. In dismissing the petition Deane J at first instance³⁰ found that the word “able” in sub-section 2(a) did not mean “willing and able”.

Sarina is not typical of matters that come before the Court. Most arguments of this nature either fail or require a much closer examination of the debtor’s financial affairs. However it is not necessary that a debtor have immediate cash available to pay not only the judgment debt but all other creditors. An ability to pay debts includes money which can be procured by sale or mortgage of assets within a relatively short period of time.³¹ From a practical point of view a debtor should be in a position to provide cogent evidence of his or her financial circumstances in particular independent valuations of property and letters from financial institutions indicating a willingness to advance funds on short notice.³²

Somewhat curiously the previous version of s.52(2)(a) included the words “from his own money”. This does not appear in the most recent version of the legislation nor in the statutory definition of insolvency in s.95A of the Corporations Act 2001. On that basis it has been held that a debtor can be solvent and able to pay all debts as they become payable as a matter of commercial reality even if the source of funds is an unsecured borrowing from or extension of credit by a third party.³³

It is also important to note the distinction between s.95A of the Corporations Act and s.52(2)(a) which, in the former case, requires all debts to be payable “as and when they fall due”. Section 52(2)(a) simply provides for an ability to pay his or her debts. Accordingly under the Bankruptcy Act a Court will consider debts which may become payable in the foreseeable future in determining whether there is an ability to pay “all debts”.³⁴ The same requirement does not have to be met for the purposes of insolvency as defined by s.95A of the Corporations Act 2001.

The onus of proving an ability to pay all debts is on the debtor. It is not sufficient to merely establish an excess of assets over liabilities. As previously discussed such assets must be realisable either by way of sale or mortgage for the test to be satisfied.

It is often argued by debtors they have claim against the creditor or someone else which will realise sufficient money to pay all creditors in full.  These arguments very rarely succeed as it is nearly impossible for a Court exercising jurisdiction in bankruptcy to determine the merits or otherwise of proceedings (if they have actually been commenced) in another Court.³⁵

Even if the ability to pay debts is established a Court retains a discretion whether or not to make a sequestration order. It was argued (but not decided) in ANZ Bank v Foyster³⁶ before a petition was dismissed on this basis the Court had to be satisfied the creditor would be paid by some other means of execution. However in Re: Stubberfield; Ex parte Paradise Grove Pty Ltd³⁷ a bankruptcy petition was dismissed because a debtor had sufficient assets to meet the judgment but refused to pay. It was argued by the petitioning creditor that because the debtor’s assets were jointly owned with his wife there was no immediate way of executing on the judgment. This was rejected by Drummond J as there were appropriate avenues available.

Other sufficient cause — s.52(2)(b)

The circumstances giving rise to “other sufficient case” are not closed.³⁸  These examples include improper motive or abuse of process. However an ulterior private purpose does not of itself establish fraud. Generally speaking to establish an abuse of process it must be shown the predominate purpose of the proceedings is one other than for which it was designed.³⁹ However it has been held not to be an abuse of process to bankrupt a debtor for the purposes of stifling litigation if the creditor is otherwise entitled to a sequestration order.⁴⁰

Debtors also argue that a sequestration order should not be made as they are involved in litigation against a creditor which would result in the judgment debt being extinguished and even substantial amount owing back to the debtor. To some extent this argument overlaps with that referred to above of going behind the judgment debt.  Sometimes these arguments can be run as a basis for setting aside or extending the time to comply with a bankruptcy notice. However the debtor will not be assisted if the counter-claim or set off is one which could have or was raised in the proceedings which gave rise to the judgment debt.⁴¹ If for example the debtor and creditor are involved in proceedings in another Court which give rise to an interlocutory costs order it is unlikely for the debtor to be bankrupted if he or she has a genuine claim against the creditor which is being prosecuted diligently.⁴²

Payment of debt to petitioning creditor

Often the amount claimed in the bankruptcy notice and the petition is paid by the debtor subsequent to the presentation of a petition but prior to the hearing date. If there is no other debt owing to the creditor there is no longer basis upon which the creditor can prosecute the petition. This is because the creditor is no longer owed a liquidated sum by the debtor payable either immediately or at a certain future time.⁴³ Unless another creditor appears on the application and
seeks to substitute the petition will be dismissed normally with an order for costs.

Substitution of petitioner

Where a petition is not prosecuted with due diligence or for any other reason the Court considers proper a creditor to whom the debtor is indebted is an amount required by the Bankruptcy Act the other creditor can be substituted as the applicant for the purposes of the petition.⁴⁴

For practical purposes an application for substitution arises where the original creditor has been paid and doesn’t wish to further prosecute the petition. It is usual for the substituting creditor to put on credible evidence regarding his or her debt. There does not have to be a final determination at the application for substitution regarding the existence of such debt as this can be argued at the hearing. An order for substitution will also be made if there is no doubt about the substituting creditor’s debts and the act of bankruptcy notwithstanding there was some doubt about the original petitioning creditor’s debt.⁴⁵

A substituted creditor stands in the shoes of the original petitioning creditor but need not have a judgment debt. However the substituted creditor’s debt must be liquidated and otherwise comply with the Act. That does not mean to say that a petition which was fundamentally flawed (i.e. no act of bankruptcy) cannot be dismissed if there is a substituted creditor. A substituted creditor can prosecute the petition notwithstanding that the judgment referred to in the bankruptcy notice has been set aside subsequent to the act of bankruptcy.⁴⁶

Adjournment to allow appeal

As a general proposition the Court should not sequestrate the estate of a debtor where an appeal is pending against the judgment relied upon as the foundation for the bankruptcy proceedings where the appeal is genuine and arguable.⁴⁷ On the other hand a sequestration order ought to be made if the appeal is frivolous unlikely to succeed and not being prosecuted with all due diligence.

Adjournment to convene meeting under part X of the Act

Where an authority signed by a debtor pursuant to section 188 of the Act has become effective and a creditor’s petition is presented either before the authority became effective or the first meeting of creditors called under the authority proceedings in relation to the petition are stayed until the conclusion or adjournment of the meeting whichever is the earlier.⁴⁸ However the Court will not automatically adjourn the petition after a meeting of creditors has taken place to allow the debtor to execute a personal insolvency agreement unless it is demonstrated that it would be for the advantage of creditors that the debtor’s affairs be administered under the agreement.⁴⁹
 
Adjournment to put on further evidence

As a general proposition Courts should endeavour to adjudicate finally on all matters in dispute between the parties. This would include adjourning a trial to adduce further evidence or amending pleadings notwithstanding non-compliance with previous directions of the Court.⁵⁰ However it is not the practice of the Federal Court or the Federal Magistrates Court to adjourn bankruptcy petitions on the first return date merely for the asking. For example in Spencer v Lane Rowin Pty Ltd⁵¹ a debtor asked for an adjournment of a petition on the first return date to put on better evidence regarding her solvency. The debtor had provided some affidavit material but it was insufficient. The debtor was unable to satisfy the Court that she would be in a position to obtain further evidence even if an adjournment was granted. On that basis the adjournment was refused and the sequestration order made. An appeal to the single Judge of the Federal Court was dismissed.

Debtor’s petitions — s.55

A debtor may present to the Official Receiver a petition against himself or herself. The petition must be in accordance in the approved form and accompanied by a statement of the debtor’s affairs and a copy of that statement. The debtor must be connected to Australia in the same way as provided for in creditors’ petitions.⁵²

The Official Receiver may reject a debtor’s petition if it does not comply substantially with the approved form or is not accompanied by a statement of affairs. It may also be rejected if the Official Receiver considers the statement of affairs is inadequate.⁵³

The Official Receiver may also reject the debtor’s petition if it is apparent from the statement of affairs the debtor is able to pay all of his or her debts and the debtor is simply unwilling to pay a particular creditor or creditors in general. Alternatively the Official Receiver can reject the petition if there is an ability to pay debts and the debtor had previously been bankrupt on debtor’s petitions at least three times or at least once in the preceding five years.⁵⁴

Acceptance of a creditor’s petition is an administrative act by the Official Receiver. It is not a judicial process. There is no requirement to refer a debtor’s petition to the Court simply because a creditor’s petition is pending. This would only occur if the Official Receiver was of the view the presentation of the debtor’s petition was for a purpose foreign to the bankruptcy laws.⁵⁵ A creditor may also apply for an interlocutory injunction restraining the presentation of a debtor’s petition if the actions of the debtor were nothing more than the continuance of a plan to defraud the applicant and evade enforcement of an earlier Mareva order.⁵⁶ The facts in Jackson are interesting and worth setting out in some detail. Mr Jackson was sued for deceptive and misleading conduct in relation to the sale of a hotel. There were good prospects of judgment being entered against him for in excess of $3M. An application was made for a Mareva injunction. One of the concerns raised by the applicant was that Mr Jackson had dissappated $4.3M in cash which was proved to be in his possession being the proceeds of loans from two financial companies. He swore an affidavit that he had $4.3M in cash but paid it to a person described as Carl Jorgensen in exchange for diamonds which in fact turned out to be cubic zirconia. To further perpetrate his fraud Mr Jackson contacted Brisbane police complaining of Mr Jorgensen’s conduct. Mr Jorgensen was never found and Mr Jackson could not produce a receipt for the stones which he allegedly purchased. More importantly there was unchallenged evidence that some two weeks earlier Mr Jackson had been seen in Hong Kong buying cubic zirconia.

Justice Shepard who heard the application for the Mareva injunction had not hesitation in disbelieving Mr Jackson’s story. It was upon that basis the applicant in the proceedings for deceptive and misleading conduct sought an injunction restraining Mr Jackson from presenting his own debtor’s position on the basis that it was simply a way of avoiding the effects of the Mareva injunction.  Mr Jackson was so restrained.

A creditor could also seek to amend a bankruptcy made on a debtor’s petition if the debtor filed a petition for the sole purpose of obtaining a later relation-back date so as to avoid recovery by his or her trustee.⁵⁷

Mark Martin

Endnotes

1.   NAB v Westbrook [2000] FCA 246 at [15].
2. Gillane v Diners Club Limited [1993] 42 FCR 90.
3. Restom v Battenberg [2007] FCA 46 at [5]-[12].
4. Taylor; Ex parte Natwest Australia Bank Limited [1992] 37 FCR 194 at 198.
5. Ibid at 198-200.
6.  Mathai v Kwee [2005] FCA 932.
7. Ibid at [111] — [119].
8. Vassis; Ex parte Leung [1986] 9 FCR 518 at 525-526.
9. Australia & New Zealand Banking Group Limited v Coutts [2003] FCA 968.
10. Australian Volunteer Coast Guard v Raymond [2001] FMCA 41 at [20] — [21].
11. s.44(2).
12. s.44(3).
13. s.44(4).
14. s.44(5).
15. s.44(6).
16. Stapleton v FTS O’Donnell Griffin & Co (Qld) Pty Ltd [1962] 108 CLR 106 at 114.
17. Re: Ousley; Ex parte Commissioner of Taxation [1994] 48 FCR 131.
18. s.47 and s.52(1)(a).
19. s.52(2).
20. Burrell v Connell [1998] 84 FCR 383; Wren v Mahoney [1972] 126 CLR 212.
21. Makhoul v Barnes [1995] 60 FCR 572 at 581; Wren v Mahoney (supra).
22. Corney v Brien [1951] 84 CLR 343; Wolff v Donovan [1991] 29 FCR 480.
23. These are usefully summarised in McDonnell, Henry & Meek Australia Bankruptcy Law & Practice 5^th Edition at at  [52.1.23].
24. Wren v Mahoney (supra).
25. Re Skaff; Ex parte Farrow Mortgage Services Pty Ltd [1993] 41 FCR 331.
26. Corney v Brien (supra) at 352-353. Skaff at 334.
27. Re Skaff (supra) at 335.
28. Sarina v Wollondilly Shire Council [1980] 32 ILR 596.
29. supra.
30. ALR 266.
31. Sandell v Porter [1966] 115 CLR 666 at 670.
32. cf Expile Pty Ltd v Jabbs Excavations Pty Ltd [2003] 45 ACSR 711 dealing with the evidence required to discharge the  presumption of insolvency as defined in s.95A of the Corporations Act 2001.
33. Lewis v Doran [2004] 50 ACSR 175.  A contrary view was taken by Mandie J in Harrison v Lewis (2001) 19 ACLC 566 at  579.
34. International Alpaca Management Limited v Ensor [1999] FCA 72.
35. see generally ANZ Bank v Foyster [2000] FCA 400.
36. supra.
37. [1995] 134 ALR 169.
38. Clyne v DCT [1985] 5 FCR 1.
39. Williams v Spautz [1992] 174 CLR 509.
40. Coyne; Ex parte Binningup (South) Pty Ltd [1992] FCA 540 at [22]; Re: King; Ex Parte Commercial Bank of Australia Limited (no.2) [1920] VLR 490.
41.  s.40(1)(g).
42. Coyne (supra); Totev v Sfar [2006] FCA 470.
43. s.44(1)(b).
44. s.49.
45. 2000 Olympic Games Pty Ltd v Daly [2000] FCA 1286.
46. 2000 Olympic Games Pty Ltd (supra).
47. Bryant v Commonwealth Bank of Australia [1996] 70 ALJR 306.
48. Field v Commercial Banking Company of Sydney Limited [1978] 22 ALR 403.
49. Corporations Act s.440A(2) Creevey v Commissioner of Taxation [1996] 19 ACSR 456.
50. State of Queensland v J and L Holdings Pty Ltd [1997] 189 CLR 146.
51. [2007] FCA 1519.
52. s.55(2A).
53. s.55(3).
54. s.55(3AA).
55. Re Rambert; Ex parte Deputy Commissioner of Taxation [1996] 144 ALR 200.