Can a creditor vote and prove for a debt in an external administration, for a debt that it bought from another creditor?
This question frequently arises in an administrator’s or liquidator’s adjudication of claims for voting or dividend purposes. Often this happens where the business of the company in administration was continuing to trade and a related party has paid debts owed by the company to maintain a working relationship with suppliers. However, the admissibility of such a claim will depend on the circumstances under which the payment was made.
Assignments, Guarantor, Security and Subrogated claims
If a legal or equitable assignment of the debt took place, then the creditor can claim as an assignee of the debt. If no assignment took place, then it is possible that a right of subrogation will apply, but this will not apply in all circumstances.
If a guarantor pays a debt of a company in administration or liquidation, the guarantor can usually make a subrogated claim for the amount paid under the guarantee (but this may be subject to certain limitations in the terms of the guarantee). In this regard, a ‘subrogated’ claim puts the guarantor in the shoes of the creditor they had to pay and the guarantor can seek reimbursement from the company, as the company was primarily liable for that debt.
Where the debt paid on behalf of the company was secured, the payor may have a subrogation claim in the place of the secured creditor they paid out.
However, where a third party has spontaneously paid an unsecured debt of the company without any request by the company for that payment to be made, then that third party may not be able to claim reimbursement from the company by way of a subrogated claim in the liquidation or administration.
Case study Subrogated Claims
We recently had to consider this issue, where a company went into voluntary administration and then was subject to a deed of company arrangement, and certain trading debts of the company were paid by a related party (to maintain a working relationship with suppliers for that related party). There was no evidence that the company had requested the related party to pay those debts.
In that matter, the claim of the related party for the amount of the company debts it paid were not admitted for voting purposes at a meeting of creditors.
This was also the outcome in the case of re Dalma No 1 Pty Limited (In Liquidation) and Anor  NSWSC 1335. In that case, a related party paid wages directly to the staff and sought the Liquidators consent to subrogate them into the priority position of the employees’ claims for unpaid wages (which have priority above other certain other claims in a liquidation). As the related party paid the employees directly (rather than funding the company to pay the employees), section 560 of the Corporations Act 2001 allowing a priority claim to the related party did not apply. Relevantly in respect of subrogation, Justice Brereton in that case held that:
At : While the common law restitutionary claim for moneys paid might avail a third party who discharges a debt at the express or implied request of the debtor, its availability is contingent on an express or implied request; there is no such remedy for a third party who spontaneously pays off a debtor’s unsecured liability.
At : In my view, the only context in which a spontaneous voluntary payment by a third party may found a claim for subrogation is in the exceptional category of the payment off of existing securities. There is no authority for extending that exceptional case to unsecured debts.
Takeaways for creditors and related parties
If you intend to make a payment on behalf of another party (in particular if it is, or may soon be, in administration or liquidation), it is important to consider whether security, subrogation or assignment may be available to maintain rights for making such payment. This may require a request by the debtor for you to make such payment, or for security or assignment documentation to be prepared and signed before making such payment.
Rostron Carlyle Rojas Lawyers are available to advise you and to prepare documentation to maintain your rights when funding or making payments for another party’s debts. Contact our Insolvency Lawyers for assistance on subrogated claims or any matters to do with insolvency or commercial litigation.
Announcements in the Federal Budget for 2018-2019 saw the Turnbull government continue their crackdown on illegal phoenix activity. Their reform package aims to transform corporations and tax laws in order to provide regulators with additional tools to disrupt “phoenixing”.
What is illegal phoenix activity?
There is no legal or statutory definition of phoenix activity. The Australian government notes that phoenixing can encompass both legitimate business rescue as well as the use of serial insolvency to avoid paying creditors.
Fraudulent or unlawful phoenix activity usually involves the transfer of assets of a company to another company in circumstances where the company that made the transfer was unable to pay its debts when due. The transfer is done in order to deprive unsecured creditors equal access to its assets. There is usually a link between the management and shareholding of the old and new company.
Illegal phoenixing is orchestrated to leave behind a shell company, whereby the liquidation of that company will occur resulting in limited to no returns to creditors. This in turn forces employees to recover their entitlements through the Fair Entitlements Guarantee scheme at the expense of the Commonwealth government.
Accordingly, it is important to seek professional advice before any business restructure.
Costs to the Australian economy
Whilst the impact of illegal phoenix activity is difficult to quantify, in 2012 the cost of illegal phoenix activity was estimated to be in the range of $1.8 to $3.2 billion per year. Such activity has widespread impact through the avoidance of debts to creditors, avoidance of paying employee entitlements and a loss of market integrity which comes at an increased cost to regulators.
In his announcement, Treasurer Scott Morrison said that the Federal Government plans to introduce a number of measures to protect Australian business from those companies that choose to “deliberately go bust to avoid paying their bills” including:
- The introduction of new phoenix offences in the Corporations Act 2001 (Cth) to target those that conduct or facilitate illegal phoenixing. This will include offences for directors that fail to produce adequate books and records to a liquidator;
- Prevent company directors from improperly backdating resignations to avoid liability or prosecution. In particular, where directors lodge a change in director notice more than 28 days after the director’s resignation, they may be liable for misconduct up until the date of lodgement;
- Limit the ability of directors to resign where it would leave a company with no directors;
- Restrict the ability of related creditors to vote on appointment, removal or replacement of an external administrator;
- Extend the Director Penalty Regime to GST, luxury car tax and wine equalisation tax, in turn making directors personally liable for such tax debts of a company; and
- Expand the ATO’s powers to retain refunds where there are outstanding tax lodgements.
These proposed measures build on reforms that already saw the introduction of the government’s Phoenix, Serious Financial Crime and Black Economy taskforces. Other announced reforms include a combined black economy and illegal phoenixing hotline, as well as reforms to address the corporate misuse of the Fair Entitlements Guarantee and non-payment of the Superannuation Guarantee Charge. At the centre of the reforms is the introduction of a Director Identification Number (DIN). The long awaited and much-discussed DIN will give every director in Australia a unique number. DINs will be used by government agencies and regulators to track the activity of directors in relation to alleged phoenix activity, including their interaction with accountants and lawyers.
The government is now tasked with rolling out the reforms and ensuring they are appropriately targeted in order to avoid legitimate and honest directors getting caught in the crackdown.
Levi Smouha, Partner of Rostron Carlyle Rojas Lawyers, is an expert in restructuring and corporate insolvency. Contact Rostron Carlyle Rojas Lawyers on (07) 3009 8444 or email our office at firstname.lastname@example.org. Australian Government the Treasury, Combatting Illegal Phoenixing (2017), 1.  “Phoenix activity: Sizing the problem and matching solutions” PWC and Fair Work Ombudsman, page 15, June 2012  Australian Government the Treasury, above n 1, 2.