Most readers would be familiar with the concept of insolvent trading and the right for liquidators to ‘lift the corporate veil’ and prosecute directors for damages caused to creditors. These claims are based on directors breaching their duty to prevent the company incurring debts when they should know that the company will not be able to pay those debts. It is a claim for compensation for the loss caused to those creditors.
ASIC may also commence a criminal action against directors for breaching this duty and have set up programs to make directors aware of their obligations.
Some readers would also be aware that the right to take an ‘insolvent trading claim’ against a director (or holding company) can pass to creditors under certain conditions, but may not be aware of those conditions. Others may not be aware of this right at all.
The right for creditors to take these actions starts with section 588M of the Corporations Act. This is the section that gives the original right to recover compensation for insolvent trading.
CORPORATIONS ACT 2001 – SECT 588M
Recovery of compensation for loss resulting from insolvent trading
(3) The creditor may, as provided in Subdivision B but not otherwise, recover from the director, as a debt due to the creditor, an amount equal to the amount of the loss or damage.
The first right of recovery goes to the liquidator. The Act places no restrictions on a liquidator commencing a recovery action at any time (subject to the 6 year limitation on commencing a claim). Subdivision B (sections 588R through to 588U) sets out the procedure and timing for creditors being able to commence their own proceedings, and what consent they may or may not need.
There are events that stop creditors from starting their own action at all. These are set out in section 588U and, even though they appear in the last of the sections of the Subdivision being considered, as they are simple exclusions I have dealt with them here.
A creditor cannot begin proceedings if that creditor’s debt is involved in another action:
“(a) the company’s liquidator has applied under section 588FF in relation to the debt, or in relation to a transaction under which the debt was incurred; or
(b) the company’s liquidator has begun proceedings under section 588M in relation to the incurring of the debt; or
(c) the company’s liquidator has intervened in an application for a civil penalty order against a person in relation to a contravention of subsection 588G(2) in relation to the incurring of the debt.”
Leaving aside those exclusions, the first point that creditors must consider when making claims is that liquidator may give consent to any particular creditor or creditors to commence their own actions at any time. The liquidator may give consent to multiple creditors at once because each creditor is only taking action for the loss that they suffered, not the losses that any other creditor suffered. Liquidators take action on behalf of all creditors at the same time. Of course nothing stops groups of creditors banding together to take actions based on their grouped debts and sharing the costs involved.
Section 588R gives the liquidator the right to grant consent to creditors.
CORPORATIONS ACT 2001 – SECT 588R
Creditor may sue for compensation with liquidator’s consent
(1) A creditor of a company that is being wound up may, with the written consent of the company’s liquidator, begin proceedings under section 588M in relation to the incurring by the company of a debt that is owed to the creditor.
(2) Subsection (1) has effect despite section 588T, but subject to section 588U.
Sometimes liquidators will be in a position to make a decision on whether they are going to commence such a claim or not within a short period. At times this may not be possible. And sometimes some liquidators just do not make a decision either way.
The Act has provides a mechanism for creditors to nudge the liquidator into making a decision. If the liquidator has not done so within 6 months of the appointment (presumably at the request of the creditor), the creditor can give notice that they intend to commence their own action, and ask for consent to do so.
The liquidator may either give that consent or not – and if not provide reasons why it is not given – within 3 months of the request. Generally the reason for not granting the consent is that the liquidator is about to commence his own recovery action for debts that include the creditors debt.
CORPORATIONS ACT 2001 – SECT 588S
Creditor may give liquidator notice of intention to sue for compensation
After the end of 6 months beginning when a company begins to be wound up, a creditor of the company may give to the company’s liquidator a written notice:
(a) stating that the creditor intends to begin proceedings under section 588M in relation to the incurring by the company of a specified debt that is owed to the creditor; and
(b) asking the liquidator to give to the creditor, within 3 months after receiving the notice:
(i) a written consent to the creditor beginning the proceedings; or
(ii) a written statement of the reasons why the liquidator thinks that proceedings under section 588M in relation to the incurring of that debt should not be begun.
If the liquidator gives the consent, the creditor may commence their action. One would suppose that if the liquidator has given consent to one creditor, they would give it to any other creditor that requests it. I have not come across or know of a situation where some creditors are refused consent while another is granted it, but it possibly may occur when the liquidator is taking action that relates to a number of debts, but for some reason not the debt of that creditor.
Sometimes a liquidator may fail to respond to a request for consent, or may refuse consent on grounds that do not appear valid or appropriate to the creditor. Relief may be sought by an application to the Court for consent to commence an action.
This Court application can only be made after a request has been made under section 588S and, obviously, refused or ignored and the three month period has expired. Any refusal and reasons for the refusal must be considered by the court when making its decision.
CORPORATIONS ACT 2001 – SECT 588T
When creditor may sue for compensation without liquidator’s consent
(1) This section applies where a notice is given under section 588S.
(2) The creditor may begin proceedings in a court under section 588M in relation to the incurring by the company of the debt specified in the notice if:
(a) as at the end of 3 months after the liquidator receives the notice, he or she has not consented to the creditor beginning such proceedings; and
(b) on an application made after those 3 months, the court has given leave for the proceedings to begin.
(a) during those 3 months, the liquidator gives to the creditor a written statement of the reasons why the liquidator thinks that such proceedings should not be begun; and
(b) the creditor applies for leave under paragraph (2)(b);
(c) the creditor must file the statement with the court when so applying; and
(d) in determining the application, the court is to have regard to the reasons set out in the statement.
If the court believes that the liquidator should have given consent based on the circumstances, it may grant leave for the creditor to commence. If not, it will leave the matter in the hands of the liquidator.