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01 Sep 2008

Costs Orders and Provable Debts

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4 min

The aim of any insolvency administration is to distribute the insolvent's assets amongst their legitimate creditors – being creditors with provable debts. Knowing who is a creditor entitled to receive a dividend is obviously important. But knowing who is a creditor with a provable debt can also become important when voting at meetings of creditors.

Most of the time deciding who is and is not a creditor with a provable debt is relatively easy. Most creditors are either statutory (e.g. the ATO), trade creditors or financiers and can easily show the amount of their debts. But sometimes the question of whether someone is a creditor, and for what amount, can be disputed. This question has been highlighted over the last two years.

Both the Bankruptcy Act and the Corporations Act have sections that define what is and is not a provable debt. The Bankruptcy Act allows: “all debts and liabilities, present or future, certain or contingent, to which a bankrupt was subject at the date of the bankruptcy, or to which he or she may become subject before his or her discharge by reason of an obligation incurred before the date of the bankruptcy, are provable in his or her bankruptcy.”

The important words are: incurred before the date of the bankruptcy. The date of bankruptcy is the date of the sequestration order or the acceptance of the debtor’s petition. The Act says that the debt must be ‘incurred’ before that date. But what is incurred? This was the subject of a December 2007 decision in the High Court inFoots v Southern Cross Mine Management Pty Ltd [2007] HCA 56 in relation to costs orders.

At the time of the bankruptcy, judgment had been handed down, but no costs order had been granted. Were the costs under a costs order that was granted after the date of bankruptcy – that related to a judgment made before the date of bankruptcy – provable in the estate? The High Court said No. It said that costs orders must have been granted (that obligation incurred) before the date of the bankruptcy for the costs to be provable.

The result is that the creditor will have a provable debt for the claim, where the basis of the claim occurred before the date of bankruptcy even if a judgment was obtained post date of bankruptcy, but not for a costs order made after bankruptcy which is a different claim based on the judgment and is only 'incurred' when the costs order is granted.

This position can be contrasted to the Corporations Act. In general terms the definition is the same. Section 553(1) says “in every winding up, all debts payable by, and all claims against, the company (present or future, certain or contingent, ascertained or sounding only in damages), being debts or claims the circumstances giving rise to which occurred before the relevant date, are admissible to proof against the company.”

The contrasting words are: the circumstances giving rise to which occurred before the relevant date. This contrast was highlighted in the Federal Court in Environmental & Earth Sciences Pty Ltd v Fouris [2006] 152 FCR 510.

This decision was also based on whether a costs order that had not been made ‘before the relevant date’ - but was based on a judgment given before the liquidation commenced - was provable or not. The Court found that that a ‘contemplated’ costs order was a provable debt because the basis of granting that order, the judgment, had been granted before the relevant date so the ‘circumstances’ had occurred.

It appears that the two decisions show the difference between the words incurred (the obligation must have been incurred before bankruptcy) and occurred (the basis of the debt only needs to have occurred before liquidation). This is one of the reasons why some claims are provable in corporate insolvencies, but not personal insolvencies.

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