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01 Oct 2013

Guarantees and rights to lodge Proof of Debts


5 min

The recent decision of Retail Adventures Holdings Pty Ltd has caused a lot of commentary in the last few weeks. In particular one aspect of the case involves guarantees and the rights of the guarantor to prove in an insolvent estate.

We would all be familiar with the concept of a third party entering to a separate agreement with a creditor of a debtor to guarantee a debt and the liability that arises from that third party agreement, the guarantee. We would also all be familiar with the fact that the guarantor only has the right to prove in the insolvent estate of the debtor for the guaranteed debt once the creditor has been paid in full and only for the amount that the guarantor actually paid under the guarantee.
This case is not about these points. This case is about the right of the guarantor to prove in the insolvent estate of the debtor for any amount they are owed, at any time, and other limitations that are imposed on the guarantor.

The situation in this case in its simplest form involves a company in administration (the administration point is significant in one aspect), a landlord and holding company that was both a creditor in its own right, and a guarantor of the landlord’s debt. In actual fact the holding company was also in administration, but that point is not significant to the questions arising under the guarantee.

The question relevant to this article and posed to the Court was the effect of a clause in the guarantee stating that the guarantor may not prove in competition with the landlord in the insolvent estate of the debtor until the landlord is paid in full. How far does that limitation ‘to prove’ extend?

The principle reason of the clause has to be to allow the landlord to get the greatest dividend from the estate by limiting the guarantor creditor from sharing in the assets. The whole reason of a guarantee is to increase the creditor’s chances of being paid by bringing another ‘debtor’ into the commercial relationship.

Most people will naturally and quite rightly conclude that the guarantor cannot prove for any amount that is paid under the guarantee until the landlord’s debt is paid in full. Many will also quite rightly assume that the effect of the ‘non-competition’ clause is to stop the guarantor from proving and receiving a dividend on any of their other debt before the landlord’s debt is paid in full.

But the Court has said that the ‘non-competition’ clause goes further.

The clause covered all types of insolvency administration including voluntary administration. No dividends are paid in a voluntary administration and Court looked for wider effects of the clause. It concluded that the ‘may not prove in competition’ clause was not limited to just proving for the receipt of dividends, but to any rights accrued from proving in an estate, including the right to vote at a meeting of creditors.

I mentioned before that the company was under voluntary administration. This case revolved around whether the guarantor had a right to prove and therefore a right to vote at the second meeting of creditors for its other debts. The Court said that it did not have a right to prove and vote on any debts as it had given away those rights in the ‘non-competition’ clause. In this case the holding company could not vote to accept a deed of company arrangement at the second meeting albeit that it was the largest creditor. This is also the case if the guarantor was going to vote in the same manner as the creditor – that is, not strictly in competition on that resolution.

This also opens a few other questions that were not answered directly in the case:

  1. What if the creditor holding the guarantee does not prove for whatever reason? It would appear sensible to conclude that the guarantor’s proof of debt is not in competition with the creditor’s proof of debt until the creditor lodges one. Once one has been lodged the guarantor’s proof of debt can be rejected, but that may be after a vote has taken place or a dividend has been paid.
  2. What if the other debt of the guarantor is secured? In this case, a part of the guarantor’s debt that was excluded from voting (remember that it was a voluntary administration and secured creditors can vote at meetings) was secured. The Court did not distinguish between whether the debt was secured or not, it was just whether the debt gave a right to prove and hence vote that was caught under the restriction.
  3. Does this clause restrict the right of the guarantor in its capacity of secured creditor to appoint a receiver and manager? This point was not argued or decided for a number of reasons and is not really a question about the right to prove for a debt, but further wording of the relevant clause ‘may not make any claim or enforce a right against the tenant or its property’ may restrict that action separately from the limits on the ‘right to prove’.

From a practical point of view, creditors holding guarantees from other parties (particularly if they are also creditors) will need to advise insolvency practitioners of whether their guarantee has such a clause and the identity of the guarantors. Once the practitioner is aware that there is a guarantee (we are not mind-readers) and there are limitation clauses, the appropriate proofs of debt may be rejected. But this should be done before votes are taken or dividends are paid.

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