Cash flow is crucial to the efficient running of a business. Mounting debt can significantly affect the operations of your company, result in increased interest costs and cause you to be unable to meet your own financial liabilities. If not addressed, debts can reach critical levels and will ultimately lead to insolvency.
To survive, strategies to prevent debts getting out of control must be embedded into your company’s DNA.
Every situation is different. In some instances, debtors might query or challenge invoices, either to buy time or to reduce invoiced amounts (whether validly or invalidly) or both. In other cases, late payers might be habitual, only paying after multiple late fees have been incurred or stern letters received. In the worst cases, debtors that are themselves going out of business will offer any pleasant excuse to stave off payment, knowing full well that any payment is unlikely.
It is always preferable to resolve debtor issues at an early stage. Addressing problems in the first instance can minimise costs in the long run. Nonetheless, when phone calls are being left unanswered and reminder letters are not bringing any results, tougher strategies may need to be considered.
Commercial litigation is one means by which disputes can be resolved when there is disagreement about the amount or existence of a debt. Litigation requires parties to go through the courts and follow a series of processes as outlined in the relevant rules and procedures. If the matter goes to trial, the final decision will be made by the judge. During the lengthy litigation process, parties will in most cases settle their dispute. In this sense, litigation can be effective. But it is accompanied by cost, risk and delay, and should not be the first choice for the resolution of a debtor dispute.
In many commercial transactions there is no dispute in relation to the existence and amount of the debt. The debtor may simply fail to pay, or refuse to make payment. If the debtor is a company (“debtor company”), a statutory demand under Section 459E of the Corporations Act 2001 (C’th) (“the Act”) can be a direct and effective way to force payment.
In this newsletter we outline what statutory demands are, and how you can employ them to your best advantage.
Pay up or else
A statutory demand under Section 459E of the Act is a written demand made by a creditor against a debtor company to pay its debt. Under the Act, the demand must be for a minimum amount of $2000. Once served, the debtor company has 21 days to refute the claim. This can only be attempted if the debtor company can show there is a genuine dispute over the existence or quantum of the debt. If no such attempt is made and the debt remains unpaid, this will lead to the legal presumption that the debtor company is insolvent. Insolvent companies cannot continue to trade, and may be wound up by a court on the petition of a creditor. In practice, the prospect of insolvency and winding up is a powerful motivator for debtor companies. Indeed, the presentation of a statutory demand on a company can constitute a material act of default under many financing documents.
What’s a debt?
A statutory demand may be issued by any person or company to whom a company owes a “debt”. The definition of a “debt” is important. The courts have characterised a debt as “a liquidated sum in money presently due, owing and payable by one person, called the debtor, to another person called the creditor”. Therefore, a “debt” does not include a claim for unliquidated damages, nor a mere allegation by one party that another owes it some money.
There are some simple rules that can be applied to assist in characterising whether an amount owed is a “debt” for the purpose of issuing a statutory demand:
- firstly, a debt will exist if an amount is owed in exchange for goods or services that have already been supplied by the creditor to the debtor company;
- secondly, if the creditor knows that there is a genuine dispute by the debtor company over whether the alleged debt exists, then it will not be considered to be a “debt” for the purposes of a statutory demand;
- thirdly, claims against insurers are generally claims for unliquidated damages and accordingly are not debts until there is a court judgement, a binding settlement agreement, an arbitral award or the equivalent; and
- fourthly, prospective liabilities cannot be debts, which means that a liability that will almost certainly arise at some future time is not a debt until such time as it actually does arise.
How debtors try to frustrate statutory demands
A debtor company has 21 days in which to respond to a statutory demand. Its options are to pay the debt; negotiate a settlement; or challenge the validity of the statutory demand. If the debtor company fails to take any of these actions, a presumption of insolvency arises and the debtor company may be subject to official procedures, including winding-up and eventual de-registration.
There are limited grounds on which a debtor company may challenge the validity of a statutory demand. Those most frequently relied upon are these:
- that there is a genuine dispute about the existence or amount of the debt;
- that the company has an offsetting claim against the creditor; or
- that there is a formal defect in the statutory demand and a “substantial injustice” will be caused if the demand is not set aside.
The first two grounds are straightforward and arise if there is a dispute about the existence of the debt or about the amount claimed. The “substantial injustice” ground may be more “creatively” applied. Debtor companies will often use this ground to raise an objection to a minor or curable defect when no substantive excuse can be found. Defects which are validly covered under this ground include misstating the amount of debt, or misnaming the debtor company.
Nonetheless, the courts are not limited to these grounds and will often find other reasons to set aside demands in the interests of justice and to ensure the process is not abused by creditors. Therefore a creditor must proceed legitimately and carefully, in both substantive and procedural terms.
Genuine disputes and offsetting claims
A debtor company may apply to have a statutory demand set aside if there is genuine doubt or dispute about the existence of the debt. If successful, the creditor will be ordered to pay the debtor company’s costs of having it set aside.
Every creditor claiming payment by a company of a disputed debt is entitled to test the genuineness of that dispute by serving a notice of demand …If the dispute is indeed genuine, the creditor will pay the penalty of a costs order when the debtor successfully applies to set aside the demand under s.459G. That is the risk that the creditor takes in serving the notice of demand.
Therefore, before issuing a statutory demand against a debtor company, a creditor must consider carefully whether the debt has been (or will be) genuinely disputed by the debtor company. Importantly, the dispute about the debt must be genuine. A court will not accept spurious excuses by a debtor company, such as might be raised merely as a delaying tactic.
Similarly, a creditor must carefully consider whether it owes a debt to the debtor company that may offset (either wholly or in part) the debt described in the statutory demand. If the court sets aside the statutory demand because the debtor company has an offsetting claim against the creditor, then it is possible that the court will order the creditor to pay the debtor company’s court costs.
There has been much judicial discussion on what constitutes a “genuine dispute”. In Eyota Pty Ltd v Hanave Pty Ltd the court stated that the expression “genuine dispute” meant a “plausible contention requiring investigation” or a “serious question to be tried”. A further interpretation was provided in Spencer Constructions Pty Ltd v G & M Aldridge Pty Ltd where the court found a dispute needed to be bona fide and not be based on grounds which were “spurious, hypothetical, illusory or misconceived”. The general theme of most of the relevant case law is that the threshold for establishing a genuine dispute or offsetting claim is relatively low. The court will not go into an extended inquiry into the merits of the case, but rather will simply set the statutory demand aside if it appears to be a dispute that is genuine.
An “offsetting claim” is a genuine claim that the debtor company has against the creditor by way of counterclaim, set-off or cross demand (even if it does not arise out of the same transaction or circumstances as a debt to which to demand relates). It must relate to a claim which is capable of being quantified as an amount in money and must not be frivolous or vexatious. Similar to a “genuine dispute”, an “offsetting claim” must be:
Advanced in good faith…[meaning] arguable on the basis of facts asserted with sufficient particularity to enable the court to determine that the claim is not fanciful.
Should a debtor company apply to set aside a statutory demand, either on the basis of a genuine dispute or an offsetting claim, it must make an application to the court supported by an affidavit. The affidavit must contain facts that show “something more than a mere assertion” but need not amount to the kind of proof that would be required in a court of law. As stated, it is not too difficult to frustrate a statutory demand – if some facts are available that at least cloud the creditor’s claim – and creditors should carefully consider whether a debtor company can raise any genuine dispute or offsetting claims before pursuing a statutory demand.
Don’t shoot yourself in the foot
The formal requirements for a statutory demand made under the Act must be strictly adhered to. If a formal error or defect is found to be the cause of the “substantial injustice” then the statutory demand will be set aside. Under the Act, a “defect” is defined as including an irregularity; a misstatement of an amount or total; a misdescription of a debt or other matter; and a misdescription of a person or entity.
The presence of one of these “defects” will not be fatal to the statutory demand unless it does or could result in “substantial injustice” to the debtor company. Case law provides many examples of defects that have been found to cause substantial injustice, such as:
- including debts in the statutory demand that are not yet due and payable, even if some of the included debts are due and payable;
- misdescribing the nature of the debt (the courts have stated that the “specification of the debt in a statutory demand is a fundamental requirement”);
- the debt being payable to an entity other than the claiming creditor;
- in the case of a debt owed to two creditors, a signature by only one of them;
- if a statutory demand relates to multiple debts, failing to properly describe the individual debts; and
- if a statutory demand relates to multiple debts, failing to state the total amount claimed.
More wriggle-room for debtors
Section 459J of the Act allows a demand to be set aside where “there is some other reason why the demand should be set aside”. Similar to the criteria for “genuine disputes” and “offsetting claims”, this is a very broad provision. The “other reasons” that have been used by courts as a means of setting aside statutory demands are due to formal irregularities, even if those irregularities fall short of the “substantial injustice” threshold. Some examples include:
- where the amount identified as the debt in the statutory demand is grossly overstated;
- where the statutory demand has been brought for an improper purpose and is deemed to be an abuse of process;
- where the date of the supporting affidavit is earlier than the date on the statutory demand, meaning that the court could not be sure that the debt was already paid to the creditor between the two dates; and
- where the person providing the affidavit has failed to state that they believe there is no genuine dispute about the existence of the debt.
The courts have clearly determined that a statutory demand should not been used as a means of coercing or forcing an alleged debtor company to pay a disputed amount.
Statutory demands – an important part of your cash flow strategy
Properly managing debt exposure starts early – as early as the time at which you select your business partners and customers, and when you decide the limits of debt that your business can sustain. The next protection is to have properly and clearly articulated business contracts and standard terms of business in place. These documents themselves should deal with fees/costs, billing, the resolution of disputes, and the consequences of a failure to comply with obligations.
Inevitably, during the operation of your business, payment disputes will arise. Commercial litigation is one option for debt recovery. However the procedures – prepare a detailed statement of claim which pleads the creditor’s case, receive a defence from the debtor company, and then argue any number of procedural points before even achieving a hearing – can drag out the proceedings and force outcomes that are more about financial clout and legal strategy than merit.
But if you see no genuine dispute or set-off standing in the way of payment, then a statutory demand against your debtor company is a much more effective method to resolve a debt problem. Generally speaking, statutory demands do not entail lengthy pleadings or fact-finding missions. If a debt exists, and there is no dispute, a debtor company must either pay or face the possibility of being wound-up by the court. It is a process that is faster and much more direct than litigation. It forces the debtor company to meet the claim – by way of payment – or to find some immediately arguable excuse that will find favour with a judge. We recommend that you keep it in mind.