Obtain advice before you lodge a proof of debt or vote in a liquidation

Secured creditors should remember that submitting a proof of debt and voting in a liquidation may result in the loss of their security if they get it wrong.

The Supreme Court of New South Wales has delivered a timely reminder to secured creditors of a company in liquidation, where the secured creditor lost its security because it submitted a proof of debt for the full amount of its debt and voted on a poll at a creditor’s meeting for its full debt.

Cosmopolitan Constructions

In the matter of Cosmopolitan Constructions Pty Ltd (in liquidation) [2013] NSWSC 780, the secured creditor held an equitable charge supported by a caveat over property owned by the company.

The secured creditor lodged a proof of debt for the full amount of its debt, disclosed its security and said the value of its security was nil.

At a meeting of creditors, the secured creditor voted on a poll for the full amount of its debt and was admitted for the full amount of the debt for the purposes of the vote.

Regulation 5.6.24 Corporations Regulations 2001

In relation to a liquidation, regulation 5.6.24 of the Corporations Regulations provides:

  • A secured creditor is entitled to vote only in respect of the balance, if any, due to the creditor after deducting the estimated value of the security.
  • If a secured creditor votes in respect of its whole debt, the creditor must be taken to have surrendered its security unless the Court is satisfied that the omission to value the security has arisen from inadvertence.

The regulation makes no distinction between a vote on a substantive issue and a vote on a non- substantive one. Even voting on procedural matters that appear innocuous and have no direct impact on the return to creditors can be caught by the regulation.

In Cosmopolitan Constructions, the vote related to a resolution for the removal of the liquidator.

Cases have held that the regulation does not apply to a vote on the voices (or by a show of hands), but does apply where a poll is taken.

The Court in Cosmopolitan Constructions decided that the creditor’s actions in submitting the proof of debt (for the full amount and valuing the security as nil) and voting on a poll at the meeting in respect of the full amount of the debt were consistent with the creditor having elected to surrender its security.

This meant that the secured creditor lost its security and joined the pool of unsecured creditors in the hope that there might ultimately be a dividend to unsecured creditors.

The regulation deals with one scenario where a secured creditor is deemed to have surrendered its security.

Section 554E Corporations Act 2001

As well as this regulation, section 554E of the Corporations Act provides that if the secured creditor:

  • surrenders its security, the creditor may prove for the whole of the amount of the secured debt;
  • realises its security, the creditor may prove for the balance of the debt after deducting the net amount realised; or
  • has not realised or surrendered its security, the creditor may estimate the value of its security and prove for the balance of the debt after deducting the estimate of the value of the security.

An unresolved point in the Cosmopolitan Constructions was the liquidators’ alternative argument that the creditor, by simply valuing its security in the proof of debt as nil, had elected to surrender its security.

Justice Black held on the facts that it wasn’t necessary to determine whether this was the case, but it certainly was consistent with the way the creditor voted at the meeting – that is, by treating its security as having no value.

The decision in Cosmopolitan Constructions is an important reminder to secured creditors to obtain advice before submitting any proof of debt and voting at a creditor’s meeting – it is not a matter of simply filling in the blanks on a form sent out by the liquidator.

Why lodge any proof of debt or vote in the liquidation?

Before submitting any proof of debt or voting at any meeting, we suggest that a secured creditor needs to consider a threshold issue and ask itself:

Why do we want to lodge any proof of debt or vote at the meeting of creditors?

Will our position as a secured creditor be improved by lodging the proof of debt or by voting?

In some liquidations there may be no dividend payable to unsecured creditors. In this situation, it may be in a secured creditor’s interest not to lodge a proof of debt or to vote.

The difficulty for a secured creditor is that, at the time the liquidator is calling for proofs of debt or a meeting of creditors is to be held, the secured creditor may not have realised its security.

If the secured creditor thinks it will have a surplus, it may consider that there is no reason for it to lodge a proof of debt or to vote.

If the secured creditor thinks it will have a shortfall (after the realisation of its security), it should consider the threshold issue. If the creditor decides it is in its interests to lodge a proof of debt or to vote, it will need to be careful that it doesn’t lodge a proof of debt for the full amount of the debt. The creditor will also need to disclose its security and provide a good faith estimate of the value of that security.

Although undecided in Cosmopolitan Constructions, there is a danger that even valuing the security as nil could be seen as an election to surrender the security.

The message for a secured creditor in a liquidation is to be careful about completing any proof of debt or voting at any meeting of creditors.