A company’s non-compliance with a statutory demand is the most common method of proving its insolvency in any winding up proceedings. Generally, if it does not make good the debt under the statutory demand within 21 days of service, the company will be presumed to be insolvent. What can a company do if it disputes the legitimacy of the debt?
The basics – compulsory winding up and statutory demands
The Corporations Act 2001 (Cth) (the Act) provides that the Court can order that a company be wound up if it is insolvent. The definition of insolvency under the Act is the inability to pay debts as and when they fall due. This is a question of fact that is to be determined by reference to the company’s financial position as a whole, which must be understood having regard to commercial realities.
While there are many ways of proving that a company is insolvent, by far the most common is noncompliance with a statutory demand served pursuant to section 459E of the Act. If a company is owed a liquidated debt of at least $2,000 that is immediately due and payable, a creditor may serve a statutory demand on the company. Provided that the formal requirements of that section are satisfied, the company is presumed to be insolvent if it fails to pay the outstanding debt, make arrangements for payment to the creditor’s satisfaction, or apply to the court to have the demand set aside within 21 days of service.
Setting aside statutory demands where the debt is disputed
If a company disputes that it owes the debt to the creditor, it must apply to the court within 21 days of service to have the statutory demand set aside. The court will only set the statutory demand aside if there is a “genuine dispute” about the existence or the amount of the debt to which the demand relates.
Essentially, “genuine dispute” means that there is a bona fide dispute that exists in fact and is not being alleged on spurious, hypothetical or misconceived grounds. In other words, there must be a serious question to be tried, or investigation to be had, as to whether the company does in fact owe the alleged debt. The company bears the onus of proving that there is a genuine dispute regarding the existence of the debt as at the time the court hears its application to have it set aside. However, this onus is not a very demanding one and will be discharged if the company puts forward sufficient evidence to show that there is some question as to whether the debt truly exists.
However, there can be no genuine dispute where the debt in question is a judgment debt, even if that judgment is subject to a pending appeal. This is because the court’s decision is treated as the final say on the matter unless or until it is overturned by an appellate court. To get a statutory demand set aside where there is a judgment debt that is subject to appeal, a company must apply to the court:
- for a stay of operation of judgment, which suspends the judgment debt until the stay is lifted. This is distinct from a stay of enforcement of judgment, which does not suspend the judgement debt but merely stays the enforcement of the judgment debt; or
- to exercise its discretion to set aside the statutory demand for some other reason, namely, that the judgment is subject to a pending appeal. However, the court will generally only set aside a statutory demand for this reason on the condition that the company pay the judgment debt into court or provide some other form of security for the judgment debt.
If the court orders that a statutory demand be set aside, it will be of no effect while the order is in force and thus cannot form a basis for presuming that the company is insolvent.
Take home points
- A statutory demand be issued if there is no legitimate dispute as to the existence of the debt.
- If the company served with a statutory demand fails to have it set aside or does not respond within 21 days, the creditor can apply to the court to wind the company up within 3 months.
- If the creditor applies to have it wound up, the company can only oppose the application by proving its solvency, for example, via forensic expert evidence. In essence, the company will need to rebut the presumption of insolvency arising out of non-compliance with a statutory demand, which may be a challenge for companies with ongoing financial difficulties.
- A statutory demand issued for any unpaid judgment debt is unlikely to be set aside, even if the judgment is subject of on appeal, unless a stay of operation of the judgement is obtained or the debt claimed is secured by payment into court or by other means.
- If a company is not successful in getting the statutory demand set aside or rebutting the presumption of insolvency during winding up proceedings, its directors should be mindful that they may be ultimately liable for insolvent trading if they allow the company to continue to incur debts at a time when it is insolvent or becomes insolvent for incurring the debts.