Creditor’s statutory demand for payment of debt

In article:

Updated May 2020

Summary

• A statutory demand for payment of debt is an important tool for creditors in getting payment from reluctant debtors and/or pushing for insolvency;
• There are strict requirements that a statutory demand must meet in order to be enforceable and there are significant risks to getting it wrong.
• Creditors need to consider the mechanisms that debtors have to oppose a statutory demand or another attempt to force insolvency as well as other legal avenues available to them;
• Statutory demands are useful for creditors, as long as care is taken before issuing them to ensure there is not a debt in dispute and all requirements are met;
• Scroll down for our update on the government’s amendments to the operation of statutory demands in light of COVID-19 economic pressures.

Sometimes it is a real battle for creditors to get paid what they are owed by a company. In this article we look at perhaps the most powerful weapon in the creditor’s arsenal: the statutory demand for payment of debt. Creditors need to be careful, however, as this weapon has the potential for serious blowback and can lead to an all-out ‘insolvency war’ with a debtor company’s directors.

What is a statutory demand?

Where payment is overdue from a company (the ‘debtor company’), creditors need to consider the different legal avenues available to them to get what they are owed. One option which is open to the creditor is to seek the winding up of the debtor company due to insolvency. After all, if a company is not paying its bills it might be reasonable to conclude that it is unable to do so. Once wound up, the remaining assets of the company must be distributed to all creditors in accordance with the ‘priority rules’ set by law.

It’s not easy for a creditor to get a company wound up, however. There are strict rules under the Corporations Act 2001 requiring proof that a company is insolvent. Perhaps the most straightforward way for a creditor to prove insolvency, in advance of a winding up application, is via a statutory demand for payment of debt , the subject of this article.

A statutory demand works in the following way: where the debt is greater than $2000, a company may serve a demand for payment on a company in a form specified in the Corporations Act 2001 and associated regulations. If the company fails to pay within 21 days of service of the statutory demand, and does not seek or succeed in having that demand set aside, the company is deemed to be insolvent. Note: under temporary changes implemented by the government to address COVID-19, the minimum amount for a statutory demand has risen and the grace period for payment or setting aside the demand has been lengthened. Once the company is deemed insolvent, this paves the way for the creditor to make a winding up application. The presumption from this application will be that the debtor company is insolvent and it will be up to the debtor company to prove otherwise.

A word of caution: In some cases, there is a risk that, once a company realises that insolvency may be on the horizon, dodgy directors might engage in illegal phoenix activity: this is an attempt to transfer assets out of the company for ‘below market’ consideration, in order to revive the business in another form. Creditors should be aware of this possibility and seek professional advice to reduce the risk of this happening. At the time of writing this article, there is a bill before Parliament seeking to specifically outlaw this behaviour.

COVID-19 temporary changes

The Coronavirus, Economic Response Act makes two important changes to the legal requirements for a statutory demand via the new clause 5.4.01AA of the Corporations Regulations 2001:

• The amount that the creditor must be owed before issuing a statutory demand has risen from $2,000 to $20,000; and
• The previous period of 21 days for a debtor to respond to a statutory demand has now been extended to six months.

The aim of these enforcement relaxations is to give businesses time to work with professional advisers to re-organise or restructure their business before creditors are allowed to initiate winding up proceedings. The new, temporary provisions mean that companies have time to:

• Seek or advance more working capital. For example, companies will have more time to acquire financing via the Coronavirus SME Guarantee Scheme which will make it easier for small and medium-sized enterprises (SMEs) to access business loans to tide them over.
• Obtain reliable financial information about the company. Many companies in distress are not on top of their financials, and how they might reduce costs and increase cash flow. They will now have time, for example, to consider the new Instant Asset Write-Off and depreciation rules that the Government has introduced.
• An alternative to using formal processes (such as voluntary administration or small business restructuring) is to undertake a pre-pack insolvency arrangement. This restructuring method is unconventional in Australia, and it is not universally accepted in the insolvency industry as appropriate. The method involved undertaking asset transfers before a formal insolvency (such as liquidation) is commenced to save a business.

A cautionary note: Other than the change to statutory demands, existing mechanisms for liquidating companies remain unchanged. Additionally, these relaxations will only be in operation for 6 months from the date of commencement, and the laws will revert to normal before the end of the year if the government does not intervene to extend the operation of the amendment.

Statutory demands as debt collection

While the legislative intent of a statutory demand might be to facilitate winding up of an insolvent debtor company, what do creditors really want from it? 99 per cent of the time, creditors use a statutory demand as a debt collection tool. It is a cheaper and often more efficient method for the creditor to get their debt paid than pursuing a claim in court for ‘judgement debt’. Of course, there are risks to pursuing this path, which we shall consider shortly.

Note also, that a statutory demand need not only arise from outside the debtor company. It is relatively common for directors to be owed money by the company. Where the relationship between that creditor director and the debtor company has broken down, that director may also use this tool to pursue debt payment.

The Formal Requirements of a Statutory Demand

In order to successfully serve a statutory demand for payment of debt all the following conditions in section 459E of the Corporations Act 2001 must be complied with.

• The debt be for the “statutory minimum”, which is currently $2,000.00 ($20,000.00 during the operation of the temporary COVID-19 relaxations of the law) and need not be a judgment debt (as opposed to a bankruptcy notice which requires a judgment debt);
• The demand must specify the debt and its amount;
• The demand must require a company to pay the debt (or otherwise provide security) within 21 days of service (6 months during the operations of the temporary COVID-19 relaxations of the law);
• The demand must be in writing;
• The demand must be in the prescribed form (Form 509H – Corporations Regulations 2001 (Cth) Schedule 2);
• The demand must be signed by or on behalf of the creditor (i.e. their legal representative);
• If the debt claimed is other than a judgment debt, the demand must be accompanied by an affidavit.

The Debtor Strikes Back

Once a creditor has fired off the statutory demand, how can the debtor company and its directors fight back? In many cases it will be sensible for the debtor company to try its best to pay the debt or negotiate with the creditor for a compromise. Failing those options, what legal avenues are available to the debtor company?

Under section 459G of the Corporations Act 2001, the debtor company could apply to the court to have that statutory demand set aside on a range of possible grounds, including:

• Genuine dispute about the debt. This is the most common ground relied upon by companies to set-aside a statutory demand. The existence of a ‘genuine dispute’ doesn’t require the court to determine whether one side has a better claim than the other. Rather it is enough that there is a “serious question to be tried” (McLelland CJ in Eyota Pty Ltd v Hanave Pty Ltd (1994)).
• Off-setting claim. This means a genuine claim that that the company has against the creditor by way of counterclaim, set-off or cross-demand (even if it does not arise out of the same circumstances as a debt to which the demand relates). As with a dispute, it is not necessary that a case be decided one way or another, but that there is a ‘serious question to be tried’ or an ‘issue deserving of hearing’ (Britten-Norman Pty Ltd v Analysis & Technology Australia Pty Ltd (2013)).
• On this ground, there must be a defect in the statutory demand and substantial injustice caused unless the demand is set aside. Under section 459J(1)(a) of the Corporations Act 2001, a statutory demand can be set-aside on the basis that it is defective and that substantial injustice would be caused by it. A defect occurs if one of the requirements that we set out above in section 3 is not fulfilled. This may in turn constitute a substantial injustice where the effect of this defect in the statutory demand is the debtor company being unable to properly identify (due to the ambiguity created by the defect) what the statutory demand is in fact demanding.
• Some other valid reason. These grounds are broad, but it should be something separate to the other reasons available for setting aside a statutory demand.

For more information on all these grounds for setting aside that statutory demand see What are the grounds to set-aside a statutory demand?

If the debtor company is not successful in having the statutory demand set aside, the creditor will have up to three months after the date of non-compliance to apply to the court for orders winding up the debtor company. Once the application is made, there is still the option for the debtor company to oppose that application.

The most common grounds for a debtor company to oppose an application is on the basis of section 459C(3), where the debtor company can prove to the court that they are, in fact, solvent. If a company wants to oppose the application, pursuant to section 465C of the Corporations Act 2001, they must file and serve on the applicant:

1. Anotice of grounds which the person opposes the application; and
2. An affidavitverifying the matters stated in the notice.

Note, however, that proving solvency is an onerous task, and a significant amount of evidence relating to the overall health of the company will need to be submitted. Ideally this evidence would come from audited accounts (Ace Contractors & Staff Pty Ltd v Westgarth Development Pty Ltd [1999]).

Another possibility is for the directors of the debtor company to appoint a voluntary administrator and pursue a ‘Deed of Company Arrangement’ (DOCA). This can then be used as a basis for applying to the court for an adjournment of the winding up application. It is worth keeping in mind, however, that the majority of Voluntary Administrations will end up in liquidation anyway. For more information see: The Complete Guide to Voluntary Administration

It is not easy (nor cheap) for a debtor company to fight a winding up application. In light of this, debtor companies would be better to focus their attentions on opposing a statutory demand.

Return of the Creditors: Possible alternatives to statutory demand

We have covered the importance of the statutory demand for establishing debtor company insolvency, or as a debt payment tool. But what about other legal options? There are potential disadvantages to statutory demands. If the statutory requirements are not strictly followed, or the debtor successfully sets aside the debt, the creditor will likely have a substantial bill for the debtor company’s costs. Because of this, it is absolutely crucial that creditors are aware of any dispute over the debt before using a statutory demand. In light of the risks involved, other possibilities that creditors should consider include:

• Unsatisfied judgment. This is where the company applies to the court to obtain judgment for its debt, seeks to enforce that debt, and has the execution of that debt returned unsatisfied. This might be a more efficient option where the creditor was previously unaware that the debtor may be insolvent and judgement proceedings are already well underway;
• Appointment of receiver or a receiver and manager, or an order to that effect;
• Possession or control of secured property, or a person appointed for that purpose. Any of the options related to receivership and secured property could be a faster and less risky option if they happen before the statutory demand process would be completed.

Any of the options considered above will only be appropriate on those rare occasions where a statutory demand is not more efficient and less costly.

Another possibility is for the creditor to, rather than establishing a presumption of insolvency, apply to the court, seeking to prove that the debtor company is actually insolvent. For example, where there are a large number of outstanding debts and unsatisfied judgements, or admissions by the debtor company that it cannot pay.

Another option is for the creditor to apply for winding up on the grounds that it is ‘just and equitable’ to do so. This might be useful, if none of the other grounds apply.

As the last two options will involve substantial hearings before a Judge in court, they are often expensive and potentially time-consuming options.

Conclusion: Statutory demands are a quick and cheap option

As long as formal requirements are met, a statutory demand is an effective mechanism for getting a reluctant debtor company to pay its bills and/or wind up a debtor company while avoiding a descent into ‘insolvency wars’. A solvent debtor company may just pay the debt rather than risk a winding up proceeding. The take-home message is that, compared to other options, statutory demands are fast and cheap (there is a fixed fee for issuing them) and they can also circumvent the need for expensive court action. Check to see if the COVID-19 relaxations still apply before pursuing a statutory demand so you are aware of the new requirements.