30 April 2004
Key Points:
Secured lenders may need to tighten up their back office procedures if recent judicial rumblings start to get louder. The Federal Court has questioned the use of judicial discretion to validate the late registration of debentures and other charges. If other courts were to adopt the same attitude, lenders and other secured creditors would need to revisit their compliance systems -or face the prospect of losing their security.
The Corporations Act requires the public registration of charges over company property. When a company goes into liquidation, priority between secured creditors is determined by the chronological order in which they registered their charges.
Public registration allows other potential creditors to determine the extent to which the company's assets are pledged to the payment of secured creditors. In general terms, unsecured creditors are only entitled to be paid out of those assets - if any - left over after secured creditors have taken their cut. A company which has given charges over all or most of its assets may be seen a greater credit risk for unsecured creditors than a company which has no charges over its property.
This straightforward position is subject to some important qualifications.
A charge must be registered within 45 days of its creation. It is possible to register a charge after that 45 days, but late registration has a number of consequences. The most important of these is that the charge will be voided if the company goes into liquidation within six months of the late registration.
The second important qualification is that the Court has the power to extend the time for registration of a charge. This can work in the following way:
In practice, it's relatively common for chargeholders to lodge a charge late but not to apply for an extension of time. It's only when the company goes into liquidation that the creditor realises that the late registration will be useless without a court order to validate it.
Courts will hear extension applications made after the company has gone into liquidation (in the example above, an application made after 1 May, rather than on 14 March). Although reluctantly, the courts will tend to grant an extension if they can be convinced that the late lodgement was a genuine accident and that other creditors' interests will not be prejudiced.
However, doubts have now been expressed about the validity of this retrospective application procedure.
"The better view"
A Full Court of the Federal Court recently expressed strong reservations about whether courts actually have the power to hear extension applications after the company has gone into liquidation.
All three judges said that, when read correctly, the relevant statutory provision only allows applications before the date of winding up. Once winding up has begun, therefore, a court should have no power to grant an extension.
Despite expressing this view, two of the judges acknowledged that their reading of the statute was at odds with the prevailing line of cases. Faced with this, they opted to follow the existing authorities, rather than their own preferred interpretation.
The third judge, Justice Whitlam, held that the existing authorities were plainly wrong and should not be followed.
Implications
Although the Federal Court ended up granting this particular extension application, its comments will provide significant ammunition for unsecured creditors and liquidators.
It's now reasonable to expect that, sooner or later, this issue will be taken to the High Court for final pronouncement. Although it's impossible to predict how the High Court would rule, history shows that it doesn't hesitate to overturn entrenched authorities if it thinks that those authorities were incorrect.
A High Court ruling that extensions can't be granted after winding up has begun would not be a disaster for secured creditors. On the other hand, it would highlight the need for effective procedures for handling charges.
Many financial institutions already have compliance processes for ensuring timely registration. Nevertheless, the fact that applications for extensions regularly appear in court suggests that there may still be room for improvement across the industry as a whole.
For further information, please contact Karen O'Flynn.
