Litigation and Dispute Resolution Insights

23 March 2010

Statutory demands for creditors

By Karen O'Flynn.

Key Points:
The Corporations Act provisions on statutory demands are pretty straightforward; it's the application of those rules that can sometimes cause problems for issuers.

The amount of litigation about statutory demands can give a misleading impression of their complexity. The reality is that the relevant Corporations Act provisions are pretty straightforward; it's the application of those rules that can sometimes cause problems for issuers.

The law

A company is deemed to be insolvent if, having received a statutory demand, it fails to pay the creditor or have the demand set aside by a court. A company may be wound up if it is insolvent. This means that a statutory demand is a useful way to pressure a company to pay its debts.

The Corporations Act spells out a very clear procedure that must be followed by both the creditor and the company. A creditor's failure to follow that procedure will usually result in the court setting aside the statutory demand (occasionally accompanied by the award of indemnity costs against the creditor). Accordingly, it is important to understand the statutory requirements.

From beginning to end

A creditor to whom a company owes at least $2000 may serve a statutory demand on the company. The statutory demand must:

  • be on the prescribed form (Form 509H);
  • be accompanied by an affidavit verifying that the debt is due and payable.

Strict compliance with Form 509H is not necessary: the Act gives legal effect to any document "purporting" to be a statutory demand. However, the court can set aside defective demands that will cause substantial injustice. Despite considerable litigation on what sort of defects will cause substantial injustice, no definitive principles have emerged. Creditors should, therefore, stick to Form 509H.

Failure to comply with Form 509H is not the only potential pitfall for creditors. Creditors continually make mistakes in three areas:

  • relying on a disputed debt;
  • service; and
  • inadequate affidavit.

Genuine dispute

The Court can set aside a demand if there is a "genuine dispute" (or offsetting claim) about the debt, and the amount in dispute would either wipe out the debt or reduce it to below $2000.

There is no statutory test for "genuine dispute", so the courts have established their own test: has the debtor company satisfied the court that there is a serious question to be tried about the size or existence of the debt? This sets a very low threshold, but the courts are unwilling to turn the set-aside procedure into a full trial of a contractual dispute between the company and the creditor.

Creditors should not use a demand to try to force payment of debts that they know to be genuinely disputed (if they do, they face the possibility of an award of indemnity costs). On the other hand, they can safely rely on a demand if they know that the company has absolutely no grounds for refusing to pay. In between is a grey area, where the decision to proceed with a statutory demand is as much about the creditor's willingness to risk an adverse costs order as about its belief that the debt can't be disputed. Some judges suggest that the safer course is to obtain a judgment debt against the company before serving a statutory demand. The problem with that solution is that it imposes additional delays on the recovery of the debt, which may not be a viable option if the creditor itself is in urgent need of funds.

Problems with service

Service is a perennial bugbear for anyone dealing with a company, but it is a positive nightmare if you're trying to serve a statutory demand. The Corporations Act sets out a non-mandatory procedure for effecting service on a company:

  • all companies must register their office address with ASIC and keep those registered details up to date;
  • a person wanting to serve documents on a company may serve them at the address recorded on the ASIC register.

Despite this straightforward process, companies regularly come up with the corporate equivalent of "the dog ate my homework" when served with a statutory demand.

The Act makes it quite clear that, if a company wants to have a demand set aside, it must apply to the court within 21 days of service of the demand. Despite this, companies are constantly filing set-aside applications late, usually because (they claim) they didn't receive the demand on the day it was served. Sometimes, they don't file at all, and turn up to the subsequent winding up hearing and argue that they never received the statutory demand in the first place.

The range of explanations for late (or non-) receipt of a statutory demand is limited only by the imagination of the company involved. It can range from "some mailboxes in our area have been robbed recently" to "we use our accountant's office, and he changed address without telling ASIC". There is no consistency in the courts' approaches to these stories. A few tips will help if the issue ends up in court:

  • hand delivery is the safest way of ensuring effective service;
  • keep a contemporaneous record of all the details of service (courts are more inclined to find that the demand was never served if the creditor has no record of having sent it);
  • if a demand is returned to sender, it may be a good idea to start the process again, perhaps by serving the demand on a director of the company (ditto if a process server reports that the office appeared to be deserted).

Affidavit

As mentioned above, a statutory demand must be accompanied by an affidavit which verifies that the debt is due and payable by the company. That affidavit must comply with the rules of court.

Apart from the formal requirements for an affidavit, there are three practical points on which the statutory demand affidavits tend to fall down:

  • there is no indication of how the deponent knows that the debt was due and payable;
  • the deponent fails to state that he or she believes that there was no genuine dispute about the existence or the amount of the debt;
  • the affidavit is sworn some time before the date of the statutory demand.

Ideally, the affidavit should be sworn by someone in the creditor's office who has first-hand knowledge of both the quantum of the debt and its history (because knowledge of that history provides the basis for swearing that there is no genuine dispute). For these reasons, it is inadvisable to have the affidavit sworn by the creditor's solicitor.

What happens next

Once a statutory demand has been served, several things can happen:

  • the company pays in full (by no means unknown);
  • the company contacts the creditor and they negotiate a settlement;
  • the company applies to have the demand set aside;
  • the company does not respond, and the creditor applies to have it wound up.

Once it has received a statutory demand (whether or not it admits that it has received it), a company is in a fight for its life. There are no gentlemen's rules: the company will go through the statutory demand and affidavit with a fine-tooth comb, searching for any defect that can be used to have the demand set aside.

Very often, these defects (or even disputes about the claimed debt) will have little or no merit. However, once a set-aside application has been served, the time limit for compliance with the demand is automatically extended until the court finally disposes of the application. That means that the company will get a breathing space of several weeks or months, which its directors may use to find the funds to carry on business. That is why it is a good idea to do everything possible to ensure that, once the set-aside process is completed, the creditor emerges the winner: having the demand set aside and having to begin the whole process again can be very time-consuming.

Another practical point is to keep an open mind. Even with the best will in the world, a creditor may make a fatal mistake in a demand. If the company draws such a mistake to the creditor's attention (eg. the demand was sent to ACME Widgetorium No 3 Pty Limited instead of its sister company ACME Widgetorium No 4 Pty Ltd), the creditor would be well-advised to withdraw the demand and start again. Courts are very unforgiving of creditors who persist with statutory demands that are obviously fatally flawed.

In our next edition we'll examine some of the issues relevant to the receipt of a statutory demand.

For further information, please contact Karen O'Flynn.

Disclaimer
Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states or territories.