How To Use Creditor Rights To Your Advantage

The appointment of an external administrator* is rarely a cause for celebration but it does not always mean that all is lost. As a creditor, your best chance of achieving a recovery and bringing about a return is to take immediate action to formulate a strategy based on the range of options available to you.

There are four broad categories of rights available to creditors:

1. Personal guarantee rights.
2. PPSA rights — particularly as a PMSI holder.
3. Secured rights against real property of the company.
4. Unsecured claims against the company.

As a general rule, the more categories available to you, the greater your prospects of generating a return.

Creditor right #1: Personal guarantee

From our experience, when a company goes into external administration, it is the creditors with strong personal guarantee rights who are the most likely to achieve an optimal outcome.

The first step in deciding whether the personal guarantee is viable for your situation is to look at your documentation, run searches and undertake inquiries to ensure the guarantor is not bankrupt and to determine whether they own any real property.

If the company is in liquidation, a guarantee can in most circumstances be pursued immediately. If the company is in voluntary administration, it is not as straightforward due to moratorium provisions that prevent guarantees from being enforced against related parties during the administration period.

The official start of the administration period is the date the administrator is appointed. The official end is when administration ceases, which is often at the second meeting of creditors when a resolution is passed for the company going into liquidation. Alternatively, when a resolution is made to put a deed of company arrangement in place, it is when this deed is signed.

Having all the documents in place ready to go as soon as the administration period ends will help put you in a strong bargaining position.

• Demand guarantees

  Although less common, demand guarantees do appear from time to time. If the guarantee states that the guarantor will become liable ‘on demand’, liability will not crystallise until a demand has been made.

  In a voluntary administration, a demand cannot be made under the guarantee during the administration period. This means that liability under a demand guarantee cannot be crystallised until after the administration period ends. Worse still, this may also mean that there is no entitlement to lodge a caveat over guarantor’s property until after the administration period.

  Pull out your credit agreement guarantee documents and check the wording. Make sure it does not include any wording about the guarantor being liable upon demand.

• Caveats

  In our experience, caveats are among the best tools available under a personal guarantee. If there is any real property, the power to lodge a caveat is extremely valuable. Where there is sufficient equity in the property, appropriately drafted charging clauses also create the opportunity to enforcing a sale as mortgagee in possession.

  Despite common misconception, case law makes it clear that a caveat can be lodged as soon as the administrator is appointed. Lodging a caveat gives notice that you have a right over the property.

  Mini case study: Window systems company uses multiple creditor rights

  The following Results Legal case demonstrates how using your creditor rights put you in the box-seat, rather than waiting around for whatever crumbs the liquidator throws you.

  A window systems company was faced with the prospect of losing $200,000 when one of its customers went into liquidation. The customer had received the stock but not yet paid for it. Thankfully our client had a good set of terms and conditions of trade and all four of the categories of creditor rights were available to them.

  We determined the best strategy would be to rely on the personal guarantee and the PMSI claims. We immediately lodged a caveat for the client over the property of the guarantors. The property sold and there was $180,000 worth of equity, which went straight into a trust account to be divided between the caveators.

  One of our other clients had the first-ranking priority, and they received $50,000. Our window systems client was further down on the list, but we managed to secure $90,000 straight off the debt. They were then still able to proceed with their PMSI claim and recover a significant portion of stock pursuant to their retention of title rights.

Creditor right #2: PSSA

The Personal Property Securities Act 2009 (Cth) (PPSA) provides creditors with powerful rights when negotiating with external administrators, provided that their security interests are registered correctly on the Personal Property Securities Register (PPSR).

If you are a purchase money security interest (PMSI) holder with retention of title claim, it is important to enforce your claim as soon as your customer goes into external administration. Never sit back and assume that the liquidator will act in your best interests. Keep in mind that you are on the other side of the fence from the liquidator because claims from secured creditors can diminish the funds that are available for the liquidator and the unsecured creditors.

Never assume the liquidator knows about your PMSI claim. Even if they are aware of your claim, do not think their focus is on looking after you or working to get you a return.

Your first step should be to put the liquidator on notice of your claim. Send correspondence outlining the value of the debt and that you’re a secured creditor with a PMSI claim. Include a copy of your security agreement, terms of trade and PPS registration. Ask for the correspondence to be acknowledged on receipt.

The next step is to find out if there is any property that you can maintain a claim over. Go to the stock records to see if you can discover what stock is available and whether you’re in a position to go about pursuing it. Sometimes you might get lucky and the liquidator will have good stock records, which they will share with you.

Most of the time, it will be necessary to undertake a stocktake — as soon as possible.

• Do not delay

  Do not wait for the external administrator to contact you before you enforce your rights. When proving claims, it is important to be proactive. This is particularly true for situations where you received payment for some of your goods, but not others.

  Conduct a reconciliation to establish what stock was on hand as of the date of the external administrator's appointment. Work out what stock was technically unpaid for. And then calculate the dollar value of your PMSI claim.

• Take possession

  As soon as you have identified the existence of property subject to your PMSI claim, take possession. This should be a simple enough exercise in a liquidation scenario, but there may be some restrictions in a voluntary administration scenario. To handle this, notify the administrator of your intentions to take possession and seek their consent. If there is any pushback, take steps to protect your rights so you obtain fair value for these assets.

• Disclose security in the proof of debt form

  As a PPS creditor, it is important to make sure that security is disclosed in the proof of debt form. When you complete and lodge the form, notify the liquidator of your security interest under the PPSA. If you do not estimate the value of your security, you are at risk of giving up your rights as a PPS creditor.

  Say you are owed $200,000, and you estimate your goods are worth $50,000. There is nothing to stop you from lodging a proof of debt, provided you disclose that you are claiming a PMSI with an estimated value of $50,000.

  At a practical level, sometimes the better approach would be to merely hold off on lodging a proof of debt until your PPS claims have been resolved. Unless you are lodging a credit insurance claim and there is benefit to having your credit adjudicated early, we usually advise clients to hold off on holding a proof of debt until PPS claims are resolved.

  In doing so, write a letter to the external administrator advising them that you are making a PPS claim and intend to lodge a proof of debt if there is a shortfall when the claim is resolved. Tell them you will proceed on the basis that they give you notice before they call for and adjudicate on proofs to declare a dividend. In most instances, it will be some time before the liquidator takes this step.

Consider a proceeds claim

Since the PPSA has been in place, we have had notable success in recovering money for clients under proceeds claims. As a PMSI holder, it is well worth considering your option to pursue a claim against proceeds.

Start by making inquiries into the status of the company's debtors ledger: ask ‘is there any value’, ‘is there any cash in bank’? If the answer is yes, the next step is to assess whether you can have a direct claim on those debtors or a direct claim on money that is sitting in the bank account.

Mini case study: The value of a proceeds claim

The following Results Legal case demonstrates the value of pursuing proceeds if you are a PMSI holder.

A plastic resin supplier was owed around $500,000 when their customer went into receivership. As the resin was used to manufacture a range of different plastic products, there was considerable stock in trade. The cash realisation was around $900,000.

We were able to compel the receiver to acknowledge our client’s PMSI claim. From there we undertook an analysis of the likely value of our client’s proceeds claim and negotiated with the receive to split the money that was sitting in the bank account.

The result of this proceeds claim: a $350,000 cheque for our client, the plastic resin supplier.

Creditor right #3: Secured rights against real property

This category of rights — secured rights against real property — refers to a direct security interest over the land or buildings of the company. This is not a right that comes up very often; however, it could be relevant if your customer is a property developer that has a partially or fully completed development. Should you find yourself in this scenario, it makes sense to include a clause in your credit agreement that gives you the right to lodge a caveat and enforce an equitable mortgage against the property.

Creditor right #4: Unsecured claims against the company

In an external administration, unsecured claims against a customer are unlikely to bring about a significant return. As an unsecured creditor, knowing how to hold the external administrator accountable will help to compel a fairer outcome.

Make sure you are across what the administrator is doing and maintain a questioning attitude to their decisions. It is unwise to operate under the assumption that the administrator will act in your best interests.

New law reform rights for creditors

Recently implemented insolvency law reforms have focussed on insolvency practitioners and their interrelationship with stakeholders, particularly creditors. These new regulations place creditors in a much stronger position to hold liquidators accountable.

Creditors now have the right to request information, reports or documents. This is a useful tool, particularly if you have doubts about whether the liquidator is pursuing all the correct remedies.

Creditors have the power to convene a meeting with the liquidator at any time. You can do it by resolution of creditors, requested in writing.

The creditors can pass a resolution giving a direction to an external administrator. The administrator does not have to comply, but they must provide a written reason for refusing to do so.

• The right to replace an insolvency practitioner

  Before these reforms, there were limited opportunities to remove the insolvency practitioner, even if the creditors were unhappy with their decisions. Now creditors can remove and replace an insolvency practitioner by convening a meeting and passing a simple resolution.

• The right to compel additional information

• The right to call a meeting

• The power to give instruction

• Strengthened voting position

  Creditors now have a statutory right to challenge resolutions passed in reliance on related party votes. As part of these changes, creditors can challenge a resolution to pass a deed of company arrangement passed in reliance on related party votes and/or a casting vote.

  This means that when you see a deed of company arrangement pushed through that you do not believe is in the interests of creditors, you have an express right to apply to the court to challenge it.

Well-written personal guarantee and terms of trade documents can help strengthen your creditor rights.

About the Author
Karl Hill is the founder and Managing Director of Results Legal. Specialists in legal recovery, commercial disputes and insolvency law, Results Legal focuses primarily on protecting and promoting the rights of creditors. Karl has 20 years’ experience in commercial litigation, insolvency and legal recovery and has represented the interests of hundreds of trade creditors to recover debts and resolve disputes.

* The terms external administration, liquidation and voluntary administration are used generically in this article, other than where it is apparent that a specific reference is intended.

Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstance before acting on it, and where appropriate, seek professional advice from a finance professional such as an adviser.