Dowd and Co

Provable Debts

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Section 82 of the Bankruptcy Act 1996 (Cth) (the Act) provides relevantly:

(1) Subject to this Division, all debts and liabilities, present or future, certain or contingent, to which a bankrupt was subject at the date of the bankruptcy, or to which he or she may become subject before his or her discharge by reason of an obligation incurred before the date of the bankruptcy, are provable in his or her bankruptcy

(6) If the Court finds that the value of the debt or liability cannot be fairly estimated, the debt or liability shall be deemed not to be provable in the bankruptcy.

It is well established that a guarantee of a debt owing at the date of bankruptcy is provable in the bankruptcy even if liability under the guarantee is contingent on an event yet to occur at the date of bankruptcy (such as demand being made). But what about when the principal advance isn’t made until after the date of bankruptcy?

For instance, a purchaser of goods agrees prior to bankruptcy that any future purchase will be on certain terms. The purchaser does not have to buy goods, but if it does, it will be on the terms of the agreement. Commonly in such situations, a third party such as the director of the purchasing entity will also give a personal guarantee for payment of any goods purchased in the future.

What happens when the guarantor becomes a bankrupt before any goods are purchased? That is, at the time of bankruptcy of the guarantor, the purchaser does not owe any money at all so not only is the guarantee contingent on the debtor not paying a debt but also on incurring a liability at all.

According to the Supreme Court of South Australia in Gray v Oz North Food & Liquor Wholesalers (NT) Pty Ltd (Gray v Oz), the answer is that the guarantee is still a contingent liability at the date of bankruptcy.

The South Australian Full Court granted leave to appeal the decision in Gray v Oz in January on the basis, at least in part, that the issue had yet to be authoritatively decided. While there is a 1996 unreported decision of the New South Wales Court of Appeal Proud v Brims Distributors Pty Ltd (Proud) that made a similar finding (the decision in Proud was not referred to in Gray v Oz), hopefully there will be a Full Court decision later this year.

The Facts

Gray v Oz was an appeal to a single judge of the Supreme Court of South Australia from a decision of the Magistrates Court. The appellant (Gray) had provided a guarantee of all monies owing by Omnyx Pty Ltd to the respondent (Oz) arising from the supply of goods by Oz. The guarantee had been provided as part of a credit application by Omnyx in relation to the supply of alcoholic products from time to time.

Gray executed a personal insolvency agreement under Part X of the Act on 12 January 2012. Between 11 April 2012 and 22 May 2012, Omnyx purchased goods from Oz under the agreement totalling $87,292.30.

It was uncontested that entry into the agreement released Gray from all provable debts in accordance with s.82 of the Act as if he had become a bankrupt on that day. However, Oz argued that its trading terms, and therefore the guarantee by Gray, were merely a standing offer to enter into an agreement as and when goods were ordered. There was therefore no consideration for the promise of the guarantee until goods were ordered. Consequently, it was submitted that a new contract of guarantee was created with each purchase of goods but until goods were ordered, there was no enforceable agreement and therefore no liability. As a result, it was submitted that there were no provable debts at the date of bankruptcy.

Oz alternatively submitted that even if the guarantee was a contingent liability, the debt could not be fairly estimated at the date of bankruptcy such that it was not provable.

A contingent debt

Stanley J accepted that for a debt to be provable there must be an enforceable obligation incurred before entry into the Part X agreement.

However, his Honour rejected the submission that the liability only arose at the time goods were purchased. Rather, Stanley J held that at the time of the Part X agreement, there was a continuing guarantee which could be revoked in respect of liabilities that might accrue in the future. As it was revokable at will, it followed that liabilities would continue to accrue under the guarantee unless and until it was revoked.

Therefore, the guarantee was in effect prior to the date of bankruptcy but liability under the guarantee was contingent on Omnyx ordering goods and failing to pay.

Stanley J’s findings are consistent with the decision of the New South Wales Court of Appeal in Proud where the Court considered liabilities arising after discharge of the bankruptcy under a similar contractual arrangement.

In Proud, Cole JA (with whom Mahoney P and Waddell AJA agreed) held that unless the guarantee was terminated on the instant of bankruptcy, a breach of the guarantee was capable of occurring before discharge and therefore there was a contingent liability at the date of bankruptcy.

Value of the debt

Stanley J rejected the submission that the value of the debt could not be fairly estimated as at 12 January 2012. Rather, his Honour found that while the debt is to be adjudicated as at the date of bankruptcy, it could be calculated by reference to any occurrence of the contingency after that date. His Honour further noted that s.98 of the Act would allow a creditor to amend the proof of debt, with the trustee’s consent, if the contingency occurred during the bankruptcy.

In the circumstances considered in Gray v Oz, Stanley J held that as the contingency (ordering goods and failing to pay for them) had occurred prior to discharge, the value of the liability could be calculated accurately.

In Proud the goods were not ordered until after discharge from bankruptcy. Nevertheless, the Court held that the mere fact that no goods had been ordered prior to bankruptcy did not answer the question of value of the contingent debt. While the relevant factual circumstances might still mean the debt could not be fairly estimated, it was open to the trustee, or a court on appeal, to determine a value of the debt, including a value of nil, and in which case the debt would be provable in the bankruptcy. As there was no evidence before the Court as to whether any such determination had been made, the matter was remitted to the trial judge.

Conclusion

While Gray v Oz is the subject of an appeal, it would appear that a continuing guarantee given in support of trading terms is capable of being a provable debt even if no goods have been purchased prior to the date of bankruptcy of the guarantor, or indeed prior to the date of discharge.

While the circumstances of any specific case may still mean the debt cannot be fairly valued, the mere fact that no goods have been ordered, or no credit extended prior to bankruptcy or discharge is not enough.

Depending on the circumstances, the trustee may be able to value the contingency as at the date of bankruptcy, including attributing a value of nil or determining a value by reference to events occurring during the bankruptcy.
 

Matthew Hocking  | Partner | +61 7 3238 0607 | mhocking@dowdandco.com.au

 

Area of Expertise

Insolvency and Reconstruction


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