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Overdue commercial debts impede the cash flow of a company. Restricted cash flow increases interest cost, prevents due payment of your own debts, and can ultimately lead to insolvency. Many late payers are simply habitual, and will eventually meet their obligations after steadily more insistent reminders. However, where polite demands do not produce results, companies are forced to consider formal remedies.

Commercial litigation is a tool that is appropriate when there is a dispute about the amount or existence of a debt. In such a circumstance the judicial “umpire” will resolve these issues, or the parties will settle their dispute, after following the applicable legal rules and procedures. This is usually costly, risky and time-consuming.

However, in many commercial transactions there is no dispute in relation to the existence and amount of the debt. The debtor may simply fail to pay, or refuse to make payment. In such cases a statutory demand under Section 459 of the Corporations Act2001 (C’th) (“the Act”) can be a direct and effective way to force payment.

However, it is not fail safe. Knowing when and how to use a statutory demand, and obtaining the best advice, is essential. Inappropriate use of statutory demands can cause creditors to lose even more time and money in recovery of their unpaid bills.

What is a statutory demand?

A statutory demand under Section 459 of the Act is a written demand made against a debtor company to pay its debt to the creditor who issues the demand. A debtor company faced with a statutory demand cannot delay paying the debt by raising spurious defences. Unless the debtor company can show that there is a genuine dispute over the existence or quantum of the debt, a subsequent failure to meet the demand will lead to the legal presumption that the debtor company is insolvent. Insolvent companies cannot continue to trade, and may be wound up by a court on the petition of a creditor.

Rules for establishing if a debt is owed to the creditor

A statutory demand may be issued by any person or company to whom a company owes a “debt”. The definition of a debt is important. The courts have characterised a debt as “a liquidated sum in money presently due, owing and payable by one person, called the debtor, to another person called the creditor”. Therefore, a “debt” does not include a claim for unliquidated damages, nor a mere allegation by one party that another owes it some money.

There are some simple rules that can be applied to assist in characterising whether an amount owed is a “debt” for the purpose of issuing a statutory demand:

  • firstly, a debt will often exist if an amount is owed in exchange for goods or services that have already been supplied by the creditor to the debtor company;
  • secondly, if the creditor knows that there is a genuine dispute by the debtor over whether the alleged debt exists, then it will not be considered a debt for the purposes of a statutory demand;
  • thirdly, claims against insurers are generally claims for unliquidated damages and accordingly are not debts until there is a court judgement, a binding settlement agreement, an arbitral award or the equivalent; and
  • fourthly, prospective liabilities cannot be debts, which means that a liability that will almost certainly arise at some future time is not a debt until such time as it actually does arise.

Options facing a debtor company

A debtor company has 21 days in which to respond to a statutory demand. Its options are to pay the debt; negotiate a settlement; or challenge the validity of the statutory demand. If the debtor company fails to take any of these actions, a presumption of insolvency arises and the company may be subject to official procedures which can lead to its winding up and de-registration.

There are limited grounds on which a debtor company may challenge the validity of a statutory demand. The most frequent are these:

  • that there is a genuine dispute about the existence or amount of the debt;
  • that the company has an offsetting claim against the creditor; or
  • that there is a formal defect in the statutory demand and a “substantial injustice” will be caused if the demand is not set aside.

The first two grounds are self explanatory: the debt must not be in dispute, and the creditor company must not itself be in debt to the debtor company. The third ground is an interesting one, and is often used as a reason to set aside a statutory demand where the defect seems to be minor or curable, and where there is in reality no substantive excuse available to the debtor company. Defects which can lead to a demand being set aside include misstating the amount of the debt, or misnaming the debtor company.

However the courts are not limited to these grounds, and will often find other reasons to set aside demands in the interests of justice and to ensure that the process is not abused by creditors.

Genuine doubt or dispute about a debt, and offsetting claims

If a creditor uses a statutory demand when there is a genuine doubt or dispute about the existence of the debt, the creditor runs the significant risk that the statutory demand will be set aside by a court and that the creditor will be ordered to pay the debtor company’s costs of having it set aside. The Supreme Court of the Northern Territory said as much when it stated that:

…creditors have to realise that if they invoke winding up proceedings by issuing a statutory demand they run the risk that if a debtor establishes that the amount claimed is subject to a genuine dispute, the debtor will get an order for costs…1

Therefore, before issuing a statutory demand against a debtor company, a creditor must consider carefully whether the debt has been (or will be) genuinely disputed by the debtor company. Importantly, the dispute about the debt must be genuine. It cannot be raised simply for spurious reasons as a delaying tactic, as this would be an abuse of court process.

Similarly, a creditor must carefully consider whether it owes a debt to the debtor company that may offset (either wholly or partly) the debt described in the statutory demand. Again, if the court sets aside the statutory demand because the debtor has an offsetting claim against the creditor, then it is possible that the court will order the creditor to pay the debtor company’s court costs.

What constitutes a “genuine dispute” or an “offsetting claim” has been the subject of significant judicial debate. The theme of most of the relevant case law is that the threshold for establishing a genuine dispute or an offsetting claim is relatively low. In Spencer Constructions Pty Limited v G&M Aldridge2 the court stated that a “genuine dispute” is a dispute that is bona fide and must not be based on grounds which are spurious, illusory or hypothetical. The court will not make a determination about the merits of the dispute, but rather will set the statutory demand aside if the dispute is genuine.3

Similarly, the court in Gujarat NRE Australia v Williams stated that a genuine offsetting claim is a:

…claim on a cause of action advanced in good faith, for an amount claim in good faith. ‘Good faith’ means arguable on the basis of facts asserted with sufficient particularity to enable the court to determine that the claim is not fanciful.4

Defects in statutory demands can be fatal

The formal requirements for a statutory demand under the Act must be strictly adhered to. If a formal error or defect is found to be the cause of a “substantial injustice” then the statutory demand will be set aside. Under the Act, a “defect” is defined as including an irregularity; a misstatement of an amount or total; a misdescription of a debt or other matter; and a misdescription of a person or entity.

The presence of one of these “defects” will not be fatal to the statutory demand unless it does or could result in “substantial injustice” to the debtor. The courts have provided plenty of examples of defects that have been found to cause substantial injustice, such as:

  • including debts in the statutory demand that are not yet due and payable, even if some of the included debts are due and payable;
  • misdescribing the nature of the debt (the courts have stated that the “specification of the debt in a statutory demand is a fundamental requirement”);
  • the debt being payable to an entity other than the claiming creditor;
  • if a statutory demand relates to multiple debts, failing to properly describe the individual debts; and
  • if a statutory demand relates to multiple debts, failing to state the total amount claimed.

Other reasons to set aside a demand

Other reasons have been used by courts as a means of setting aside statutory demands that have formal irregularities, even if those irregularities fall short of the “substantial injustice” threshold. Some examples include:

  • where the date of the supporting affidavit is earlier than the date on the statutory demand, meaning that the court could not be sure that the debt was not paid to the creditor between the two dates; and
  • where the person providing the affidavit has failed to state that they believe there is no genuine dispute about the existence of the debt.

Importantly, the courts have made clear that a statutory demand should not be used as a means of coercing or forcing an alleged debtor to pay a disputed amount. In Universal Music Australia Pty Ltd v Brown the court set aside a statutory demand because it found that it was being used as a negotiating tool in an ongoing monetary dispute.

Statutory demands: Very useful in the right circumstances

If used correctly, the statutory demand procedure has significant advantages over alternative debt recovery tools, especially traditional commercial litigation. In commercial litigation a creditor must prepare a detailed statement of claim which pleads the creditor’s case concerning its alleged right to payment. The debtor company may then enter a defence, which gives the debtor company an opportunity to raise all types of counter-arguments, some of which may be flimsy, unprovable or otherwise lacking merit. Commencing recovery proceedings allows a debtor company the opportunity to raise a dispute of some sort which can delay and drag out the proceedings long enough to force a more advantageous settlement, even if in reality there is no genuine dispute.

Successful statutory demand procedures avoid these problems. Extensive proceedings, such as detailed pleadings and fact finding in relation to the relationship between the parties, the breakdown of that relationship, and how the law should be applied to work out responsibility, liability and quantum, are not required. If the debt exists, and there is no genuine dispute and no set-off, then the debtor must either pay or face the possibility of being wound-up by the court. This process is faster, much more direct, and focuses the attention of the debtor on the need for it to pay its debt, because if it fails to pay it could be subject to external management or otherwise be forced out of business.

1) Ranford Gold Mines Pty Ltd v P and H Earthmoving Pty Ltd, Supreme Court of the Northern Territory, 1994, unreported

2) (1997) 76 FCR 452

3) Panel Tech (Aust) Pty Limited v Australian Skyreach [2003] NSWSC 896

4) Gujarat NRE Australia v Williams [2006] NSWSC 518

5) Portrait Express (Sales) Pty Ltd v Kodak (Australasia) Pty Ltd (1996) 20 ACSR 746

6) IFA Homeware Imports Pty Ltd v Shanghai Jerrys Candle Co Ltd [2003] FCA 533

7) Ibid

8) Condor Asset Management Ltd v Excelsior Eastern Ltd [2005] NSWSC 1139

9) Chippendale Printing Co Pty Ltd v Deputy Commissioner of Taxation (1995) 55 FCR 562

10) Wildtown Holdings Pty Ltd v Rural Traders Company Ltd [2002] WASCA 196

11) IFA Homeware Imports Pty Ltd v Shanghai Jerrys Candle Co Ltd [2003] FCA 533

12) Universal Music Australia Pty Ltd v Brown [2003] FCA 1213

This memo presents an overview and commentary of the subject matter. It is not provided in the context of a solicitor-client relationship and no duty of care is assumed or accepted. It does not constitute legal advice.

© Moulis Legal 2010