1

INSOLVENCY LECTURE 1

LAW EXTENSION COMMITTEE

Lasr revised: 9 November 2010

2

WELCOME TO THE COURSE

• Lecturers: John Gooley, David Russell

• The Course Outline was completely revised 12 months ago

• Notes and slides from previous students will be of limited use to you

• We now do 6 weeks of personal insolvency (bankruptcy) and 6 weeks of corporate insolvency

• Prescribed texts (see p.7-8 of Course Outline):– Keay’s Insolvency 6th edition– Nichols - Annotated Bankruptcy Act 2009 edition– 2010 Corporations Legislation - Thomson Reuters

• The Powerpoint slides (hyperlinked), the use of journals and law library databases

3

THE ASSIGNMENT

• Available on the website

• Due on 18 January 2011

• Only one question with a word limit of 1500 - make sure you answer all 4 components

• A pass mark is 50%. If I write “see me” on your paper, you must contact me as you have come close to a fail

• Lecture 2 covers topics relevant to the assignment

• The assignment contains the question AND what is expected in your answer

4

THE ASSIGNMENT

On 1 March 2010 Matthew served Terry with a District Court Statement of Claim. Terry was busy around that time and put it to one side. Before Terry sought legal advice, Matthew applied for default judgment.

On 1 June 2010 Matthew obtained default judgment in the amount of $25,000 against Terry. That amount was inclusive of interest. The amount remained unpaid.

On 1 July 2010, Matthew prepared a bankruptcy notice in which he claimed an amount of $26,500. The increased amount was due to a wrong calculation being made by Matthew as to interest. The notice also asserted that the entitlement to post-judgment interest arose under s 91 of the Civil Procedure Act 2005. Terry then went overseas on holidays and left it to his secretary, Amanda, to arrange for the service of the bankruptcy notice.

On 2 July 2010 Amanda instructed Kevin, a process server, to serve the bankruptcy notice on Terry. Amanda did not know Terry's last known address or where he currently worked so she gave Kevin details of Terry's former place of work. As Terry could not be located, on 2 July 2010 Kevin left the bankruptcy notice at the office of Terry's former employers. They sent the bankruptcy notice on to Terry, who received it on 18 July 2010.

Terry seeks your advice on 19 July 2010.

5

THE ASSIGNMENT

You are required to advise Terry in relation to the following:

(a) has there has been valid service of the bankruptcy notice?

(b) is the bankruptcy notice valid or invalid and, if so, on what grounds?

(c) what applications could Terry make in the circumstances and on what grounds?

(d) what evidence should Terry call on such applications?

You are expected to support your answer by identifying relevant statutory provisions and discussing relevant cases.

6

THE EXAM : 8 MARCH 2010 AT 9AM

• Detailed discussion of the exam will be in Lecture 10 and on the Sunday of Weekend School 2

• Exam is open book but not electronic

• The LPAB website contains exam information and past exam papers

QUESTIONS AND COMMENTS

• You can ask questions before, during or after lectures

• Feel free to email questions to the lecturers, to be dealt with at the next lecture

• Do you already have insolvency experience which you can share?

7

HISTORY OF BANKRUPTCY LAW

• The Roman Law of the Twelve Tables (450 BC)– Gave the debtor 30 days to pay or find someone else to pay– If payment not made, fastened in stocks for 3 market days– If still unpaid, debtors were entitled to physically divide the debtor’s body

among themselves– Division was in proportion to the creditor’s share of the debt

• The first English bankruptcy statute (1542)– Creditors could complain to the Lord Chancellor and obtain seizure of the

debtor’s property– The remedy was initially only available to traders

• The debtors’ prison– Until 1869 in England– Until January 2009 in Greece– Still exists in Dubai

8

COMMONWEALTH LAW

• The Commonwealth Of Australia Constitution Act in s 51(xvii) gives the federal parliament power to legislate in relation to bankruptcy and insolvency

• The current legislation is the Bankruptcy Act 1966

• Federal courts deal with bankruptcy matters - s 27

• Inspector-General in Bankruptcy - ss 11,12

• Insolvency and Trustee Service Australia (ITSA)

• Official Receiver - s 15

• Official Trustee - ss 18,19

• Registered trustees - s 154A

9

PURPOSES OF BANKRUPTCY LAW

• Pari passu distribution– proportional sharing– only deals with unsecured creditors– often little left after payment of secured creditors and costs

• Protection– bankrupt is protected against further claims by creditors– protection for creditors– assets collected and divided amongst creditors– bankrupt has the slate wiped clean and can start again

• Investigation– why the insolvency occurred– whether other assets are available for creditors

• Restrictions on dealings– financial conduct of bankrupt is restricted and supervised

10

INTERACTION WITH OTHER AREAS OF LAW

• Property law - what if your vendor goes bankrupt?

• Commercial law - can you obtain title from a bankrupt seller?

• Litigation - can you sue or be sued by a bankrupt?

• Family law - can maintenance owed by a bankrupt parent be recovered?

• Superannuation - can creditors get at a beneficiary’s entitlement?

• Even if you never appear directly in a bankruptcy case, you will certainly need to know the effect which bankruptcy has on titles and rights.

• Bankruptcy affects your future right to practise law:– the “bankrupt barristers” scandal– Legal Profession Act 2004 s 498(1)(d)

11

“SOLVENT” AND “INSOLVENT”

• S 5(2) provides: “A person is solvent if, and only if, the person is able to pay all the person's debts, as and when they become due and payable.”

• s 5(3) provides: “A person who is not solvent is insolvent.”

• But how do you prove insolvency?– You know nothing about the debts, liabilities, income and expenses of the

debtor– The debtor may not even keep financial records

• The Bankruptcy Act provides a simple means of establishing insolvency by prescribing that certain events constitute an “act of bankruptcy”

12

ABILITY TO PAY DEBTS AS THEY FALL DUE

• Sandell v Porter (1966) 115 CLR 666

“Insolvency is expressed in s. 95 as an inability to pay debts as they fall due out of the debtor's own money. But the debtor's own moneys are not limited to his cash resources immediately available. They extend to moneys which he can procure by realization by sale or by mortgage or pledge of his assets within a relatively short time - relative to the nature and amount of the debts and to the circumstances, including the nature of the business, of the debtor. The conclusion of insolvency ought to be clear from a consideration of the debtor's financial position in its entirety and generally speaking ought not to be drawn simply from evidence of a temporary lack of liquidity. It is the debtor's inability, utilizing such cash resources as he has or can command through the use of his assets, to meet his debts as they fall due which indicates insolvency. Whether that state of his affairs has arrived is a question for the Court and not one as to which expert evidence may be given in terms though no doubt experts may speak as to the likelihood of any of the debtor's assets or capacities yielding ready cash in sufficient time to meet the debts as they fall due.”

13

ABILITY TO PAY DEBTS AS THEY FALL DUE

• Sandell v Porter (1966) 115 CLR 666

• High Court considered a previous version of the definition - “unable to pay his debts as they become due from his own money”

• This does not mean just cash on hand

• Regard should be had to monies which a debtor could borrow on mortgage, or which could be obtained by selling assets

• Whether a person is insolvent will be a question of fact in each case

• The cases have approved a “cash flow” test not a “balance sheet” test

14

TYPICAL SEQUENCE OF EVENTSTYPICAL SEQUENCE OF EVENTS

Court judgmentIssue and service

ofbankruptcy notice

Failure to comply= act of bankruptcy

Court makes sequestration order

Presentation ofcreditor’s petition

Court hearing

15

COURSE OF A BANKRUPTCY

• What follows is a broad summary of the topics to be covered in detail in Lectures 2-6

• Debtor fails to pay a debt, causing creditor to take action under Bankruptcy Act

• Debtor commits one of the acts of bankruptcy listed in s 40, usually failure to comply with a bankruptcy notice - s 40(1)(g)

• Voluntary and compulsory bankruptcy:– debtor presents a debtor’s petition - s 55; OR– creditor presents a creditor’s petition - s 47

• Court hearing a creditor’s petition may make a sequestration order against the estate of the debtor - s 43

• “Sequestration” is not a defined term but an ordinary English word meaning to set aside or separate

16

VESTING OF PROPERTY

• The property of the bankrupt vests forthwith in the Official Trustee

• S 58(1) provides:

(1) Subject to this Act, where a debtor becomes a bankrupt:

(a) the property of the bankrupt, not being after-acquired property, vests forthwith in the Official Trustee or, if, at the time when the debtor becomes a bankrupt, a registered trustee becomes the trustee of the estate of the bankrupt by virtue of section 156A, in that registered trustee; and

(b) after-acquired property of the bankrupt vests, as soon as it is acquired by, or devolves on, the bankrupt, in the Official Trustee or, if a registered trustee is the trustee of the estate of the bankrupt, in that registered trustee.

17

DEALING WITH ASSETS

• Trustee takes possession of property of the bankrupt - s 129

• Bankrupt must file a Statement of Affairs - s 54

• Trustee may convene a meeting of the creditors - s 64

• Creditors must lodge a Proof Of Debt - s 82

• Official Receiver may launch investigation - s 77C

• Trustee pays costs of administration of the estate, then pays dividends to creditors who have proved their debts - s 140

18

TERMINATION OF BANKRUPTCY

• General rule - discharge from bankruptcy after 3 years - s 149

• Trustee may object to the discharge - s 149D

• Annulment by Trustee certifying that all debts have been paid in full - s 153A

• Annulment by court order - the sequestration order ought not to have been made - s 153B

19

THE COMMENCEMENT OF THE BANKRUPTCY

• A defined term in s 5 :

"the commencement of the bankruptcy" , in relation to a bankrupt, means the time at which his or her bankruptcy is, by virtue of section 115, to be deemed to have commenced.

• Court orders usually have effect from when made - but not in the case of a sequestration order

• The bankruptcy will commence at the time of commission of the earliest act of bankruptcy in the 6 months immediately prior to presentation of the petition - s 115

• This date of commencement is important in relation to the doctine of “relation back”

20

RELATION BACK

• Section 115(1) provides:

If a person becomes a bankrupt on a creditor's petition and subsection (1A) does not apply, then the bankruptcy is taken to have relation back to, and to have commenced at, the time of the commission of the earliest act of bankruptcy committed by the person within the period of 6 months immediately before the

date on which the creditor's petition was presented.

• Section 116(1) provides:

Subject to this Act:

(a) all property that belonged to, or was vested in, a bankrupt at the commencement of the bankruptcy, or has been acquired or is acquired by him or her, or has devolved or devolves on him or her, after the commencement of the bankruptcy and before his or her discharge; …………………………………...

is property divisible amongst the creditors of the bankrupt.

21

VOID TRANSACTIONS

The trustee can challenge and seek to set aside certain transactions:

• Transactions which are undervalued - s 120

• Transactions to defeat creditors - s 121

• Transactions which give a preference to a creditor and which thus disadvantage the general body of creditors - s 122

• Certain superannuation contributions - s 128A

22

EFFECTS OF BANKRUPTCY

EFFECT ON THE BANKRUPT

• All “divisible” property vests in the Trustee - s 58• Conduct can be investigated by the Trustee - s 77C• Must notify Trustee of change of name or address - s 80(1)• Must make contributions from income, over a threshold level• Must surrender passport - s 77• Must disclose to anyone to whom they apply for credit of >$3,000 that they are

bankrupt - s 269• Prohibited from managing or being a director of a corporation - Corporations Act

s 206A• Restrictions on practising as a barrister, solicitor or real estate agent• subject to any agreement between the partners, bankruptcy dissolves any

partnership - s 33(1) Partnership Act 1892

23

EFFECTS OF BANKRUPTCY

EFFECT ON LEGAL PROCEEDINGS

• Legal proceedings are a form of property which vests in the Trustee

• Legal actions brought by the bankrupt before the bankruptcy are stayed, until the Trustee elects to prosecute the claim or discontinue - s 60(2)

• Exception: a bankrupt retains the right to pursue actions for personal injuries and wrongs - s 60(4)

• A party cannot commence or continue with legal proceedings against a bankrupt, without the leave of the court - s 58(3)(b)

24

EFFECTS OF BANKRUPTCY

EFFECT ON THE BANKRUPT’S PROPERTY

• On the date of the bankruptcy all divisible property vests in the Trustee - s 58• Certain property is exempted or protected - see later• Vesting has effect subject to orders of the Family Court - s 59A

EFFECT ON CREDITORS

• Creditor cannot enforce remedies in respect of a provable debt - s 58(3)(a)• Creditor has a right to share in distribution of the estate • Secured creditors not affected - s 58(5)

25

PROPERTY AVAILABLE TO THE TRUSTEE

• Section 116(1):– property belonging to bankrupt at date of bankruptcy;– property acquired by bankrupt after commencement of bankruptcy and

before discharge;– the right to exercise power over property.

• Void dispositions - property recovered by the trustee

• Recoveries received by creditors - s 118

• Recoveries from sherrifs and courts - ss 119, 119A

26

PROTECTED DEALINGS

• “Relation Back” can catch transactions carried out in the months before the making of a sequestration order.

• However, certain transactions are protected.

• Section 123 protects persons who have acquired property from the debtor and did not know at the time that a petition had been presented:

– transaction must be before the date of the bankruptcy– in good faith– in the ordinary course of business

• Section 124 protects persons who pay money or deliver property to the bankrupt in good faith and in the ordinary course of business, and

– if transaction is after date of bankruptcy, also have to show that person acted without negligence

• Maintenance payments made before the bankruptcy are protected - s 123(6)

27

EXEMPT PROPERTY - s 116

• Property held in trust - s 116(2)(a)

• Certain prescribed household property - s 116(2)(b) and Reg. 6.03

• Property used for earning income - s 116(2)(c) and Reg. 6.04

• Means of transport - s 116(2)(ca) (value < $6,000)

• Insurance policies and superannuation funds - s 116(2)(d)– except for void super contributions under ss 128B and 128C - see lecture 5

• Damages received for personal injuries or personal wrongs

• Property transferred under Family Law Act orders - s 116(2)(q)

28

NEXT : LECTURE 2

• Acts of bankruptcy

• Bankruptcy notices

• Reading:

– Powerpoint slides lecture 2– Keays 53-68– Bankruptcy Act ss 40,41,43,44– Nichols 113-156