Reconsider, Baby: Investigating proof of debts and going behind court judgments

When can liquidator (or trustee in bankruptcy) reject a proof of debt?

In dealing with distressed companies and estates, liquidators and trustees are faced with competing claims and a limited number of assets in which to meet those competing claims. The situation is further complicated by the increasing costs involved in administering the estate or company.

Often, many creditors (particularly unsecured creditors) are unable to recover the whole or even a portion of their debt.  Therefore, liquidators and trustees are required to scrutinize claims made by creditors to ensure that any claims made are legitimately incurred and provable debts.

Once a creditor has lodged their claim in the estate[1] the trustee or liquidator is required to examine each proof and the grounds of the debt. After examination, the trustee or liquidator may choose to:

1.     Admit the proof of debt;

2.     Admit it in part or reject it in part;

3.     Reject it in whole; or

4.     Require further evidence in support of the proof of debt.

In practice, if the trustee or liquidator is not satisfied with the proof, they will require further information from the creditor before rejecting the proof. The Courts have consistently noted that a trustee or liquidator in determining whether or not to admit or reject a proof of debt will be acting in a quasi-judicial capacity “according to standards no less than the standards of a court or judge”[2]

In effect, the trustee or liquidator is replacing the Court in determining whether or not to admit a debt though not to the extent of replicating the judicial process engaged in by a court or judge in its full extent and rigour. Rather, it means that a liquidator or trustee must do more than “merely acting prudently or in good faith” and engage in a bona fide examination of the legitimacy and enforceability of the of the debt or liability to which the proof of debt relates to.

The trustee or liquidator must provide written reasons if they decide to reject a proof of debt within the time frame specified by the relevant Act, to allow the creditor an opportunity to challenge the decision to reject.

Aggrieved creditors may seek to appeal a trustee or liquidators decision to the court.[3]

Both the Corporations Act 2001 and the Bankruptcy Act 1966[4] contain provisions allowing liquidators and trustees the power to amend or reverse a decision to admit or reject a proof of debt (either partially or in its entirety).

Investigating a claim arising pursuant to a court order or judgment

An example of a proof of debt which may be lodged with a trustee or liquidator is a liquidated amount pursuant to a court order or judgment. On face value, one would assume that they should always be paid out by the trustee or liquidator. However, this is not always the case.

The trustee or liquidator may be unsure whether or not to accept a proof of debt even if it is pursuant to a court judgment or order. Where the debt arises as a result of a judgment by a Court, there are circumstances where a trustee or liquidator may “go behind a judgment” to determine whether or not to reject the debt.

The Courts have long held that the power to go behind a judgment is a discretionary one. There are many factors in which a reviewing court may weigh up in deciding whether or not to go behind a judgment including how the judgment was arrived at (e.g. after a full examination of evidence at trial or merely by consent between the parties), if there was an element of fraud or collusion or miscarriage of justice.

Before deciding whether or not to go behind a judgment, the Court will conduct a preliminary investigation on the merits of the allegations about the judgment, before delving into a secondary investigation of the entire matter leading up to the judgment. The ultimate question the Court wishes to answer is whether there was in truth a prima facie debt before there was an obligation to enter a judgment.

Obviously, judgments obtained in certain circumstances (such as default judgment procedures under the various rules of court) may be more susceptible to being set aside if an investigation into the background of the judgment

Ultimately, while the legislation requires trustees and liquidators to investigate and pay out proof of debts which have been satisfactorily proved, there are circumstances in which even a debt incurred pursuant to a court order may be queried.  We strongly urge you to contact us if you have any doubts as to whether or not to admit a proof of debt, or to speak about the insolvency process generally.

[1] Pursuant to section 84 of the Bankruptcy Act 1966 or under Division 6, Part 5.6 of the Corporations Act 2001

[2] Tanning Research Laboratories Inc v O’Brien (1990) 91 ALR 180

[3] Pursuant to section 1321 of the Corporations Act 2001 or section 104 of the Bankruptcy Act 1966

[4] Section 102 of the Bankruptcy Act 1966