Judge gives lesson

Judge gives lesson to insolvency practitioners on determining proofs of debt

05 September 2019

Key Points:

  • In a recent decision of the Supreme Court of Victoria, the Court held that an appeal under the new Insolvency Practice Rules against an insolvency practitioner’s determination on a proof of debt at a meeting of creditors is a hearing de novo (ie a fresh hearing) without any need for the appellant to identify error by the original decision-maker.
    • This is a different approach from the prior case law concerning appeals under the former Corporations Regulations, and its correctness may be sought to be challenged in future appeals.
    • However, the decision highlights the need for an insolvency practitioner whose determination is challenged to put before the Court an affidavit disclosing all information and reasons upon which their determination was made.
    • The decision also highlights the desirability for creditors wishing to vote at meetings to ensure their proofs of debt include all necessary information and documentary evidence to substantiate their debt.

    The Insolvency Practice Schedule to the Corporations Act 2001 (Act) and the Insolvency Practice Rules (Corporations) 2016 (Rules) came into force on 1 September 2017 introducing new rules governing how meetings of creditors are required to be conducted in an external administration.

    The recent decision in El-Saafin & Anor v Franek & Ors (No 3) [2019] VSC 155 considered the application of the new Rules in relation to a number of interesting questions:

    1. The quality of particulars and evidence required to substantiate an alleged debt for voting purposes.
    2. The level of scrutiny the external administrator should apply in considering a proof of debt.
    3. The nature of an appeal under s75-100(4) of the Rules against an external administrator’s decision to admit or reject a proof of debt.

    In this case, Mr Glavas, the administrator of a company in voluntary administration presiding at the second meeting of creditors, admitted certain proofs of debts and refused other proofs of debt for voting purposes.

    As a result of those determinations, a resolution to wind up the company was passed by a majority of creditors in value, but not in number. Mr Glavas then exercised his casting vote and the company was placed in liquidation.

    Hassan El-Saafin and Mohamed El-Saafin were the company’s directors. They submitted proofs of debt which were admitted, and they voted against the resolution to wind up the company. They commenced an appeal pursuant to s75-100 of the Rules against the decisions made by Mr Glavas regarding various proofs of debt.

    Evidence before the Court

    Early in the decision, his Honour commented that Mr Glavas’s affidavit did not comply with rule 14.1(5) of the Supreme Court (Corporations) Rules 2013 (Vic), which requires an external administrator whose act, omission or decision is appealed to file an affidavit stating the basis on which the act, omission or decision was done or made, and exhibiting a copy of all relevant documents that have not been put in evidence by the person instituting the appeal.

    What is not expressly mentioned in the decision is that Mr Glavas resigned as liquidator of the company around the time the appeal was commenced. As a result, Mr Glavas had limited access to records upon which to prepare his affidavit.

    Interestingly, when the Judge raised this issue at a directions hearing, none of the parties sought an order requiring or granting leave to Mr Glavas to file such an affidavit.

    The result was that the appeal proceeded on the basis of an incomplete record of Mr Glavas’s reasons and without all the material considered by him in reaching his decisions on the disputed proofs of debt.

    Hearing De Novo?

    A threshold question considered by his Honour was whether the appellants were required to demonstrate error by Mr Glavas in his decision-making process, or whether the appeal was a ‘pure’ hearing de novo such that the parties were not required to demonstrate any error and could introduce any new evidence they wished, with the Judge then free to make his own decision whether the disputed proofs should have been admitted or rejected.

    On this question, his Honour referred to a number of single judge decisions under the previous Corporations Regulations which held that an appellable error, such as bad faith or erroneous application of the law, was required to be demonstrated.

    However, his Honour ultimately relied on the High Court’s decision in Tanning Research Laboratories Inc v O’Brien1 to find that the appeal was in the nature of a hearing de novo such that there was no restriction of the parties adducing fresh evidence and no requirement for them to demonstrate any actual error by the original decision-maker.

    In our view, the approach taken by the Judge on this point is likely to be challenged in future decisions. Tanning concerned an appeal from a determination of a proof of debt for dividend purposes, not voting purposes at a meeting. Removing, as a threshold requirement, the need to establish error by the original decision-maker throws into doubt the validity of any resolution passed at a creditors’ meeting, until the period for lodging an appeal has lapsed or any appeal (if brought) is finally determined. It gives an aggrieved party a ‘free hit’ at a decision made by the chair of the meeting, including the ability to introduce evidence or documents which they elected to withhold from the chair.

    Decision

    After deciding the threshold questions referred to above, his Honour then embarked upon a detailed consideration of each disputed proof. Without going into exhaustive detail, his Honour tended to find that proofs which were supported by documentary evidence (for example a contract of sale accompanied by receipts for payment) ought to be admitted, whereas those that were either wholly unsupported by documents, or a paucity of documents (for example a contract of sale but nothing further) ought not to be.

    The outcome of his Honour’s deliberations was to uphold some of Mr Glavas’s decisions and substitute his own determination for other of Mr Glavas’s decisions in relation to the disputed proofs.

    In the case of a proof of debt admitted in the amount of $3,768,023.04 (the most significant debt), his Honour held that where the value of the debt could not be ascertained merely by reference to the proof of debt in light of some complex issues with it, it was appropriate to admit the debt for a nominal value.

    On the basis of his Honour’s determinations in respect of the disputed proofs, the outcome of the vote at the creditors’ meeting would have been different, ie to end the administration rather than place the company into liquidation.

    However, as his Honour had concerns about the solvency of the company, his Honour ordered a solvency report from the newly appointed liquidator of the company, to inform what orders his Honour might ultimately make as a consequence of his findings.

    Observations

    Future courts may approach differently the question whether an appellant is required to demonstrate error by the insolvency practitioner in admitting or refusing a disputed debt in any appeal brought under s75-100(4) of the Rules.

    However, the decision highlights that an insolvency practitioner whose decision is challenged should, as much as possible, file a comprehensive affidavit setting out the evidence before them and their reasoning in respect of their decision on each disputed proof.

    There is also guidance for creditors in the decision, in that his Honour tended to find that proofs of debt substantially supported by documentary evidence should have been admitted while proofs of debt which were not supported, or which were poorly supported, by documentary evidence should be rejected.

    1 (1990) 169 CLR 332

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