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Setting aside unreasonable personal insolvency agreements under the Bankruptcy Act

26 June 2014

In this issue:

  • Personal insolvency agreements under Part X of the Bankruptcy Act reviewed
  • The statutory right of a creditor to apply to the court to set aside a personal insolvency agreement discussed
  • Cases where the reasonableness of a personal insolvency agreements is under consideration in view of the amount available for distribution under the agreement

Introduction

Through a personal insolvency agreement (PIA) under Part X, Bankruptcy Act a debtor is provided with the means to discharge liabilities to creditors and so avoid the consequences of bankruptcy. Moreover, Part X of the Bankruptcy Act is intended to provide a better alternative for creditors than the debtor’s bankruptcy.

Whether a proposal under Part X shall proceed is left to the decision of creditors, informed by disclosure of the debtor’s financial affairs, and by a controlling trustee’s summary and comments on that disclosure, accompanied by a recommendation as to whether creditors’ interests would be better served by accepting the debtor’s proposal or by the debtor’s bankruptcy: see sections 188(2C), 189A(1) Bankruptcy Act.

The decision of creditors to adopt a debtor’s proposal is achieved through a special resolution passed by a majority in number and at least three-fourths in value of the creditors voting on the resolution: see sections 204(1), 5(1), Bankruptcy Act.

Understandably where creditors have arrived at a decision in this fashion the courts have shown a reluctance to interfere with their decision. As one Court observed “this Court should be cautious in substituting its own judgment for that of the creditors.”

The operation of sections 222(1) (d) and (e) Bankruptcy Act

Notwithstanding the reluctance of courts to disturb the decision of creditors, section 222(1)(d) Bankruptcy Act recognises that if a court on the application of a creditor is satisfied that the terms of a PIA are:

  • unreasonable; or
  • not calculated to benefit the creditors generally

then the court may make an order setting the PIA aside. Moreover, section 222(1)(e) extends the discretion conferred on the court by permitting the court to set aside a PIA if satisfied that “for any other reason, the agreement ought to be set aside.”

With respect to the apparent scope of section 222(1)(e) the courts have shown a tendency to take into account a range of factors under that provision that will support a finding under section 222(1)(d) as to whether or not the PIA under consideration is reasonable, or calculated to benefit the creditors generally: see New Age Construction (NSW) Pty Ltd v Etlis (2013) FCA 884, 2/9/2013 (para. 61).

This approach is well illustrated by cases where a court is reviewing the reasonableness of a PIA in view of the amount being made available for distribution to creditors under the agreement.

Where amount available for distribution is negligible compared to total debts

It is not surprising that a significant number of cases have come before the courts seeking to have a PIA set aside as unreasonable where the benefit provided to unsecured creditors is negligible, and the discrepancy between that benefit and the amount of the total indebtedness is substantial.

In addressing this issue recent authorities have consistently adopted the following propositions, usefully summarised by the Full Court of the Federal Court in Hingston v Westpac Banking Corporation (2012) FCAFC 41, 23/2/2012:

  • serious consideration will be given to setting aside the PIA where the amount available for distribution is trivial or negligible when compared to the debtor’s total debts;
  • however, such a discrepancy is not necessarily determinative;
  • as a consequence, an application to set aside a PIA should seek to identify other compelling factors apart from mere discrepancy between the dividend offered and the actual debt.

A recent example of this approach is afforded by Osborne v Gangemi (2011) FCA 1252, 4/11/2011. In that case a distribution of $80,000 was proposed in relation to total debts of over $4 million. This would result in a dividend of about one cent in the dollar after deducting the trustee’s likely costs. In setting aside the PIA and making a sequestration order Bromberg J said (at para 47):

“The authorities to which I have referred demonstrate that a composition is likely to be set aside where the amount available for distribution is trivial or negligible when compared to the debtor’s total debts. That will be particularly so where the debtor’s affairs call for further investigation and insufficient information was available to creditors for them to have made an informed decision that a more advantageous outcome may not be achieved through the bankruptcy of the debtor. The closeness of the vote of creditors will be relevant and particularly so where the result may have been influenced by creditors who were not at arm’s length from the debtor or whose interests coincide with the debtor’s interest in avoiding bankruptcy, rather than the interests of creditors generally.”

Similarly, in Onesteel Trading Pty Ltd v D’Arrigo (2013) FCCA 1019, 9 /8/2013, PIAs offering estimated returns from $0.001 to $0.03 in the dollar were set aside and sequestration orders made. A combination of factors lead the Court to find that the PIAs should be set aside under sections 222(1)(d) and (e) Bankruptcy Act. In particular:

  • The estimated return to the creditors under the PIA is almost zero and significantly disproportionate to the debts owed;
  • There is at least a prospect of a better return to creditors under bankruptcy given the need for further investigation of the position of the debtors and the greater powers of a trustee in bankruptcy, funded by the applicants to conduct such an investigation;
  • The creditors are unlikely to be disadvantaged and there is no real assurance that the funding will be available for the PIAs; and
  • There is a serious question that [one creditor] was admitted to vote for an amount in excess of what could be regarded as an amount which could flow from a genuine estimate of its damages. Without that amount the PIAs would not have been approved by the creditors.” (para 48).

Summing up

The wide discretion bestowed on the courts to set aside PIAs needs to be exercised cautiously. PIAs provide a useful means of dealing with the personal insolvency of an individual where a genuine accommodation can be made with that individual’s creditors. The decision of creditors, when exercised reasonably and in the interests of all creditors generally will usually provide the best outcome from a bad situation. Moreover, a creditor who is unwilling to accept that outcome, and who contemplates applying to set aside the PIA will need to carefully consider the prospects of success, and the possibility of an adverse costs order should the application be unsuccessful.

The amount available for distribution under the proposal is likely to be a very significant factor in determining the reasonableness of a PIA. However, the authorities indicate that such a discrepancy per se is not necessarily determinative. Other factors of the kind reviewed above may need to be taken into account by a court, such that it is the cumulative effect of the smallness of the dividend in conjunction with those other factors which will cast doubt on whether the terms of a PIA are reasonable and calculated to benefit the creditors generally.

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