The perils of loud letters of demand

A creditor being paid its debt following a letter of demand can be a Pyrrhic victory, if the debtor ends up in insolvency and the liquidator or trustee demands the payment back from the creditor as an unfair preference.

The liquidator or trustee has to show that the creditor reasonably suspected that the debtor was insolvent for the payment to be recoverable.

Communications by the creditor may be evidence of that suspicion, in particular if the demand letter is written in CAPITAL letters, and impugns the debtor’s solvency.

In Trenfield v HAG Import Corporation (Australia) Pty Ltd (No.2) [2018] QDC 129, there were email exchanges in standard font, in which the creditor in fact wrote that it was

“quite clear … that you have no intention of paying your account as per our trading terms, that is ‘as and when they fell due’ and this raises the issue of your trading position with regard to the Corporations Law (sic)”.

That was then followed by, as the Judge said, an email from the creditor

“in a much larger font, which I suspect is the email equivalent of shouting”.

The debtor “replied (in a standard font size)” with what the Judge said was “the ancient plea for more time”.

The judgment concerned the costs to be paid, in particular whether indemnity costs should be ordered against the creditor for unduly resisting the liquidator’s claim.

While the capitalised email helped the liquidator’s case, a later email in standard font confirmed the indemnity costs order.  The creditor had emailed saying the debtor

“is unable to meet our overdue account ‘as and when it has fallen due’ and the inescapable consequence is the Robins is actually trading whilst insolvent””.

The lesson

In referring to the ‘ancient plea’, the Judge referred to the Bible, Matthew 18:26:

“Since the man was unable to pay, the master ordered that he be sold to pay his debt, along with his wife and children and everything he owned. Then the servant fell on his knees before him. ‘Have patience with me’, he begged, ‘and I will pay back everything’”.

However, unlike the creditor in this case, the master

“had compassion on him, forgave his debt, and released him”.

The further lesson

Courts will not necessarily assume a suspicion of insolvency from a creditor’s robust letters of demand, which in some quarters are standard practice.

The potential for the necessary suspicion is raised if supported by other indicia.

But if ‘shouting’ is perhaps not always a give-away, a creditor who ‘inescapably concludes’ insolvency is. And writing strong letters of demand can be a two-edged sword, written carefully; but letters impugning the debtor’s solvency are best avoided.

The question why a creditor has to repay money if it suspects or knows their debtor is insolvent is not clearly explained in insolvency law or policy.  It seems to stem from some sense of morality about the unfairness of a creditor knowingly taking the money resulting in other creditors being worse off.

At the same time, extracting a payment is not in breach of any law.

Keay’s Insolvency (10th ed, 2018, Ch 5) queries the reality of a stated purpose of preference law being to deter ‘the race of diligence’ of creditors to dismember the debtor before bankruptcy …’.

Would a creditor be deterred by the distant and uncertain prospect of a preference recovery?

Fingers crossed

Rather, the position is better stated in Nationwide v Franklins [2001] NSWSC 1120.

“There is nothing compelling a creditor somehow to remain pure by shunning a payment in respect of which there exists some theoretical future possibility of its proving to be preferential. A normally motivated creditor would be inclined to accept such a payment conscious of any risk of disgorgement, and with fingers crossed to the extent indicated by the circumstances”.

The ATO

Though it should be noted that creditors subject to model litigant obligations, such as the ATO, may decide not to accept a payment arrangement if the ATO is not satisfied that the debtor’s other creditors are being paid: PS LA 2011/14; and that if a demand for payment of a preference is made, the ATO may decide to repay under settled criteria.

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