One of the ‘COVID-19’ bankruptcy reforms made in Australia on 25 March 2020 was to extend the period of a stay of creditor claims against a debtor from 21 days to six months, termed a temporary debt protection.[1]
Importantly, a debtor commits an act of bankruptcy when they access this protection.[2] The fact of the protection being sought must be advised to the debtor’s creditors listed in the statement of affairs the debtor is required to lodge.
The consequence of that act of bankruptcy is that if the debtor later goes bankrupt within 6 months, all the debtor’s assets vest in the trustee as from the date of that act of bankruptcy.
The consequence of an act of bankruptcy
During that time, the debtor is treated as being
“something less than a mere trustee of his assets for the creditors in his bankruptcy. Until this state of suspense has been removed either by a [sequestration] order or by lapse of time, he has no right to deal with those assets that were in his hands, and can give no title in them to any transferee with notice. Similarly, with regard to the debts and other choses in action which form part of his estate, he cannot collect them or give a valid discharge for them, and anyone making a payment to him with notice of the act of bankruptcy does so at his peril.”: Radio Corporation v Bear.[3]
If the debtor were to go bankrupt during the six months, the stay necessarily ends and the bankruptcy commences earlier, on the date of the act of bankruptcy.
This makes any dealings by the debtor with their creditors open to challenge by a trustee under relation back. This is subject to defences in s 123, with notice of an act of bankruptcy only not negativing the defences of good faith or the ordinary course of business.
But if the full six month period is used by the debtor, the act of bankruptcy will have expired: s 44. Nevertheless, those dealings with creditors and others may be reviewed under s 120 (undervalued transactions) or s 121 (transfers to defeat creditors) or under other recovery rights of a trustee that can extend back two years or more.
21 days v 6 months
One purpose of the 21 day stay offered a debtor was to give a short breathing space to allow closer consideration of their options.[4] The debtor must be given details of the options when they are granted the stay. The stay also provides some short opportunity for the debtor to come to some agreement with their creditors.
The new stay period of 6 months gives debtors and their creditors a good period within which to come to some negotiated payment agreement, in particular if the creditors can see that the debtor’s insolvency is caused by the current crisis, and not through mismanagement. However, those negotiations occur in the context of potential recovery rights in any later bankruptcy.
New Zealand
While this change to s 54A will be useful, NZ’s proposed company business debt hibernation has some additional elements which Australia might have considered, or might yet, including for companies.
Apart from certain threshold criteria to be met, directors may give notice to creditors that they propose to seek a six-month moratorium on debt repayment. This immediately activates a one-month moratorium, during which period the creditors can vote, by majority, to allow the full six months. The proposal will then bind all creditors other than employees.
The idea is to give businesses the space to talk to their creditors about prioritising paying some debts and deferring others.
Importantly, any payment made during the moratorium by the business is to be exempt from the voidable transaction regime, as long as it is entered into in good faith, at arm’s length and is not intended to deprive existing creditors. That gives those dealing with the debtor some confidence to continue to do so.
Details of the NZ law are yet to be released.
[1] Section 54A Bankruptcy Act; and ss 54B-54L.
[2] Section 40(1)(da)
[3] [1961] HCA 26; 108 CLR 414 at 423.
[4] AFSA’s last recorded statistics are that 964 declarations under s 54A were made in 2012-2013.
