Irrevocable and Continuing Guarantees Versus the Bankruptcy Act

All debts and liabilities, present and future, certain or contingent, to which a bankrupt was subject at the date of the bankruptcy, or to which he or she may become subject before his or her discharge by reason of an obligation incurred before the date of the bankruptcy, are provable in his or her bankruptcy; s 82(1) of the Bankruptcy Act 1966 (Cth) (“Bankruptcy Act”) [emphasis added]. Such debts and liabilities are defined as provable debts; s 5(1) of the Bankruptcy Act.

What would you say if:

1. A director of a company becomes a bankrupt (“First Bankruptcy”);

2. Prior to the First Bankruptcy, the director had provided a creditor with a personal irrevocable and continuing guarantee;

     a. As to the irrevocable part: meaning that the director could not unilaterally revoke it at any time;

     b. As to the continuing part: meaning that it was in respect of the debts incurred by their company from time to time;

3. The First Bankruptcy was then annulled as a result of creditors approving a standard composition (“Composition”) under s 73(1) of the Bankruptcy Act;

4. The company there after incurs further debt but does not pay for it and subsequently goes into administration and liquidation;

5. The creditor then claims against the director pursuant to the guarantee and for these debts incurred after the Composition;

6. The director does not pay;

7. The creditor obtains default judgment and following service of a bankruptcy notice and creditor’s petition, a sequestration order is made against the director (“Second Bankruptcy”).

Can the bankrupt take action to set aside the sequestration order obtained in the Second Bankruptcy on the basis that the debt under the guarantee was provable in the Composition?

The answer is yes. The debt was provable in the Composition and did not exist by the time of the Second Bankruptcy. This is because the obligation (the irrevocable guarantee) was incurred before the date of the First Bankruptcy.

The answer would be the opposite if this type of guarantee was revocable. In that circumstance, recent authority from the Full Court of the Supreme Court of South Australia is to the effect that the relevant “obligation” is only incurred at the time the debt is incurred and therefore the debt would not be provable in the Composition; Darwin Food Pty Ltd v Gray [2018] SASFC 84 per Kouarkis CJ, Blue and Hinton JJ.

Gavin Parsons and Associates recently successfully argued a case on behalf of a director, relying on the above authority. That was, that as the director in that case had provided an irrevocable and continuing guarantee, the sequestration order obtained by the creditor in the Second Bankruptcy was liable to be set aside (which it was, by consent).

In summary:

1. The relevant terms of the specific guarantee are crucial (the director needs to carefully consider the guarantee document same, or engage our firm/experienced lawyers to do so);

2. Subject to a range of other factors (outside the scope of this article), if the guarantee is irrevocable and continuing, the creditor may be prohibited from taking fresh enforcement or other action and instead may need to prove in the Composition (even if the guaranteed debts arose after the Composition);

3. If the relevant guarantee is revocable and continuing, then the creditor is (again, subject to a range of factors outside the scope of this article), able to take fresh enforcement or other action. This is because a revocable and continuing guarantee means that the director can revoke it at any time and therefore the obligation is only incurred at the time the debt is incurred and the director has not revoked the guarantee before the occurrence of the same ; Darwin v Gray above, per Kourakis CJ at [3].

We can assist you with any questions you have regarding these matters. Please contact us today on (02) 9262 4471.

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Date posted: 2019-07-16