Statutory demands - a cheap and effective way to recover a debt, but Beware the Tiger by the Tail

The Corporations Act 2001 (Cth) (Act) allows a creditor to serve on a debtor a ‘statutory demand’ to pay a debt within 21 days, or risk the creditor applying to the appropriate court for orders that the debtor be ‘wound up in insolvency’.

The statutory demand has served for many years as a quick, cheap and effective way of recovering a debt, provided it is in the correct form and is properly served on the debtor company. And there are two further provisos.

The first is that there should be no genuine dispute about the existence or amount of the debt. In fact, the Act requires that, unless the claimed debt is a judgment debt, a creditor must accompany the demand with an affidavit declaring that the creditor knows of no genuine dispute regarding the debt. The second further proviso is that there should be no ‘other reason’ that the demand ought to be set aside by the court.

The Act permits an alleged debtor to approach an appropriate court for orders setting aside the demand, with costs, if any of the above provisos is breached.

In a case decided in May this year, In the matter of AAP Investments (Aust) Pty Limited (AAP), a creditor learned to its cost in the Supreme Court of New South Wales that issuing a statutory demand without attention to the two further provisos was rather like grabbing a tiger by the tail and not letting go when it had the chance.

In that case, AAP had received a bill of costs in November 2014 from its solicitors (B&C) regarding complex legal matters for which B&C had been retained. The Legal Profession Act 2004 (NSW) provided machinery for AAP to seek an independent assessment of its bill, and AAP (through another lawyer) informed B&C of that intention towards the end of November 2014.

In fact, AAP had not commenced the assessment procedure by the onset of Christmas 2014 and B&C proceeded, between Christmas and the New Year, to issue proceedings in the District Court of New South Wales to recover its claim as a debt.  AAP failed to file a defence in time and a default judgment was entered in favor of B&C in early February 2015.

Immediately afterwards, B&C obtained a garnishee order directed to AAP’s bank for payment of the judgment debt, and AAP commenced injunction proceedings to restrain that action.  At about the same time, AAP’s lawyer was writing to B&C, pressing APP’s claim for assessment.

It was in this disputatious context that B&C issued and served its statutory demand, based on the unpaid judgment debt.  Because the debt was a judgment debt, there was no requirement under the Act for B&C to serve any affidavit stating that B&C believed there was no genuine dispute.

Within days, AAP applied to the District Court to set aside B&C’s default judgment so that it could defend B&C’s claim, and AAP’s lawyer wrote to B&C asking that the demand be withdrawn.  B&C declined to take that action and AAP then applied to the Supreme Court, within the permitted 21 days, for the demand to be set aside.  

Before the matter came before the Supreme Court, the District Court set aside the judgment on which the demand depended. Nonetheless, B&C chose to defend its position on the basis that there could not be a genuine dispute about the bill of costs because of the clear terms of the costs agreement and the detailed nature of the bill.

The Court gave no credit to that argument. The demand was based on the District Court judgment, now gone, and not on the claim underlying the judgment.  Once the judgment was set aside, there was no scope for considering the underlying claim in order to decide whether or not there was a genuine dispute.

But ultimately, the Court found that there was no need to decide whether there was a genuine dispute. It was sufficient to rely on the “some other reason” proviso to set aside the demand. Demands based on judgment debts have commonly been set aside under that proviso because of pending appeals.  

In the AAP case, the Court found that the matter was even clearer because, as at the time the matter was being decided, the judgment in question had already been set aside. In those circumstances the failure to pay the judgment debt could not reasonably give rise to a presumption of insolvency. The Court duly ordered that the demand must be set aside even though there had been a judgment in place at the time the demand was issued.

The Court then turned attention to the costs consequences of that outcome. In the usual course, ‘costs follow the event’: that is, the successful party is entitled to its costs either on ‘the ordinary basis’, or on the ‘indemnity basis’.

In this case, B&C argued that, since it was entitled to issue a demand on the basis of an existing judgment debt, then it should have the benefit of costs up to the date that the default judgment was set aside, and that the parties should pay their own costs thereafter.

However, the Court took the view that B&C should have known that it was inherent in any default judgment that it may be set aside, and that was a risk a creditor had to take into account in issuing a statutory demand. Furthermore, it should have been clear to a creditor in the position of B&C that, once the default judgment had been set aside, the demand based upon it was likely also to be set aside.

Accordingly, the Court decided that B&C should pay AAP’s costs up to the date the default judgment was set aside on the ordinary basis, but after that date on the indemnity basis.

The lessons to be learned from this case are clear: a creditor should issue a statutory demand only when it is objectively apparent that there is no dispute at all about the existence or amount of an alleged debt, and that reliance on a default judgment, when the creditor knows that the claim nevertheless remains disputed, is unwise.

Author: Bill Andrews