It is very common for commercial documents to contain provisions which limit the right of creditors to lodge proofs of debt in circumstances where doing so would compete with the rights of another creditor.

One of the most common examples is found in guarantees. It is often, if not invariably, the case that a bank providing credit to a Small-Medium Enterprise (“SME”) will require the director(s) of the corporate SME to give a personal guarantee of its obligations to the bank. Commonly the landlord of premises rented by the company will also require such a guarantee as indeed may suppliers and other creditors of the company. It is common for such guarantees to contain clauses which say that the guarantor may not (amongst other things) prove in competition with the bank, lessor or supplier (as the case may be).

It has usually been considered that the effect of such clauses is to grant rights as between the bank, guarantor and so on which rights are enforceable in the hands of the bank so that if a dividend is to be paid the bank can effectively claim payment of the dividend which may otherwise be payable to the guarantor.

A recent decision of the Federal Court however decided that such clauses have much greater effect than previously thought and that they grant rights and impose obligations which go beyond just rights and obligations between the parties to the agreement.

The decision suggests that administrators and/or liquidators should review the company’s records to determine whether such clauses exist in guarantees or other documents signed by the company and if they do the administrator/liquidator should reject any proof of debt lodged by any party in breach of the obligations contained in that agreement. If the records are not available liquidators/administrators should arguably, as part of the proving process, ask any relevant parties (directors, banks and landlords etc.) to provide such documents even if they are not volunteered.

In Strawbridge, in the matter of Retail Adventures Pty. Limited (Administrators Appointed) v Retail Adventures Pty. Limited (Administrators Appointed) [2013] FCA 891 Jacobson J considered the effect of a clause in the following terms:-

“The guarantor may not;…

(d) prove in competition with the Landlord if a liquidator, provisional liquidator, receiver, administrator, or trustee in bankruptcy is appointed in respect of the Tenant or the Tenant is otherwise unable to pay its debts when they fall due;

until all money payable to the Landlord in connection with this Lease or the Tenant’s occupation of the Premises is paid.”

The solicitors for the landlord wrote to the administrators asserting that this clause meant that the guarantor was prevented from proving in the administration of the company and enforcing any right against the company, including any right to vote at the meeting of creditors.

The administrators approached the Court seeking directions as to whether they would be entitled to withdraw the proofs of debt they had lodged in their capacity as administrators of the guarantor (in that case the holding company of the company in question).

Having considered the guarantee, his Honour held that the words in the documents ought be given their ordinary meaning. In particular, the Court noted that in an administration the creditors are not paid a dividend. His Honour considered therefore that for the clause to do any work it must be interpreted so as to prevent the guarantor lodging a proof of debt for voting purposes.

His Honour said that as Regulation 5.6.23 of the Corporations Regulations 2011 provides that no person may vote at a meeting unless their claim has been admitted, the very act of lodging a proof of debt constitutes the making of a claim against the company which is something that the relevant provision of the guarantee was designed to avoid. His Honour rejected an argument that the clause should be read so as to only prevent the guarantor competing for the purposes of receiving a dividend.

His Honour also rejected an argument that section 555 of the Corporations Act 2001 (Cth.) Act should be read so as to allow the claim to be admitted notwithstanding the prohibition in the guarantee. His Honour commented that section 555 deals with the ranking of debts and claims in a winding up only.

His Honour concluded that in light of the prohibition contained in the guarantee the proof of debt lodged by the holding company should be rejected and not admitted even for voting purposes.

What is particularly notable about this decision is both that the application was not made by the landlord claiming to be entitled to the benefit of the provision and the finding that the right of competition which the Court protected was not a financial one.

In passing we do note that the decision has a strange outcome. It could be argued that the act of lodging the proof does not compete. It may be that the better conclusion is that it is any vote that should be considered. If the landlord and the guarantor were to vote in the same way, it is difficult to see how a competition arises. That does not seem to have been argued before his Honour.

It may be that the decision does no more than give a common contractual clause its ordinary meaning. The decision does however suggest that administrators and liquidators may need to make a review of security documents, leases and contracts a routine part of their process to determine voting rights in ways which go much beyond a mere consideration of the amount of the debt claimed by a creditor.

It is of course often the case that, particularly with SME’s, directors and or other related parties lodge proofs of debt with the administrator for voting purposes. Those persons have often also given guarantees of the obligations of the company.

This case states that if the person with the benefit of a guarantee (or other binding contractual provision) lodges a proof of debt with the administrator the administrator should review the guarantee (or any other relevant document) and if it contains a similar provision reject any proof of debt lodged by the guarantor without waiting for anyone to insist that happen.

This practice should become part of the regular process undertaken when considering the admissibility of proofs of debt and the failure to undertake the process may lead to criticism of the administrator/liquidator if not followed. The failure to consider any restrictions that may arise as a consequence of the inclusion of these provisions may lead to significant criticism if a resolution is carried using a proof of debt which it transpires should not have been admitted in the first place.

In our view this decision has the potential to impact very significantly on the way administrators and liquidators approach the admissibility of proofs of debt and should be reviewed carefully by all practitioners.