June 2005

Double proofs you won't find on the top shelf: recovering debts from debtors and guarantors

Recovering money paid under a guarantee

As is commonly known a guarantor is someone (either a company or an individual) who guarantees the indebtness of a debtor to a creditor.

If a debtor cannot pay a creditor then a guarantor may be required to pay the whole or part of the debt to the creditor, depending on the terms of the guarantee. The debtor is then obliged to reimburse the guarantor for the amount paid by the guarantor.

However, where a debtor becomes insolvent (or bankrupt in the case of an individual debtor) a guarantor can only make a claim for reimbursement in the insolvency administration of the debtor in certain circumstances.

Conversely, the creditor may be able to claim payment of the whole of the original debt, even though the creditor has received part payment from the guarantor.

Lodging a proof of debt

Where a debtor becomes insolvent the debtor's trustee, administrator or liquidator may call for lodgement of "proofs of debt" by creditors. Proofs of debt are claims made in the insolvent estate by creditors for a share of the money available.

The number and amount of these claims and the total funds available for distribution determines what proportion of its debt (a "dividend") each creditor will receive.

Consider for example a company in insolvency administration with assets to distribute of $100,000 but in respect of which proofs of debt totalling $1,000,000 have been lodged. The creditors will share equally in the $100,000 and the return to creditors will therefore be 10 cents for every $1 they are owed.

The rule against double proofs

The rule against "double proofs" prevents separate dividends being paid out of a single insolvent administration in respect of the same debt.

So, if D owes C $100, and G has guaranteed payment of D's debt to C, G might pay only $50 in partial satisfaction of its guarantee. C is still owed $50 by D, and G is also able to demand payment from D of $50 in reimbursement of the $50 G paid to C under the guarantee. The rule says only one of C or G can lodge a proof of debt in D's liquidation or administration. Which of the creditors claiming in respect of a single debt is, therefore, to be preferred?

The position is illustrated by the following scenarios where a guarantor pays a creditor pursuant to a guarantee:

(a) Where the guarantee is for the whole of the debt and the guarantor pays the whole of the debt

the guarantor may lodge a proof of debt in substitution for the principal creditor in relation to the whole debt.

(b) Where the guarantee is for part of the debt and the guarantor pays that part of the debt the guarantor may substitute in relation to part of the debt.

However,

(c) Where the guarantee is for the whole debt but only part of the debt is paid the principal creditor should still lodge a proof of debt for the full amount of the debt without accounting for money received from the guarantor.

Similarly,

(d) Where the guarantee is for the whole debt but the extent of the guarantor's liability is limited to a certain maximum amount the principal creditor should again lodge a proof of debt for the full amount without accounting for money received from the guarantor.

The last two examples illustrate the rule against double proofs.

It's not so straightforward

In the Court of Appeal decision of Oceanfast (Lumley General Insurance Limited v Oceanfast Marine Pty Limited & Ors [2001] NSWCA 479) the appellant, ("Lumley"), was liable under a number of performance bonds to the purchasers of tug boats. The bonds were payable if Oceanfast Marine Pty Limited ("Marine"), which was the builder, failed to perform its obligations in accordance with a series of tug boat construction contracts. Marine, and its guarantor Oceanfast Pty Limited ("Oceanfast"), both went into voluntary administration resulting in a loss to the purchasers of the tug boats of approximately $15,000,000.

Lumley made a payment of $5,000,000 pursuant to the performance bonds to the purchasers. In the administration of Marine and Oceanfast, Lumley sought to prove for that $5,000,000. The purchasers sought to prove for the whole $15,000,000 debt. The administrators accepted the purchasers' proof of debt but rejected Lumley's proof of debt.

Lumley brought proceedings and Austin J, at first instance, held that the purchasers were entitled to prove and Lumley was not, "having regard to the rule against double proofs".

However the majority on appeal held that Lumley was entitled to prove for the $5,000,000 paid under the performance bonds, thus reducing the purchaser's claim to $10,000,000, and that no question of double proofs arose. Their reasoning was as follows:

  • In order to claim from Marine, Lumley was entitled to rely on an independent principle stated in Moule v Garrett (1872) LR 7 Ex 101 where Cockburn CJ said (at 104):

"where the plaintiff has been compelled by law to pay, or being compellable by law, has paid money which the defendant was ultimately liable to pay, so the latter obtains the benefit of the payment by the discharge of his liability; under such circumstances the defendant is held indebted to the plaintiff in that amount."

  • The performance bond was not a guarantee. It was not a promise that Lumley would answer for the debt or obligations of Marine. Instead, it was a promise that Lumley would pay money to the purchaser if the purchaser demanded payment and provided a copy of a notice of non performance and a particular certification.

  • Therefore the purchasers were entitled to prove only for $10,000,000 and Lumley was entitled to prove for the $5,000,000 as they were separate debts and no question of double proof was involved in the case.

The critical finding was that the debt owed by Marine to the purchasers under the construction contracts, and the debt owed by Lumley under the performance bonds, were not the same debt. The distinction may seem technical, but the courts will nonetheless uphold the rule.

What about joint debtors?

Because joint debtors owe the same debt to their creditor, the rule against double proofs can also apply for the benefit of creditors where one or more joint debtors pay part of the debt. This means that in an appropriate case, the creditor can seek to prove in a debtor's insolvency for the full amount of a joint and several debt and, simultaneously, seek to recover from a co-debtor or co-debtors, until the creditor receives the full amount of the debt (Handberg v Smarter Way (Aust) Pty Ltd [2002] FCA 469). The co-debtor(s) is unable to lodge a proof of debt in competition with the creditor. Care must be taken not to release joint debtors who part pay debts as this will ordinarily release the whole debt. Instead, a covenant not to sue should be entered.

What should you do?

Suppliers of goods and services will often be able to claim debts owed to them from more than one purchaser or from guarantors. If any of the principal debtors becomes insolvent the creditor should remember that a claim may be able to be made in the insolvent administration for the whole of the debt, notwithstanding that part payment has been received from a joint debtor or guarantor.