Wiping the slate clean: Claims against a discharged bankrupt

Articles, Restructuring + Insolvency

There are many consequences of bankruptcy for an individual. For example, a trustee is appointed to the bankrupt’s estate (in whom the bankrupt’s property vests); the bankrupt is required to make income contribution payments to the Trustee proportionate to the bankrupt’s income and other personal circumstances for the duration of the bankruptcy; the bankrupt is restricted from travelling outside of Australia without the Trustee’s consent; and the bankrupt is automatically disqualified from managing corporations, among other consequences. These consequences will last for a period of three years unless the Trustee seeks a extension of the bankruptcy, in which case the period can be extended for up to eight years.

Subject to any extension, at the end of this three year period, the bankrupt is discharged.

Wiping the slate clean

Pursuant to section 153(1) of the Bankruptcy Act 1966 Cth) (Act):

“…where a bankrupt is discharged from a bankruptcy, the discharge operates to release him or her from all debts (including secured debts) provable in the bankruptcy, whether or not, in the case of a secured debt, the secured creditor has surrendered his or her security for the benefit of creditors generally”.

A discharge from bankruptcy has the effect of “wiping the slate clean” so that a bankrupt cannot be pursued for claims that arose prior to the bankruptcy and were properly provable in the administration of his or her bankrupt estate unless, for example, the debt was incurred by fraud or fraudulent breach of trust (see section 153(2)(b) of the Act). The definition of “fraud” in section 153(2)(b) of the Act is given a broad definition to include, what would be considered in equity, unconscionable conduct amounting to fraud. This includes false representations that were made knowingly, without belief in its truth or recklessly without care for its truth or otherwise i.e. where the person willfully shuts their eyes to what a further inquiry would find (Skalkos v Smiles & Ors [2006] NSWSC 192).

Debts and liabilities provable in bankruptcy

Section 82(1) of the Act relevantly provides:

“Subject to this Division, all debts and liabilities, present or 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 way reason of an obligation incurred before the date of the bankruptcy, are provable in his or her bankruptcy”. 

Section 82(2) of the Act relevantly provides:

“Demands in the nature of unliquidated damages arising otherwise than by reason of a contract, promise, or breach of trust are not provable in bankruptcy”. 

For example, in circumstances where a company enters liquidation leaving debts to creditors that were incurred at a time when the relevant company was insolvent (i.e. unable to pay all of its debts as and when they became due and payable) the liquidator or a creditor with the permission of the liquidator, can bring an action against the director personally for those debts incurred. This is a statutory right of recovery contained in section 588M Corporations Act 2001 (Cth) (CA) which provides that a company’s liquidator may recover from the director, as a debt due to the company, an amount equal to the amount of the loss or damage in circumstances where the following applies:

      “(a) a person (…called the director) has contravened subsection 588G(2) or (3) in
              relation to the incurring of a  debt by a company;

       (b) the person (…called the creditor) to whom the debt is owed has suffered loss
             or damage in relation to the debt because of the company’s insolvency; 

       (c) the debt was wholly or partly unsecured when the loss or damage was
             suffered; and

       (d) the company is being wound up;

       whether or not:

      (e) the director has been convicted of an offence in relation to the
           contravention; or

      (f) a civil penalty order has been made against the director in relation to the

The insolvent trading provisions of the CA and the wording “as a debt due to the company” have been held to constitute a liquidated claim for damages arising from statute that is provable in the estate of a bankrupt (Taylor v Rudaks [2007] FCA 1962).

Breach of fiduciary duties

In Auto Group Limited v England [2008] NSWSC 40, Bryson J gave some useful insight into the meaning of the wording “breach of trust” contained in section 82 of the Act. Whilst recognising that many breaches of trust are a breach of a fiduciary duty, Bryson J said the following:

‘Many breaches of trust are breaches of fiduciary duty but a breach of fiduciary duty is not necessarily a breach of trust; there is no contextual or other reason for giving “breach of trust” in section 82(2) a meaning other than its ordinary meaning, applicable only where there is an identifiable trust, trustee, equitable owner and trust property’. 

For example, where there has been a breach by a trustee of their fiduciary obligation, such as a misappropriation of the fund they are entrusted to maintain, equity has historically treated a claim against the fiduciary as a demand in relation to a liquidated debt. Such a claim can not be pursued against the bankrupt following discharge unless that debt was incurred by means of fraud.

Civil penalty provisions of the CA

Pursuant to section 1317H CA , a court can order a person to compensate a company for loss and damage suffered by the company if the person has contravened one of the civil penalty provisions of the CA. This includes obligations of directors and officers of a company:

  1. to exercise due care and diligence in performing their duties (section 180 CA);
  2. to exercise their powers and discharge their duties in good faith (section 181 CA);
  3. not to use their position improperly to gain an advantage for themselves or someone else, or to cause detriment to the company (section 182 CA); and
  4. not to use information they have gained due to their position as a director or officer to gain an advantage for themselves or someone else, or to cause detriment to the company (section 183 CA).

In Mercedes Holdings Pty Limited v Waters (No 5) [2011] FCA 1428, the Court had to consider whether a claim for compensation pursuant to section 1317H arising from a claim for a breach of section 601FD CA (a provision analogous to sections 180 to 182 CA) was a claim for a breach of trust and provable pursuant to section 82 of the Act. Perram J held that it was not and concluded that this was a statutory rule and not a rule of trusts.

The current approach was usefully summarised by Black J in Angus Carnegie Gordon in his capacity as liquidator of Lyon Form Pty Limited (in liquidation) & Anor v Leon Plant Hire Pty Limited (in liquidation) & Ors [2015] NSWSC 397, where his Honor stated:

‘It seems to me that the balance of authority now supports the view, which I would also take, that a claim for breach of director’s duties is neither a liquidated claim nor an unliquidated claim arising by reason of a breach of trust, and the claim against Carol in respect of the payments to the deed funds would therefore not be admissible to proof under her Personal Insolvency Agreement or extinguished by that Agreement, by reason of being a claim for unliquidated damages as to breach of trust’. 

For more information please contact ERA Legal.


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