Does the admission of a proof of debt create a liability?

Author

Dina Kovacevic
August 06, 2024

Overview

In this case, the court considered whether the parent of a company in liquidation could be held liable for claims lodged in the company’s liquidation on the basis of a letter of comfort provided by the parent before the company went into liquidation. Complicating matters was that the company was a retail foreign exchange broker, and 1,729 proofs of debt totalling over $51 million had been lodged with the liquidators. Pursuant to a court order, the liquidators admitted the proofs for 85% of the amount claimed, or approximately $44 million.

In dismissing the company’s request for payment of the $44 million by the parent, the court focused on the definition of a “debt” (since the letter of comfort applied to debts of the company) and the legal effect of a liquidator’s decision to admit a proof of debt. The court concluded that admission of a proof of debt does not establish a liability to pay the amount admitted or any specific amount. At most, it creates a liability to pay an amount that can only be ascertained once all proofs of debt have been lodged and admitted and the amount available for distribution is known. Accordingly, the admission of the proofs of debt could not create debts that fell within the meaning of the letter of comfort, and the proceedings were dismissed.

Background

Forex Capital Trading (FXCT) carried on business issuing over-the-counter derivative products including contracts-for-difference and foreign exchange products to retail customers.

In October 2018, ASIC commenced an investigation into FXCT and its director in relation to alleged contraventions of various provisions of the Corporations Act 2001 (Cth) (Corporations Act) and the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act).

On 12 March 2019, ASIC commenced proceedings in the Federal Court against FXCT and the director seeking freezing orders restraining FXCT from transferring overseas customer funds. The freezing orders were made ex parte and extended on a number of occasions.

On 17 March 2019, Invesus Group Limited (IGL), a public company registered in Gibraltar and FXCT’s ultimate parent, executed a letter of comfort (Letter of Comfort) undertaking to provide financial support to the company and its directors. The Letter of Comfort stated that IGL was aware of the freezing orders, the proceedings and investigations by ASIC, and of allegations that, if proved, would mean that FXCT and its directors may have to make consumer redress to certain FXCT customers.

The Letter of Comfort further stated its purpose was to provide comfort that FXCT and its directors “will be provided financial support from Invesus Group Limited so that in any event, including without limitation unsuccessful defence of any proceedings, they are able to satisfy any obligations arising from court proceedings or flowing from ASIC’s investigation and can pay any settlement amount or judgment sums required to be paid to customers of FXCT”. The letter went on to state that IGL “irrevocably undertakes” in favour of FXCT and its directors to provide or procure from external sources, financial support to meet any debts, including judgment debts, incurred by FXCT or its directors prior to or after the date of the Letter of Comfort in respect of FXCT’s customers.

On 15 July 2020, ASIC commenced proceedings in the Federal Court against FXCT and the director seeking declarations that FXCT had contravened certain provisions of the Corporations Act and the ASIC Act and orders for the payment by FXCT of a civil penalty that was ultimately agreed at $20 million. The orders were made by consent on 29 April 2021, with FXCT admitting that it had engaged in a system of conduct or pattern of behaviour that amounted to unconscionable conduct in contravention of s 12CB of the ASIC Act.

The day before, on 28 April 2021, FXCT and IGL had entered into a convertible loan agreement under which IGL agreed to provide funds to enable FXCT “to meet its obligations in respect of the penalty, legal costs and/or any other amounts imposed on it as a result of a settlement” of the proceedings that had been commenced by ASIC. The agreed penalty of $20 million was paid by IGL pursuant to that agreement.

On 27 June 2021, the sole director of FXCT’s immediate holding company passed a special resolution of FXCT that it be wound up voluntarily. Daniel Woodhouse and Nathan Thomas of FTI Consulting were appointed as joint and several liquidators of the company (Liquidators). The Liquidators wrote to IGL advising that they required additional funding to undertake the liquidation on a solvent basis. The amount requested was just over $2 million, comprised of the approximate $950,000 in claims received at that time, about $290,000 in incurred and forecast legal fees, and about $825,000 in incurred and forecast remuneration for the Liquidators.

The Liquidators received no substantive response and applied to have FXCT wound up in insolvency pursuant to s 459A of the Corporations Act. That order was made on 7 December 2021. The Liquidators then conducted extensive investigations and concluded that every former customer of FXCT who suffered a loss suffered that loss as a result of FXCT’s conduct, and that every such customer would have a valid claim against FXCT.

In May 2022, the Liquidators obtained orders permitting them to admit proofs of debt for 85% of the amount claimed notwithstanding that the customers had not established the factual basis of their claims. The basis for these orders was that over 8,600 former customers had claims against the Company, and the Letter of Comfort expired on 30 June 2022.

In all, 1,729 proofs of debt were lodged with the Liquidators totalling $51,347,208.38. The Liquidators admitted 85% (or $43,645,127.26) of the amount claimed. On 22 June 2022, Mr Woodhouse in the name of FXCT sent a letter of demand to IGL demanding the payment of the $43,645,127.26 under the Letter of Comfort. IGL responded that the Letter of Comfort did not apply to the claim made in the demand. FXCT then commenced these proceedings claiming $43,645,127.26.

The Court’s Decision

The issue of whether FXCT was entitled to recover the amount claimed turned on the correct construction of the Letter of Comfort. Specifically, did the $43,645,127.26 claimed by FXCT under the Letter of Comfort fall within the description of “any debts, including judgment debts, incurred by FXCT … prior to or after the date of this letter in respect of FXCT’s customers”? The Court found that it did not.

The primary position of both parties was that the answer to the central issue in the case turned on the ordinary meaning of the word “debts”. Although the parties took different approaches to the meaning of that word, they agreed that a “debt” means a liability to pay an amount, which amount must be ascertained or ascertainable. A “liability” in this sense is an existing legal obligation to pay the relevant amount.

FXCT advanced two arguments for why the $43,645,127.26 consisted of debts falling within the Letter of Comfort. It argued that: (1) the admission of the proofs of debt itself created debts owed by FXCT to the former customers whose debts were admitted; and (2) the Liquidators’ conclusions on the existence and the amount of FXCT’s liability to former customers were binding on FXCT and IGL and were properly characterised as conclusions that FXCT owed debts to its former customers.

The Court rejected both submissions. With respect to the first argument, the Court was not persuaded by FXCT’s submission that admission of 85% of the amount claimed established a liability to pay that amount in much the same way as a judgment or a settlement for that amount would have established a liability to pay that amount. Admission of a proof of debt did not establish a liability to pay the amount admitted or any specific amount. At most, it created a liability to pay an amount that could only be ascertained once all proofs of debt had been lodged and admitted and the amount available for distribution was known.

In administering the proof of debt / distribution scheme, the liquidator is not determining the liabilities of the company. Rather, the liquidator is determining the rights of creditors or persons who claim to be creditors to participate in the scheme. Accordingly, when a liquidator admits a proof of debt, he or she is not creating a new liability of the company in substitution for an existing liability. Rather, he or she is deciding who is entitled to participate in the distribution of the assets of the company in accordance with the scheme set out in the Corporations Act. It follows that the admission of the proofs of debt cannot create debts that fall within the meaning of the Letter of Comfort. The amount admitted to proof is not a liability of the company and any liability to pay an ascertained amount does not arise until all of the assets of the company are realised and all proofs of debt are determined.

FXCT’s alternative argument was that the conclusion of the Liquidators on the existence and amount of FXCT’s liability to its former customers was binding on FXCT and therefore sufficient to create a debt for the purposes of the Letter of Comfort. The Court rejected this argument for many of the same reasons, finding that it was not correct to say that, in admitting a proof of debt, the Liquidators were making a decision concerning the amount of the underlying liabilities of the company.

Although the amount for which a proof of debt is admitted will normally correspond to the amount for which the company is liable, as the facts of this case demonstrate, that will not always be so. The amounts for which the customers were entitled to prove in this case did not correspond to any liability the company might have had. Rather, they were amounts determined in accordance with orders made by the Federal Court to avoid the necessity of having to make any determination in relation to the company’s actual liabilities. In addition, it was not clear how the decision of the Liquidators became binding on FXCT, let alone IGL.

Conclusion

As a result, the Court dismissed the proceedings with costs.

Judge: Ball J

Counsel for IGL: Michael Izzo SC with Jonathan Burnett of Eleven Wentworth

Solicitors for IGL: Arnold Bloch Leibler

Counsel for FXCT: David Sulan SC with Brandon Smith of Banco Chambers

Solicitors for FXCT: King & Wood Mallesons