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Plausible or patently feeble? Default clause a penalty, statutory demand set-aside

17 November 2021

#Corporate Restructuring and Insolvency

Plausible or patently feeble? Default clause a penalty, statutory demand set-aside

A recent decision of Associate Justice Gardiner in the Victorian Supreme Court provides a reminder of the low threshold required to set aside a statutory demand on the basis of a genuine dispute under section 459H of the Corporations Act 2001 (Cth) (Act). It also provides guidance on the proper drafting of settlement terms to ensure they include an appropriate acknowledgement of debt.

The key facts and key provisions of the deed of settlement and release

NG Partnership and Piper Alderman (Creditors) provided legal services to Aurora Funds Management Limited (Aurora). A dispute arose as to payment for these legal services, which was resolved by the parties entering into a deed of settlement and release (Deed).

Clause 2 of the Deed provided that the parties agreed to settle the ‘Debt’ by paying the ‘Settlement Sum’ to the Creditors.

For the purposes of the Deed, the ‘Debt’ was $419,335.26, which was defined in the Deed as follows:

“... the debt owed by Aurora to Norton Gledhill in the sum of $142,470.26 (as particularised in Annexure A of this Deed) and the debt owed by Aurora to Piper Alderman in the sum of $276,865.02 (as particularised in Annexure B of this Deed).”

The ‘Settlement Sum’ was defined as “$300,000 (inclusive of GST)”.

Clause 3 of the Deed was the default clause which stated:

“In the event Aurora fails to comply with any of its obligations under clause 2 of this Deed, and Aurora fails to rectify any such failure within three (3) Business Days of being notified of any failure by Piper Alderman or Norton Gledhill, Aurora agrees that: (a) the whole of the Debt [emphasis added] will become immediately due and payable; and (b) it will pay interest on the Debt, from the date of default of the payment of the Settlement Sum until the date payment of the Debt is made, calculated at the rate for the time being fixed under section 2 of the Penalty Interest Rate Act 1983 (Vic).”

Aurora made some payments under the Deed but ultimately defaulted, owing $140,000. 11 months following the default, the statutory demand was issued for $259,335.28, the balance of the Debt that was owing (Aurora having made payments totalling $160,000 under the Deed). Following receipt of the statutory demand, Aurora paid the balance of the Settlement Sum ($140,000), meaning the Settlement Sum had now been paid in full. The Creditors then sought the balance of the Debt being $119,335.28.

The key issues

Aurora sought, in part, to set aside the statutory demand on the basis that there was a genuine dispute as to the Debt because of the default clause being an impermissible penalty provision.

Aurora’s counsel submitted that the terms of the Deed did not unambiguously acknowledge the existence of the Debt nor that it was due and owing “…merely because the sum total of the two invoices, $419,000, is defined as the ‘Debt’. In support of this argument, Aurora’s counsel referred to Recital F of the Deed which read “The Parties have agreed to resolve all or any issues regarding the Debt and the Legal Services on the basis set out in this Deed” which, he submitted, intimated that there was a ‘controversy’ regarding the invoices referred to in Clause 2, upon which the Debt was based. In this context, the stipulation to pay an additional $119,335.28 on default of payment of the Settlement Sum was “…out of proportion to the interest that the defendants, or either of them, have in the performance of the Deed.”

Counsel for the Creditors submitted that the definition of Debt in the Deed was to be taken to mean a "debt owed", to be distinguished from "amounts claimed". The Creditors’ counsel also noted Clause 2.1, which confirmed that the parties agreed to “settle the Debt” by way of a payment of a lesser amount, namely the Settlement Sum, the effect of which is that the parties to the Deed confirm that the Debt is the amount owing to the Creditors by Aurora.

His Honour agreed with Aurora’s counsel that Recital F of the Deed, which spoke of the parties agreeing to “…resolve all or any issues regarding the Debt and the Legal Services” was suggestive of a controversy as to the indebtedness between the parties. It was also held that the Deed did not provide an acknowledgment of the Debt by Aurora.

In the absence of an express acknowledgment within the Deed by Aurora that the Debt was owing, His Honour held that it was plausible, and not patently feeble (as submitted by the Creditors’ counsel) that Clause 3 of the Deed could be characterised as a penalty and be rendered unenforceable. This was all that was required to establish a genuine dispute under section 459H of the Act. His Honour held that:

“…the Court’s role in the present context is not to attempt to predict what the outcome of the controversy surrounding the construction of the Deed will be; an application to set aside a statutory demand under s 459G of the Act does not involve a final determination of the matters upon which the company relies to dispute the debt. Rather, the application is decided on the basis of whether those matters are plausibly arguable. Here, the Court’s jurisdiction is confined to a determination of whether or not Aurora has discharged the onus it bears that it has plausible arguments that clause 3 operates to impose a penalty.”

Conclusion

This decision provides a reminder of the low threshold required to establish a genuine dispute for the purposes of section 459H of the Act. It also serves as a warning to ensure that settlement terms provide an unambiguous acknowledgement of the amounts owed. Otherwise, attempts to enforce following a default may be unsuccessful.

Authors: Chris Brodrick & Mitchell Waters

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The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this article is accurate at the date it is received or that it will continue to be accurate in the future.

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