Proofs of Debt and Secured Creditors

What is a secured creditor?

A secured creditor is one that has been granted security over some or all assets of a person or company to protect their outstanding debt. Both the Corporations Act and Bankruptcy Act have provisions that deal with how secured creditors may be involved in insolvent estates.

What assets fall under the security?

Almost any asset may be secured under an appropriate charge, but only the assets under the charge will be available to the secured creditor. The security will either list the assets that it covers, or will detail a class of assets secured. These are known as Fixed or Floating charges respectively. Charges can also be Fixed and Floating and cover both options.

What can the secured creditor do with the assets?

The secured creditor can only take control of the assets covered by their charge. They are not entitled to take control over assets not covered by their charge. In a majority of cases, the assets secured will be sold and the money will be paid to the secured creditor. Secured creditors are allowed to take sufficient monies from the sale to satisfy their secured debts and costs of enforcing their charge.

Can the secured creditor appoint someone to help them?

Secured creditors can take possession of secured assets themselves, or appoint an agent to act on their behalf. Depending on the wording of the security, they may be able to appoint a receiver or receiver or manager. Each type of appointment has benefits to handle and sell different types of assets (whether real property, businesses etc.).

What do secured creditors need to do to enforce their security?

This will depend on the wording of the security. Generally security documents have provisions that detail what are breaches of the agreement and what triggers the right to exercise the charge. It will also detail the steps required to formally enforce and either take possession of assets or appoint someone to do so.

What if there is a surplus?

After a secured creditor's debts and costs have been paid in full, any surplus must be paid back to the entity, or the entity's bankruptcy trustee or liquidator if one is appointed. The secured creditor is not entitled to keep monies above the amount necessary to satisfy their debt and costs.

What if there is a shortfall?

There may not be sufficient monies realized from selling the charged assets to pay the secured creditor's debt and costs in full. In that case there is a shortfall to the secured creditor. If the secured assets have been sold, the secured creditor's position is easy to determine - as the shortfall has been realized or quantified. The secured creditor may lodge a proof of debt for the shortfall in the appropriate insolvent estate.

Do the the assets have to be sold before they can lodge a proof of debt?

No. The secured creditor may estimate the value of the unsold secured assets, deduct that amount from the amount owed and lodge a proof of debt for the balance. A secured creditor will be entitled to vote and participate in dividends for the amount of the estimated unsecured shortfall, but those rights come with some consequences.

Estimating a shortfall

To be able to lodge a proof of debt in an insolvent estate before the secured asset is sold, the secured creditor will have to estimate the value of the assets held under the security and prove for the balance of the debt. The estimated amount is declared on the proof of debt form. On one hand, the secured creditor will want a low estimate of the value so the shortfall and any dividend is high. On the other hand, there are consequences for placing a low estimate on these assets.

Redemption of security

Both liquidators and bankruptcy trustees have a right to redeem securities by paying out the estimated value. So if a secured creditor undervalues the secured assets to make their proof of debt high, the liquidator or trustee may pay them that low estimated amount and release the asset from the charge. Secured creditors will lose the right to the true value of the asset.

Enforced sale of asset

If the liquidator or trustee does not or can not redeem the security by paying out the amount estimated, they may require that the property be placed for sale. The sale will realize the asset and quantify the shortfall. Usually the secured creditor will want to sell the secured asset as quickly as practical.

Amending the estimate by request

The value of the asset may alter for some reason, or the asset may be sold after a proof of debt has been lodged for a price different from the estimated value. If this occurs, the secured creditor may apply to the liquidator or trustee, or to the court, to amend the estimate of the value of the asset on their proof of debt. If the liquidator, trustee or court is satisfied that the original value was made under a genuine mistake, or the value has changed since the estimate was made, they may allow the creditor to amend the estimate.

How does this affect paid dividends?

A change in the estimated value may happen after a dividend has been paid. Both the Corporations Act and the Bankruptcy Act have provisions for altering the secured creditor's rights to paid dividends if this occurs. Increasing the value of an estimate (lowering the shortfall and the amount of the proof of debt) will mean that the secured creditor will have to pay back a pro rata amount of any dividend received. Lowering the value of an estimate (raising the shortfall and the amount of the proof of debt) will entitle the creditor to a further (catch up) dividend.

Amending the estimate by sale

If the asset is sold after the estimate is made, the net amount realized (the amount received by the secured creditor) is automatically exchanged for the estimate made by the secured creditor. This amendment may also mean that the secured creditor may have to refund dividends, or be entitled to further dividends, depending of whether the sale price is higher or lower than the estimated value.

Deemed surrendering of security

A secured creditor may intentionally surrender their security and prove for the whole of their debt. Secured creditors may also be deemed to have surrendered their security if they vote for the whole of their debt (with the exception of meetings under Part 5.3A of the Corporations Act - being Voluntary Administrations). They lose all rights to the assets secured under the charge. Secured creditors should exercise care when voting at meetings.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

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Last Updated: 27.2.2008