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Proofs of Debt and Securities over Assets

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Introduction

Major Headings

Proving for a shortfall
Redemption of security
Amendment of valuation
Adjustment of previous Dividend
Subsequent realization of security
Voting at Meetings

Overview

Secured creditors usually rely on their securities to satisfy their outstanding debts. But at times they may also wish to lodge a proof of debt in the insolvent estate to maximize their return. They will do this when they will suffer a shortfall (the value of the asset secured is less than the secured debt) and there will be a dividend paid to unsecured creditors.

The secured creditor may also wish to vote on certain resolutions in the estate. They may have an interest in the conduct of the estate in their role as an unsecured creditor for the amount of that shortfall.

Both the Corporations Act and the Bankruptcy Act allow secured creditors to lodge proofs of debt and vote at meetings for the amount of their shortfalls. Only in Voluntary Administrations can they vote using the full secured debt. In all other cases secured creditors must be careful to complete their proof of debt correctly and only vote for the appropriate dollar amount, or they risk compromising their security.

The secured creditor may voluntarily surrender the secured asset and prove for the whole debt as an unsecured creditor. They are only likely to do so where they believe that the security is worthless and a substantial dividend is being paid to unsecured creditors.

This paper contains links to legislation. These will open in a separate window. Most of the legislation shown in this paper is only a summary or extract of the entire section. The links go to the entire section.

Proving for a shortfall

Secured creditors are able to prove in insolvent estates for the amount of any shortfall they have suffered or will suffer. Once the assets under the security have been sold, any shortfall will be quantified and the secured creditor will have no difficulty in lodging a proof of debt for any shortfall. They effectively become an unsecured creditor.

But, a secured creditor also has the right to lodge a proof of debt for an anticipated shortfall before the secured asset is sold. This may occur because the asset cannot be readily or reasonably sold before a dividend will be paid in the estate. If this is the case and the secured creditor believes that they will suffer a shortfall, the shortfall will be calculated by estimating the value of the secured asset and deducting that estimate from the outstanding debt. The proof can be lodged for that estimated shortfall.

The Bankruptcy Act says:

BANKRUPTCY ACT 1966 - SECT 90
Proof of debt by secured creditor
(1) A secured creditor is entitled to prove the whole or a part of his or her secured debt in the debtor’s bankruptcy in accordance with the succeeding provisions of this Division, and not otherwise.
(3) A secured creditor who realizes his or her security may prove for any balance due to him or her after deducting the net amount realized, unless the trustee is not satisfied that the realization has been effected in good faith and in a proper manner.
(4) A secured creditor who has not realized or surrendered his or her security may:
(a) estimate its value; and
(b) prove for the balance due to him or her after deducting the value so estimated.
(5) A secured creditor to whom subsection (4) applies shall state particulars of his or her security, and the value at which he or she estimates it, in his or her proof of debt.

The Corporations Act has very similar wording and has the same effect.

CORPORATIONS ACT 2001 - SECT 554E
Proof of debt by secured creditor
(1) In the winding up of an insolvent company, a secured creditor is not entitled to prove the whole or a part of the secured debt otherwise than in accordance with this section and with any other provisions of this Act or the regulations that are applicable to proving the debt.
(4) If the creditor realizes the security, the creditor may prove for any balance due after deducting the net amount realized, unless the liquidator is not satisfied that the realization has been effected in good faith and in a proper manner.
(5) If the creditor has not realized or surrendered the security, the creditor may:
(a) estimate its value; and
(b) prove for the balance due after deducting the value so estimated.
(6) If subsection (5) applies, the proof of debt must include particulars of the security and the creditor’s estimate of its value.

The actual proof of debt form lodged by the secured creditor must have all of the relevant detail, and it is always preferable for creditors to attach any documents supporting their debt and the estimate of the value of the security.

CORPORATIONS REGULATIONS 2001 - REG 5.6.41
Disclosure of security
A proof of debt or claim must state:
(a) whether the creditor is or is not a secured creditor; and
(b) the value and nature of the creditor's security (if any); and
(c) whether the debt is secured wholly or in part.

Estimating the value of the secured asset should not be done casually, as it results in certain rights and obligations between the insolvency practitioner and the secured creditor. These rights and obligations may cause the secured creditor to lose all or part of their rights under and benefit of their security.

Redemption of a security

Both Acts have provisions to deter secured creditors from using a very low or nominal estimate of value of the asset secured.

The insolvency practitioner (the estate) has the right to redeem - effectively purchase - the secured asset from the secured creditor by paying the amount of that estimate. The asset will then form part of the assets available for unsecured creditors and the secured creditor will have a right to lodge a proof of debt for their shortfall. They will do this if the asset is really worth a lot more than the estimated value put on it.

For example: A secured creditor is owed $120,000 and has security over an asset worth $100,000. The secured creditor places a $70,000 value on the asset and proves in the estate for $50,000. The practitioner may redeem the asset for $70,000 (effectively making a $30,000 profit for the estate) and allow the proof of debt for $50,000. The downside for the secured creditor is they will only receive a cents-in-the-dollar dividend on the $30,000 lost from the value of the security.

If the insolvency practitioner cannot redeem the security but does not agree with the estimate of value given, they may force the asset to be sold to resolve the valuation issue.

The Bankruptcy Act says:

BANKRUPTCY ACT 1966 - SECT 91
Redemption of security by trustee etc.
(1) Where a secured creditor has lodged a proof of debt in respect of the balance due after deducting the estimated value of his or her security, the trustee may at any time redeem the security on payment to the creditor of the value at which it has been estimated by the creditor.
(2) If the trustee is dissatisfied with the value at which a security has been estimated by a creditor, he or she may require the property comprised in the security to be offered for sale at such times and on such terms and conditions as are agreed on by the creditor and the trustee.
(3) If any such property is offered for sale by public auction, the creditor, or the trustee on behalf of the estate is entitled to bid for, and purchase, the property.

The Corporations Act says:

CORPORATIONS ACT 2001 - SECT 554F
Redemption of security by liquidator
(1) This section applies where a secured creditor’s proof of debt is in respect of the balance due after deducting the creditor’s estimate of the value of the security.
(2) The liquidator may, at any time, redeem the security on payment to the creditor of the amount of the creditor’s estimate of its value.
(3) If the liquidator is dissatisfied with the amount of the creditor’s estimate of the value of the security, the liquidator may require the property comprised in the security to be offered for sale at such times and on such terms and conditions as are agreed on by the creditor and the liquidator or, in default of agreement, as the Court determines.
(4) If the property is offered for sale by public auction, both the creditor and the liquidator are entitled to bid for, and purchase, the property.

Both Acts also allow the secured creditor to issue a notice to the insolvency practitioner to determine whether they will either redeem or force a sale of the asset. They will do so if the liquidator threatens to redeem or the secured creditor wishes to be sure that their estimate will be accepted. The insolvency practitioner must then redeem or force a sale within 3 months of receiving that notice or lose that right.

Amendment of valuation

Occasionally the original estimate of value placed on a security is no longer appropriate. This may happen if the asset's value naturally changes with market conditions or other circumstances have occurred that change its value after the time that the proof of debt was lodged. Alternately, the original estimate may have been incorrect and the true value is now known or capable of being estimated.

In these cases the estimate will need to be corrected, whether that correction is an increase or decrease. Both Acts allow the estimate to be amended under certain conditions.

The Bankruptcy Act says:

BANKRUPTCY ACT 1966 - SECT 92
Amendment of valuation
(1) Where a secured creditor has lodged a proof of debt in respect of the balance due after deducting the estimated value of his or her security, he or she may, at any time, apply to the trustee or the Court for permission to amend the proof of debt by altering the estimated value.
(2) If the trustee or the Court is satisfied:
(a) that the estimate of the value of the security was made in good faith on a mistaken basis; or
(b) that the value of the security has changed since the estimate was made;
the trustee or the Court may permit the creditor to amend his or her proof of debt accordingly.

The amendment is not automatic. The secured creditor must apply to the practitioner or the court for the amendment and will have to show that original estimate was reasonable under the circumstances at the time, or the value must have changed since the estimate was made. Changes cannot be made on a whim.

The Corporations Act says:

CORPORATIONS ACT 2001 - SECT 554G
Amendment of valuation
(1) If a secured creditor’s proof of debt is in respect of the balance due after deducting the creditor’s estimate of the value of the security, the creditor may, at any time, apply to the liquidator or the Court for permission to amend the proof of debt by altering the estimated value.
(2) If the liquidator or the Court is satisfied:
(a) that the estimate of the value of the security was made in good faith on a mistaken basis; or
(b) that the value of the security has changed since the estimate was made;
the liquidator or the Court may permit the creditor to amend the proof of debt accordingly.

The estimate may be amended if the insolvency practitioner or the court believes that the value has changed or the original estimate was mistaken. This may cause a further issue if this amendment occurs after the payment of a dividend.

Adjustment of previous Dividend

If the estimate of the value of a secured assets is amended after a dividend has been paid, the secured creditor may have to either have to refund any excess dividend they have received (if the estimate increases and the shortfall decreases), or they will be entitled to a catch up dividend (if the estimate decreases and the shortfall increases).

The payment of a catch up dividend will be subject to money being available in the estate and cannot disrupt any past dividend paid in the estate. That is, if the amendment occurs after a final dividend, the secured creditor will probably not receive his catch up dividend.

Conversely, monies received by the practitioner from a refund of a dividend will be paid into the estate.

The Bankruptcy Act says:

BANKRUPTCY ACT 1966 - SECT 93
Repayment of excess
(1) Where a creditor who has amended a proof of debt under section 92 has received, by way of dividend, any amount in excess of the amount to which he or she would have been entitled under the amended proof of debt, he or she shall forthwith repay the amount of the excess to the trustee.
(2) Where a creditor who has so amended a proof of debt has received, by way of dividend, less than the amount to which he or she would have been entitled under the amended proof of debt, he or she is entitled to be paid, out of moneys for the time being available for distribution as dividend, the amount of the deficiency before those moneys are applied in the payment of future dividends, but is not entitled to affect the distribution of a dividend declared before the amendment of the proof of debt.

The Corporations Act has almost identical wording.

CORPORATIONS ACT 2001 - SECT 554H
Repayment of excess
(1) Where a creditor who has amended a proof of debt under section 554G has received, in the winding up of the debtor company, an amount in excess of the amount to which the creditor would have been entitled under the amended proof of debt, the creditor must, without delay, repay the amount of the excess to the liquidator.
(2) Where a creditor who has so amended a proof of debt has received, in the winding up of the debtor company, less than the amount to which the creditor would have been entitled under the amended proof of debt, the creditor is entitled to be paid, out of the money remaining for distribution in the winding up, the amount of the deficiency before any of that money is applied in the payment of future distributions, but the creditor is not entitled to affect a distribution made before the amendment of the proof of debt.

Subsequent realization of security

Once the secured asset is sold, the amount of any shortfall to the secured creditor can be quantified.

Both Acts automatically amend estimates of values made before the realization and substitute in the net amount received by the secured creditor. This automatically adjusts the shortfall and will activate the repayment of excess dividend and catch up dividend provisions set out above to adjust any previous dividends received by the secured creditor.

The secured creditor should then be in the same position that they would have held if the secured asset was sold before the proof of debt was lodged and the dividend was received.

The Bankruptcy Act says:

BANKRUPTCY ACT 1966 - SECT 94
Subsequent realization of security
Where a secured creditor who has lodged a proof of debt in respect of the balance due after deducting the estimated value of his or her security subsequently realizes his or her security, or it is realized under section 91, the net amount realized shall be substituted for the estimated value of the security and section 93 applies as if the proof of debt had been amended accordingly by the creditor under section 92.

The Corporations Act has different words, but has the same effect.

CORPORATIONS ACT 2001 - SECT 554J
Subsequent realization of security
Where:
(a) a secured creditor’s proof of debt is in respect of the balance due after deducting the creditor’s estimate of the value of the security; and
(b) subsequently:
(i) the creditor realizes the security; or
(ii) the security is realized under section 554F;
the net amount realized is to be substituted for the estimated value of the security and section 554H applies as if the proof of debt had been amended accordingly under section 554G.

Voting at Meetings

There is one issue that may result in a deemed surrender of a security. In this issue the Acts vary slightly.

Both Acts allow secured creditors to vote at meetings of creditors. This can only occur if secured creditors make an estimate of the value of the secured asset and believe they will suffer a shortfall. It will not affect them if they have already sold their secured asset as are now in effect unsecured creditors.

The Bankruptcy Act allows a secured creditor to vote for the shortfall, termed as the excess of debt over the estimate declared on their proof of debt. That is, they are only allowed to vote for the amount of their shortfall.

BANKRUPTCY ACT 1966 - SECT 64ZA
Entitlement to vote
(5) If a creditor is a secured creditor, the creditor is not entitled to vote unless the debt, or the total amount of the debts, owed to the creditor exceeds the amount estimated by the creditor in the statement given to the trustee under section 64D to be the value of the security.

The Corporations Act has the same provisions but goes one step further and states that a security will be deemed surrendered if the creditor votes for the whole of their debt as an unsecured creditor. In essence, the Corporations Act says that the secured creditor places a nil value on their security and it is automatically redeemed.

The exceptions are meetings held under the voluntary administration provisions where secured creditor may vote for the full amount of their secured debt without any risk of losing their rights.

CORPORATIONS REGULATIONS 2001 - REG 5.6.24
Votes of secured creditors
(1) For the purposes of voting, a secured creditor must state in the creditor’s proof of debt or claim:
(a) the particulars of his or her security; and
(b) the date when it was given; and
(c) the creditor’s estimate of the value of the security;
unless he or she surrenders the security.
(2) A creditor is entitled to vote only in respect of the balance, if any, due to him or her after deducting the value of his or her security as estimated by him or her in accordance with regulation 5.6.41.
(3) If a secured creditor votes in respect of his or her whole debt or claim, the creditor must be taken to have surrendered his or her security unless the Court on application is satisfied that the omission to value the security has arisen from inadvertence.
(4) This regulation does not apply to a meeting of creditors convened under Part 5.3A of the Act.

Creditors should be aware of this issue before voting on resolutions as an unsecured creditor.

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: 2.6.2010