Secured creditors usually rely on their securities to satisfy their outstanding debts. But sometimes they may also wish to lodge a proof of debt in an insolvent estate to maximise their return.
Introduction
Secured creditors usually rely on their securities to satisfy their outstanding debts. But sometimes they may also wish to lodge a proof of debt in an insolvent estate to maximise their return. This applies when they know they will suffer a shortfall from the sale of the secured item (i.e. the value of the secured asset is less than the amount of the secured debt) and when there will be a dividend paid to unsecured creditors.
A 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 (i.e. that part of the debt not covered by the secured asset).
Both the Corporations Act 2001 and the Bankruptcy Act 1966 allow secured creditors to lodge proofs of debt and vote at meetings for their shortfall amounts. But only in voluntary administrations can they vote using the full secured debt. In all other administrations, secured creditors must be careful to complete their proof of debt correctly and only vote on the appropriate dollar amount, or they risk compromising their security. This Guide looks at the position in a bankruptcy scenario.
A secured creditor can voluntarily surrender their secured asset and prove for the whole debt as an unsecured creditor. Secured creditors would only surrender their security if they believe the security is worthless, or when a substantial dividend is being paid to the unsecured creditors.
Proving for a shortfall
Secured creditors can prove for the shortfall amount they have suffered—or will suffer. The shortfall is quantified once the secured asset is sold and then a secured creditor can lodge a proof of debt for any shortfall. Effectively, they become an unsecured creditor because the secured asset no longer exists.
However, a secured creditor can lodge a proof of debt for an anticipated shortfall before the secured asset is sold. This can happen when the asset cannot be readily—or reasonably—sold before a dividend is paid into the estate. If a secured creditor believes that they will suffer a shortfall from the sale, the shortfall is calculated by estimating the secured asset’s value and deducting that amount from the outstanding debt. The proof of debt can then be lodged for the balance of the debt, i.e. the estimated shortfall.
The proof of debt form lodged by the secured creditor must have all of the relevant detail, and creditors should attach any documents to support their debt and the estimated security value.
A secured creditor should have a reasonable basis for the estimated security value, as amending their valuation affects certain rights and obligations between the bankruptcy trustee and the secured creditor. These rights and obligations may cause the secured creditor to lose all, or part, of their rights under the benefit of their security.
A secured creditor can issue a notice to a bankruptcy trustee to determine whether they will redeem or force a sale of the secured asset. Once the notice is received, a bankruptcy trustee must redeem or force a sale within three months, or they will lose their rights over the asset.
Amendment of valuation
Occasionally the original value estimate placed on a security is no longer appropriate. This happens when the asset’s value naturally changes with market conditions, or when the value of the asset changes after the proof of debt was lodged. Alternatively, the original estimate may have been incorrect and the correct value is now known, or capable of being estimated.
In these cases, the estimate must be corrected, whether that correction is an increase or a decrease. Both Acts allow the estimate to be amended under certain conditions.
An amendment is not an automatic process. A secured creditor must apply to the insolvency practitioner, or the court, for an amendment in their claim and must show that the original estimate was reasonable at the time (i.e. under the circumstances), or that the value has changed since the estimate was made. If the amendment occurs after a dividend is paid, this may create complications. If the secured asset is sold after the proof of debt was lodged, the estimated security value must be amended to the sales amount.
Adjustment of a paid dividend
If the estimate of the secured asset’s value is amended after a dividend is paid, the secured creditor may have to either refund any excess dividend received (i.e. if the estimate increases and the shortfall decreases), or they will be entitled to a catch up dividend (i.e. if the estimate decreases and the shortfall increases).
The payment of a catch up dividend is subject to money being available in the estate and cannot disrupt any past dividend paid. That is, if the amendment occurs after a final dividend, the secured creditor is unlikely to be paid a catch up dividend.
Conversely, monies received by the insolvency practitioner from a dividend refund will be paid into the estate.
Subsequent realisation of security
Once a secured asset is sold, the shortfall amount owed to the secured creditor can be quantified. The Bankruptcy Act automatically amends value estimates made prior to asset realisation, and substitute the net amount received by the secured creditor. This automatically adjusts the shortfall and activates the repayment of an excess dividend and the catch up dividend provisions adjust any previous dividends received by the secured creditor.
Voting at meetings
A secured creditor’s actions may result in surrendering their security. In this regard the Acts vary slightly. Both Acts allow secured creditors to vote at creditors’ meetings for their shortfall amounts, if they have estimated the value of their secured asset (i.e. their shortfall amount). Their voting rights will be unaffected if they have already sold their secured asset as they are now, in effect, an unsecured creditor for the shortfall.
The Bankruptcy Act allows a secured creditor to vote for the shortfall—called the ‘excess of debt’—over the estimate declared on their proof of debt form. That is, they are only allowed to vote for their shortfall amount; they cannot vote for their secured debt amount (which is secured by the secured asset’s value).
The Corporations Act has the same provisions but also states that a security is deemed surrendered if a creditor votes for their full debt as an unsecured creditor. In essence, the secured creditor places a nil value on their security and is automatically redeemed.
However, the voluntary administration provisions allow a secured creditor to vote for the full amount of their secured debt without any risk of losing their rights.
Creditors must be aware of these implications 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.
Last Updated: 3.11.2017