Are Costs Orders provable debts?

Beware: costs pursuant to a costs order made after the relevant date

Central Queensland Development Corporation Pty Ltd v Sunstruct Pty Ltd [2015] FCAFC 63.

While the question of whether a Costs Order is provable in a winding up appears academic, it can have serious ramifications for companies entering administration with a view to executing a Deed of Company Arrangement (DOCA). 

Generally, it is a term of the DOCA that provable debts of the company are compromised by the DOCA.  It follows that a debt that is not provable will be enforceable against the company despite execution of the DOCA.  This may defeat the purpose of appointing administrators and proposing the DOCA in the first place, which would result in the effort and cost of rescuing the company being wasted.

Previously, the court authorities suggested that costs pursuant to costs orders made after the appointment of administrators may be provable debts in certain circumstances.  The Full Court of the Federal Court of Australia in Central Queensland Development Corporation Pty Ltd v Sunstruct Pty Ltd [2015] FCAFC 63 has held that this approach should not be followed.

The decision in Central Queensland Development Corporation:

The appeal concerned (among other things) the issue of whether certain claims against a company subject to a DOCA were compromised by the DOCA.

The appellant contended in the appeal that the primary Judge was in error in making a costs order of the counterclaim in favour of Sunstruct when this claim was compromised by the DOCA.

In determining this issue, the court had regard to ss 444D and 553 of the Corporations Act 2001 (Cth) (Act), which respectively deal with which creditors are bound by a DOCA and what claims are admissible to proof in the winding up of a company.

The Court found that the costs order was not compromised by the DOCA.  In short, the Court rejected the notion that a costs order made after the ‘relevant date’ (being after the appointment of an administrator in this case) is a provable debt within the meaning of s 553 of the Act, even where the event that gave rise to the costs order occurred before the relevant date.  

Previous decisions:

The court considered the previously decided cases at length.

In the Federal Court decision of Environmental and Earth Sciences Pty Ltd (ACN 002 347 971) v Vouris & Anor (2006) 57 ACSR 629, the court found that a costs order made after the appointment of an administrator to the defendant company was a provable debt under s 553 of the Act.  The Court came to this decision on the footing the plaintiff had a present claim as “the seeds” of the costs order, being the entry of judgment in the plaintiff’s favour, were the circumstances occurring before the appointment of the administrator.

The Court also considered the reasoning in the High Court decision of Foots v Southern Cross Mine Management Pty Ltd (2007) 234 CLR 52, which concerned whether a debt was provable in a bankrupt’s estate under s 82 of the Bankruptcy Act 1966 (Cth).  The High Court did not consider the reasoning in Environmental and Earth Sciences.  In Foots, a judgment for damages was entered against Mr Foots before he became bankrupt, and an order for costs arising from that litigation was subsequently made after the date of his bankruptcy.  The High Court held that the costs pursuant to the costs order were not provable in his bankruptcy.  However, the High Court stressed that the definition of provable debts under s 82 of the Bankruptcy Act 1966 (Cth) comprises a narrower class of provable debts than under s 553 of the Act. 

Rejection of the analysis in Environmental and Earth Sciences:

In coming to their decision that the costs order was not a present claim under s 553 of the Act, the Court stated that it does not agree with the analysis in Environmental and Earth Sciences, and instead adopted what was said by the majority in Foots:  

“When considering the nature of a costs orders it cannot be said that exposure to an adverse costs order is ‘incidental’ to liability of the underlying judgment debt and that as a factual and legal matter, costs are no longer an ‘incident’ of either verdict or judgment… the making of an adverse costs order turns upon discretionary considerations that arise independently of the entry of judgment against the debtor”.

What this decision means for you:

Bankruptcy:

This decision is a timely reminder that an individual will still be liable for costs order made against him or her after the date of bankruptcy.  That means that you will be liable for the debt even after being discharged from bankruptcy.  

DOCA:

This decision potentially impacts the viability of proposing a DOCA as the company may be left with a liability to pay costs even after the company is no longer subject to the DOCA.  Further, if the company has no capacity to pay the debt, the creditor may instead seek to have the company wound up.

When considering the options for the company, you should consider the possibility of a costs order eventually being made against the company (for instance, where there are Court proceedings on foot involving the company) as it may be possible to address the issue before appointing administrators.

Authors

Andrew Lambros is a Director at Bennett & Philp Lawyers

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