TGIF 24 November 2023 – Court rejects guarantor’s attempt to subrogate in related company insolvency

In this week’s TGIF, we examine the recent case of Re Eliana Construction and Developing Group Pty Ltd [2023] VSC 639 which considers guarantor subrogation rights in insolvency scenarios.

Key takeaways

• This case provides a pertinent reminder that deeds and guarantor agreements may alter the rights of parties in a liquidation scenario.
  
  
• Creditors, particularly those acting as guarantors, must recognise that their rights to subrogate, or make a claim in liquidation, may be significantly limited by the terms of such agreements.
  
  
• Liquidators should carefully scrutinise the terms of deeds and guarantor agreements before accepting or rejecting proofs of debt.

Background

Eliana Construction and Developing Group Pty Ltd (Eliana) and Rock Development & Investments Pty Ltd (Rock) (together, the Companies) were related companies that shared a sole director. Eliana operated as a property development and construction business and Rock was the registered owner of real property.

In April 2016, the Companies and their sole director entered into a Deed with the Commissioner of Taxation to repay substantial tax debts owed by Eliana and the sole director. Rock acted as guarantor under the Deed, with the real property it held serving as security. Eliana entered administration and was liquidated in late 2016. Rock was wound up in insolvency in 2017. Receivers and liquidators were appointed.

Rock’s receivers sold its property, paying the Commissioner $1,278,465.83 from the sale proceeds pursuant to the Deed. Rock’s liquidator later disputed some transactions associated with the sale, and the Commissioner consented to repay Rock $550,000.

Following that repayment, Rock’s liquidator filed a proof of debt in the Eliana liquidation. That proof of debt reflected the difference between the $1,278.465.83 in sale proceeds paid to the Commissioner and the $550,000 repaid by the Commissioner to Rock. Simultaneously, the Commissioner was lodging its own claims in the liquidation to recover the amounts owed to it by Eliana.

Eliana’s liquidator rejected Rock’s proof of debt. Rock appealed to the Supreme Court of Victoria, seeking orders to set aside the decision and to admit the proof of debt as a priority debt over the Commissioner.

Rock argued that it was entitled to rely on the principles of equitable subrogation (the right to ‘stand in the shoes’ of a creditor) to prove in Eliana’s liquidation as a priority creditor over the Commissioner.

Issues for determination

The Supreme Court was tasked to determine whether the Deed precluded Rock from proving in Eliana’s liquidation and subrogating to the rights of the Commissioner, while tax debts remained owing to the Commissioner by Eliana.

Decision of the Supreme Court

Associate Justice Hetyey held that the Deed prevented Rock from subrogating to the Commissioner's rights and from proving in Eliana's liquidation until all dues under the Deed were fully paid.

Deed

His Honour held that, on a plain reading of the Deed, Eliana’s liquidator was right to reject Rock’s proof of debt. The debt was of a kind explicitly contemplated within the Deed, which prevented Rock from proving for or subrogating to the rights of the Commissioner.

Rock argued that it discharged the debt owed by Eliana to the Commissioner when it made its initial payment of the sale proceeds to the ATO, notwithstanding that a portion of those proceeds were later repaid to Rock. His Honour was unpersuaded by that argument.

His Honour took the view that while payment of the sale proceeds initially discharged the liability owed by Eliana to the Commissioner, the Deed was worded in such a way that the Commissioner’s repayment reinstated Eliana’s liability to the extent of $550,000. Where such a liability existed, the Deed precluded Rock from proving in Eliana’s liquidation until it was repaid.

Equitable subrogation

Although the Deed operated as a complete answer to the appeal, His Honour also turned his mind to the availability of equitable subrogation.

Rock argued that its payment of the settlement proceeds wholly satisfied Eliana’s liability to the Commissioner, and that it was unconscionable for Eliana to deny Rock the right to subrogation in respect of its proof of debt.

His Honour determined that it would be inequitable to permit subrogation in the circumstances. While many reasons were given for this decision, they broadly stemmed from the fact that, under the Deed, Rock had explicitly agreed to defer its rights as Guarantor to subrogate to the rights of the Commissioner.

Allowing subrogation would place Rock in a better position than it had bargained for under the Deed. Further, Rock was attempting to circumvent the express terms to which it had consented, and that conduct was held to disentitle Rock from equitable relief.

Rule against double proofs

Equitable subrogation was also unavailable to Rock due to the rule against double proofs. This rule requires that there be no more than one proof lodged in respect of the same debt.

As guarantor under the Deed, Rock could not prove for the amount claimed until the Commissioner, as principal creditor, had received the entirety of its liability owed by Eliana. The liabilities claimed by Rock and the Commissioner could not be partitioned: they covered the same ground and the rule against double proofs applied to prevent equitable subrogation.

Comment

This case highlights the complexities involved when dealing with intertwined financial obligations of related companies and underscores the critical importance of understanding the implications of deeds and guarantor agreements in insolvency scenarios.

Creditors, particularly those acting as guarantors, must recognise that their rights to subrogate or make a claim in liquidation can be significantly limited by the terms of such agreements. Likewise, liquidators should carefully scrutinise the terms of these agreements before accepting or rejecting proofs of debt.