Creditors: When can you use a liquidation application to collect debt?

“Creditors have better memories than debtors”(Benjamin Franklin).

When you are struggling to recover your money from a recalcitrant debtor company, applying for its liquidation can be a very powerful collection tool. Suddenly the directors are faced with the imminent prospect of completely losing control of their company, its business and its assets to a liquidator. If the directors are just fighting a rearguard action to delay paying you, a liquidation (or “winding-up”) application should immediately focus their minds on finding a way to settle the debt.

But be warned – this only works with undisputed debt.  A recent SCA (Supreme Court of Appeal) case illustrates.

A R9m claim disputed

  • Company A (a provider of finance to the agricultural industry) made 3 loans to company B, totaling just under R9.2m
  • When B failed to repay the loans, A applied to the High Court for B’s liquidation
  • B defended the application, alleging that –
    • A’s representative knew that B’s representative (let’s call him “C”) had no authority from B to enter into the loan agreements
    • The loans were made solely for the benefit of C’s personal farming activities, not for company B’s benefit at all
    • The loan agreements were void and unenforceable as “simulated transactions” (B dropped an earlier allegation of fraudulent collusion between the company representatives).

Defending the claim – what a debtor must prove

The SCA confirmed that, in order to defend a liquidation application, an alleged debtor needn’t prove that its defence to the claim will succeed at trial.  On the contrary, all it has to prove is that it disputes the alleged indebtedness on grounds that are both –

  1. Reasonable and
  2. Bona fide (genuine, in good faith, without intention to deceive).

The court will decide, on the basis of the documents filed with it, whether or not the alleged debtor has raised facts which, if proved at a trial, would constitute a good defence.  If the defence is “not unreasonable” and if “a lack of bona fides cannot readily be inferred from the papers”, the liquidation application is likely to be dismissed.

A clear lesson for creditors

“In essence”, held the Court, “the matter serves as a stark reminder that winding-up proceedings are not designed for the enforcement of a debt that the debtor company disputes on bona fide and reasonable grounds”.

So whilst a liquidation application can be a formidable weapon to use against a problem debtor, if you apply on the basis of a disputed debt you are probably just wasting your time and money, putting yourself in the wrong unnecessarily, and risking an adverse costs order (on a punitive scale if you are found to have “abused the court process”).

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