Statutory demands and offsetting claims - what is best practice?

In brief - Malvern Developments successfully applies to have creditor's statutory demand set aside, satisfying Supreme Court of a genuine offset claim

In the matter of Malvern Developments (Vic) Pty Ltd [2021] NSWSC 888, the NSW Supreme Court considered an application to set aside a creditor's statutory demand under section 459H(1)(b) of the Corporations Act (Act) on the basis there was an offsetting claim greater than the amount demanded.

The Malvern decision is a timely reminder to be aware that a genuine offsetting claim that exists at the date of the hearing and is equal to or exceeds the amount claimed in a statutory demand will make an otherwise valid demand for an existing debt liable to be set aside. 

When considering whether to issue a statutory demand serious consideration must be given as to whether there exists a genuine dispute regarding the amount claimed, or as in this case, an offsetting claim. If a court considers that the demand wasn't issued in circumstances where a genuine dispute or offsetting claim has been established without a reasonable justification, then the issuing party will face the prospect of a costs order being made against them and the notice set aside. 

What is a statutory demand?

A statutory demand is a formal demand for payment of a debt made by a creditor of a company under section 459E of the Act. The debt in a statutory demand has to total more than the statutory minimum of $4,000 and the debtor company has 21-days from the date of service to either comply with the demand or commence court proceedings to set it aside. Unless an application has been made to set aside the statutory demand, the 21-day period is absolute and simply cannot be extended after it has expired.

If the 21-day period expires and no action has been taken, the company is deemed insolvent and may then be wound up by an application to either the Federal or the Supreme Court.

A statutory demand is often seen as a cheaper alternative to separate court proceedings to putting pressure on the debtor company to pay a debt if there is no issue arising in relation to the debt.

Setting aside a demand

A company may apply to the court for an order setting aside a statutory demand served on the company in the following circumstances as set out in section 459H(1) of the Act:

• there is a genuine dispute about the existence or amount of the debt to which the demand relates;

• it has an offsetting claim (as was argued to be the case in Malvern);

• because of a defect in the demand that causes substantial injustice unless it is set aside; or

• there is some other reason.

What makes an offsetting claim?

Section 459H(1)(b) of the Act prescribes that an offsetting claim is the amount of a claim(s) that a company has against the person who served the demand by way of counter-claim or cross-demand as at the date of the hearing. It is not sufficient that the claim will arise in the future. 

The concept of "offsetting claims" has been interpreted broadly by the courts and was described by Justice Barrett in Metro Chatswood Pty Ltd v CRI Chatswood Pty Ltd [2010] NSWSC 1017 at [13] as:

"the ability of the Plaintiff to assert in an offensive way a right which, if found to have substance, will result in the actual recovery by that claimant of a sum of money which, if not precisely quantifiable to the last dollar and cent, can be seen to be of a fairly quantifiable or calculable amount"

If the court is satisfied that the company has an offsetting claim, then the court is required to calculate the substantiated amount of the demand by deducting that offsetting claim from the admitted amount of debt.

What happened in Malvern Developments?

Prior to the present proceeding, Devakon had issued a statutory demand to Malvern for the amount of $333,045.10, which was owed pursuant to a judgment debt of the District Court of NSW. Issuing a demand to recover the amount of a judgment debt you would think seems fairly safe. It might be reasonable to assume that any dispute would have been dealt with before judgment was entered.

In applying to set aside the demand, however, Malvern raised an offsetting claim based on Devakon's alleged delays and work defects in a construction project. The construction contract between the parties allowed for Malvern to claim liquidated damages against Devakon in the amount of $5,575 per calendar day if practical completion was not achieved by the required date.

Devakon, in its response, argued that the date for practical completion under the contract was extended multiple times by the parties, and subsequently suspended, which avoided any liability on its part to pay liquidated damages. 

An interesting and crucial fact here was that separate proceedings under the Building and Construction Industry Security of Payment Act 2002 (VIC) (SOPA) had already been commenced by Malvern against Devakon in the Supreme Court. Malvern sought liquidated damages in the amount of $3.8 million, far exceeding the value of the statutory demand (SOPA Claim). 

Having regard to the SOPA Claim, counsel for Devakon had to accept at the hearing that the evidence led by Malvern established an offsetting claim and the amount of that claim exceeded the demand amount. 

The Court determined that the existence of the offsetting claim was a sufficient basis to set aside the demand. Costs were awarded in Malvern's favour and Devakon had to pay Malvern's costs of the proceedings. 

Lessons for creditors and debtors in light of decision in Malvern

Before issuing a statutory demand, it is best practice to issue a detailed letter of demand to the debtor setting out the basis of the claimed debt. If the debtor does not respond, then this letter can be relied upon to resist a costs order in any application to set aside the demand. It is also often successful in obtaining a costs order in favour of the creditor even if the demand is ultimately set aside.

If a demand is served upon a debtor company, it is essential, if the debt is disputed, to take action to set that demand aside within the 21-day period. This can often be done through correspondence, demonstrating the offsetting claim or another basis upon which the statutory demand should be set aside. However, if the correspondence does not see the demand withdrawn, an application to the court needs to be filed and served on the creditor within the 21-day compliance period. 

If there is a genuine offsetting claim, separate proceedings to claim that debt should also be commenced within that time period if possible. This is far more likely to convince a court that there is a genuine offsetting claim.