LIABILITY OF CREDITORS TO PAY A CONTRIBUTION WHERE THERE IS INSUFFICIENT OR NO FREE RESIDUE IN AN INSOLVENT ESTATE TO MEET EXPENSES, COSTS AND CHARGES OF SEQUESTRATION

The following article discusses an interpretation of Section 106 read with Sub-Sections 89(2) and 14 (3) of the Insolvency Act 24 of 1936 (“the Act”) and specifically with regard to the matter of FirstRand Bank Limited v Master of the High Court (Pretoria) and Others (1120/19) [2021] ZASCA 33 (“the FRB matter”).

  1. In the FRB matter, a controversial question arose as to whether any or all creditors of an insolvent estate are liable to pay a contribution for costs where there is a shortfall in the free residue of the insolvent estate. The Supreme Court of Appeal duly satisfied the need for an answer in this matter.
  2. In the FRB matter, Mr J Z Msimango (“the Insolvent”) had owned two sectional title units which had been bonded to separate banks, namely Nedbank Limited and First National Bank, and the unit mortgaged in favour of Nedbank fell within the sectional title scheme managed by a Body Corporate. The Body Corporate launched the application for the sequestration of the Insolvent’s estate, as there had been arrear levies payable, and contended, in the application, that both properties should be sold upon sequestration and that the probability of a substantial dividend becoming available to concurrent creditors will be likely.
  3. After the final order of sequestration was granted, the trustees of the insolvent estate prepared the Liquidation, Distribution and Contribution accounts which reflected a contribution amounting to R46 663.16 payable by First National Bank and Nedbank on a pro rata sharing basis. The Body Corporate was thus not seen as liable for any contribution at all.
  4. FirstRand Bank was not satisfied that it was being required to pay a contribution towards costs of sequestration and delivered an objection to the liquidation and distribution account based on its opinion that the petitioning creditor, being the Body Corporate, was the creditor liable to pay the contribution in terms of Section 14(3) of the Act. However, the Master of the High Court stated that in terms of Section 14(3) of the Act, an exception to the rule includes arrear levies owing in respect of sectional title units, in terms of the Sectional Titles Act 95 of 1986.
  5. THE SUPREME COURT OF APPEALS (“SCA”) DISCUSSION
  • According to Meskin’s Insolvency Law, the controversy surrounds the interpretation of the below-mentioned sections, more specifically whether, where there is a sequestrating creditor who is as such liable to contribute, the entire contribution is payable by the sequestrating creditor alone, or whether the secured creditor/s referred to in Section 106(a) of the Act together with the sequestrating creditor are liable for the entire deficiency proportionately to the amounts of their claims.
  • The SCA was of the opinion that the sections of the Act applicable to the matter were as follows:
  • Sub-Section 14(3) which states as follows:

“in the event by a contribution by creditors under section 106, the petitioning creditor, whether or not he has proved a claim against the estate in terms of section 44, shall be liable to contribute not less than he would have had to contribute if he had proved the claim stated in the petition”;[1]

  • Sub-Section 89(2) which states as follows:

“If a secured creditor (other than a secured creditor upon whose petition the estate in question was sequestrated) states in his affidavit submitted in support of his claim against the estate that he relies for the satisfaction of his claim solely on the proceeds of the property which constitutes his security, he shall not be liable for any costs of sequestration other than the costs specified in subsection (1), and other than costs for which he may be liable under paragraph (a) or (b) of the provisio to section 106”;[2]  and

  • Section 106 which states as follows:

“Where there is no free residue in the insolvent estate or when the free residue is insufficient to meet all the expenses, costs and charges mentioned in section 97, all creditors who have proved claims against the estate shall be liable to make good any deficiency, the non-preferent creditors each in proportions to the amount for which he would have ranked upon the surplus of the free residue, if there had been any: provided that –

  • If all the creditors who have proved claims against the estate are secured creditors who would not have ranked upon the surplus of the free residue, if there had been any, such creditors shall be liable to make good the whole of the deficiency, each in proportion to the amount of his claim.
  • If a creditor has withdrawn his claim, he shall be liable to contribute in respect of any deficiency only so far as is provided in section 51, and if a creditor has withdrawn his claim within five days after the date of any resolution of creditors, he shall be deemed to have withdrawn the claim before nothing was done in pursuance of that resolution.”[3]
  • FirstRand Bank asserted that in terms of Section 89(2) of the Act it did not have any obligation to make a contribution and that while no concurrent creditor had proved a claim against the insolvent estate in terms of Section (14)(3) of the Act, the Body Corporate, as petitioning creditor, was obliged to make the same contribution as it would have, had it proved a claim against the estate, and in the absence of any other concurrent creditor it is therefore liable for the entire contribution.
  • FirstRand Bank further asserted that the primary cause of the shortfall in the free residue was because of the costs of sequestration incurred by the Body Corporate, and the Body Corporate thus made a full recovery of the arrear levies and FirstRand Bank, which gained no benefit from the sequestration, was prejudiced in having to provide a contribution towards costs incurred by the Body Corporate.
  • The court took it upon itself to analyse the sections to determine the intended meaning thereof. The court determined that the first part of Section 106 of the Act requires all creditors with proved claims to make good the deficiency, therefore it seems on the face of it that it would include secured creditors, as well as those relying solely on their security. However, it also provides for how contributions would be made by making non-preferent creditors liable in proportion to the amount claimed. The second part of Section 106 has to be read with Section 83(12), with the result that a secured creditor will be ranked to be paid a concurrent portion of the claim not satisfied from the proceeds of the security from the free residue, thus that secured creditor would be liable to contribute in proportion to the amount that would have ranked upon the surplus of the free residue, if any had been there.
  • Section 106(a) of the Act was introduced to make secured creditors liable for contributions where they had all relied solely on their security and there were no other creditors that could pay the contribution in terms of the main provision of Section 106, which makes sense if regard is given to the wording of Section 89(2) of the Act. The court considered the case of ABSA Bank v The Master & Others NNO 1998 (4) SA 15 (N), which clarified the point made above regarding Section 89(2). In ABSA Bank v The Master, it was said that Section 89(2) of the Act was intended to ensure that the burden of a contribution fell on the creditors in whose interest costs are being incurred in administration of the estate, which means that concurrent creditors as the secured creditors are entitled to recover what is owing to them from the proceeds of their security, and there is no need for the estate to incur expense to ensure secured creditors are paid, unless part of the claim exceeds the value of the security. Therefore, the only reason for a secured creditor to rely solely on their security would be to avoid the risk of having to pay a contribution towards costs. Thus, the court stated that in this matter liability only arises in terms of Section 106 (a) or (b), meaning only if all creditors are secured creditors who have relied solely on their security.
  • Where the only other creditor aside from secured creditors who rely solely on their security is a petitioning creditor who has not proved its claim, Section 14(3) of the Act is applicable, which states that when there is no free residue or it is insufficient and a contribution is required, the creditor who has instituted the proceedings is required to contribute no less than it would have to contribute if it had proved the claim. Therefore, when there is no or insufficient free residue, the first step would be to look at the petitioning creditor to contribute along with concurrent creditors who have proved claims and secured creditors who would have ranked upon the surplus of the free residue. Only if there are no other proved and concurrent creditors able to contribute are the secured creditors relying solely on their security called upon to pay.
  • Therefore, in the FRB case where there is a petitioning creditor and two secured creditors relying solely on their security, the petitioning creditor is solely liable to pay the costs of sequestration based on its claim. The interpretation made by the court’s guards against any potential unfairness against secured creditors.
  1. CONCLUSION

It was therefore made clear that a Body Corporate, as a petitioning creditor, is solely liable for costs of sequestration where the other creditors are secured creditors who rely solely on their security.

 

Jaco Willemse                                                     Ashleigh Vercuiel

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[1]                 Section 14(3) of the Act.

[2]                 Section 89 (2) of the Act.

[3]                 Section 106 of the Act.