Franchise agreements: When is a debt incurred in the context of insolvent trading law?

  • In the case of Re Overgold the Supreme Court of Victoria held that franchise fees were incurred when the franchise agreement was made, before the company became insolvent.
  • This case offers valuable guidance on the threshold question of when a debt is incurred in the context of insolvent trading law affecting franchisees.
  • The use of the statutory defence in s 588H(2) of the Corporations Act 2001 by the sole director of the franchisee failed, due to temporal limitations applied when assessing whether corporate assets available can be realised within a realistic timeframe.

As an essential prerequisite for director liability under the insolvent trading law in s 588G of the Corporations Act 2001, the liquidator (or creditor) must prove that the debts were incurred by the company while insolvent. The Act, however, does not prescribe precisely when a debt is incurred for the purposes of s 588G. Judicial authorities show it will vary and depend on the nature of the transaction and that it is necessary to analyse the contractual context in each case.1

The determination of when a debt is incurred is necessary for several reasons, including for the purpose of calculating the total amount of debt incurred during insolvent trading, as well as to show that the defendant director had, or ought to have had, the requisite awareness that there were reasonable grounds for suspecting insolvency at that time. 

In this context, the recent decision in Re Overgold Pty Ltd [2019] VSC 624 is noteworthy. The Supreme Court of Victoria considered a novel question arising from the collapse of an insolvent franchise business:2 whether a debt in relation to franchise fees and other charges under the franchise agreement that was the subject of this case (totalling $132,446.03) were incurred at the time of entry into the franchise agreement, or at some other time. 

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