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Brief Counsel

Insolvent transactions – prior consideration is enough for the good faith defence

11 December 2012

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The High Court has clarified the extended good faith defence, introduced into the Companies Act in 2007, for creditors facing ‘claw back’ of a payment by liquidators.1

The Court’s interpretation, while good news for creditors, may make it more difficult for liquidators to recover insolvent transactions.

The 2007 amendment to section 296(3)

Before the 2007 amendment, a creditor could use the good faith defence only if it had acted in good faith and relied to its detriment on the validity of the payment.  In 2007, the defence was expanded also to protect a creditor who had acted in good faith, and who “gave value”. 

The question arises, when must that value be provided?  Before or after the allegedly voidable payment?

In Meltzer v Hiway Stabilizers New Zealand Ltd, the High Court has said that either value prior to payment by the debtor, or fresh value given by the creditor after payment by the debtor, is enough.  In doing so, the Court has followed Australian authority, and has agreed with the recent decision of Associate Judge Christiansen in Farrell v Fences & Kerbs Ltd.2

For a copy of Meltzer v Hiway Stabilizers New Zealand Ltd, click here.

For a copy of Farrell v Fences & Kerbs Ltd, click here.

Background

The liquidators of Window Holdings Limited sought to set aside payments the company had made to Hiway Stabilizers NZ Limited.  It was accepted that, at the time of the payments, the company was unable to pay its debts, and that Hiway had received more towards the satisfaction of its debts than it would have received in the company’s liquidation if still a creditor.  As such, the payments were insolvent transactions under the Companies Act. 
Hiway relied on the section 296(3) defence to oppose the liquidators’ application.  The section prevents the recovery of payments if the party from whom recovery is sought proves that, when it received the payments:
  • it acted in good faith
  • a reasonable person in its position would not have suspected, and it did not have reasonable grounds for suspecting, that the company was, or would become, insolvent, and
  • it gave value for the property or altered its position in the reasonably held belief that the transfer was valid and would not be set aside. 

The liquidators accepted that Hiway satisfied the first two limbs of the defence.  It had acted in good faith and did not suspect insolvency.  The case therefore hinged on whether Hiway could prove, in the words of the section, that:

“when [Hiway] received the property … [Hiway] gave value for the property”.

The liquidators’ unsuccessful argument

The liquidators relied on a plain meaning of the words in section 296(3) to argue that Hiway had to provide fresh or new value after the payments were made.  The section itself requires value to be given “when [the creditor] received the property”.  In this case the property was the payments in question.
The liquidators also said that, if “gave value for the property” included value given before payment, the third limb of the section 296(3) defence would be redundant, because a creditor will always have provided some prior value, otherwise it would not be a creditor. 
The liquidators went on to argue that that Parliament did not intend to override the pari passu rule and that creditors should not be able to claim the benefit of the running account defence as well as the section 296(3) defence.

“Gave value” includes value given prior to payment

The Court preferred Hiway’s argument that the primary concern is whether there was a direct relationship between the payment received and the value given.  That included the value given in the original transaction. 
The basis for the decision was the policy behind the defence, and Parliament’s desire to adopt the Australian position.
On the policy, Justice Toogood agreed with the approach taken recently by Associate Judge Christiansen in Farrell v Fences & Kerbs Ltd.  It would be “inequitable” to allow the company in liquidation to:

“keep what it has received and to recover what it paid for it, in order to increase the distribution to creditors who have provided value but received no payment”.

Avoiding the payment would, it seems, let the general body of creditors have their cake and eat it too.

The Court agreed that the 2007 amendment to the New Zealand statute was intended to align our law with the Australian position.  The Judge reviewed legislative material, Australian legislation and some Australian case law.  His conclusion was that Parliament had intended to adopt the Australian defence, even though the words of the New Zealand provision are not identical.

Important development for liquidators

The recent decisions in both this case and in Farrell v Fences & Kerbs Ltd, make recovery of insolvent transactions more difficult for liquidators. 

The defence has been widened considerably from the pre-2007 requirement that the creditor must act in reliance on the validity of the payment.  That requirement has effectively gone in relation to voidable payments to creditors.  Every creditor will have provided value – by advancing the credit in the first place.

A payment to a creditor will therefore never be voidable where the creditor acted in good faith and had no reason to suspect insolvency.  However it is worth noting that the section 296 defence applies to a wide range of cases, and is not limited to claims against creditors, so the third element will not always be redundant as suggested by the liquidators in the Meltzer case. 

But the arguments are very finely balanced.  There are other policy considerations, including the fundamental concept of pari passu sharing that underlies the law of insolvency.  We expect that the Court of Appeal will be called on to rule on the issue.  In doing so we would expect it to consider those policy issues, and review, in greater detail than the High Court, the history of the Australian provision and case law. We will follow developments with interest. 

Thanks to James McMillan and Anna Peacey for writing this Brief Counsel. For further information, please contact the lawyers featured.

Footnote

1    Meltzer v Hiway Stabilizers New Zealand Ltd [2012] NZHC 3281

2    Farrell v Fences & Kerbs Ltd [2012] NZHC 2865

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