Making a payment to a creditor (in this case, the IRD) will in and of itself give that creditor priority over competing creditors. A recent Court of Appeal judgment to that effect, under section 95 of the Personal Property Securities Act (PPSA), carries serious implications for receivers.1
The ruling suggests that the receiver has to choose between two risks – the risk of incurring penalty payments or the risk of conceding PPSA priority status unnecessarily. We suggest ways to escape this dilemma...
What does section 95 say?
Section 95 is designed to facilitate trade, in particular the payment of debts. It provides that, where a debtor “initiates” a payment of a debt owed by the debtor, the creditor receiving the payment will have priority over any security interest in the funds.
It does not matter whether the payee is a secured or unsecured creditor. It does not matter whether the security interest concerned is perfected or unperfected. Knowledge of the security interest, or lack of knowledge, is irrelevant.
The court ruling
IRD successfully invoked section 95 to prevent the money (a not insubstantial $123 million) from being recovered by the receivers. IRD succeeded although:
- the sum was paid to the IRD on the same day that the receivers’ appointor advised the IRD that they disputed the IRD’s entitlement to the funds, and
- the Court agreed that the receivers could properly have paid the funds to their appointing creditors, ahead of the IRD. (The receivers chose not to because the position at that stage was unclear, and the risk of penalties and interest on $123 million was too great.)
The Court accepted that the receivers were not liable to make the payment. But because they had caused the debtor to initiate the payment, section 95 applied to give the IRD the funds free of any security interest.
The Court’s ruling makes section 95 a very powerful provision.
The Court of Appeal agreed with the High Court that section 95 deals only with priority, and does not prevent in personam claims. That is, claims other than to some property interest in the funds themselves, such as a claim for money paid under a mistake, or under duress etc. Similarly, section 95 would not be a barrier to a liquidator’s voidable transaction claim.
However, although the payment in this case was made due to a mistaken belief on the part of receivers that the IRD had, or potentially had, better entitlement to the funds than their appointing creditors, that mistake could not form the basis of such a claim. The Court said it would subvert the purpose of section 95 to allow a mistake about priority to overturn the effect of section 95. That is the “very type of claim which is precluded by section 95”.
The result puts receivers, and liquidators, in a difficult position. Although the exact circumstances of this case may be a little unusual, receivers may from time to time wish to make a payment on the basis that priority, or entitlement to the funds, is disputed. That may well be prudent if the alternative is to face the risk of personal liability for penalties and interest.
However, the Court of Appeal’s interpretation means that it is not possible to make a payment while reserving the priority dispute for another day. The payment itself determines that the payee has priority over the competing creditor (usually the appointor of the receiver).
The Court reached this decision, in part, by confirming that common law concepts should not be implied into the PPSA, except where they were consistent with its policy. They refused, therefore, to accept the financiers’ submission that the section was not intended to apply where a receiver had been appointed and an insolvent debtor was engaged in the final realisation and distribution of its assets.
The comparison with fixed and floating charge cases was not appropriate in a PPSA framework. The result was to uphold the purpose of section 95, being to enable a debtor to pay its creditors irrespective of a security interest in the funds used to make the payment.
Is the result correct in terms of policy?
We question whether the result is indeed consistent with PPSA policy, particularly where the priority dispute had expressly been notified to IRD prior to the payment, with the secured creditors expressly reserving their position.
The purpose of section 95 is, according to the Court, to “facilitate ordinary trade and commerce”. There seems to be less of a need for such a rule in an insolvency situation, as the secured creditors in this case argued.
The sum involved would suggest that this litigation is not over yet. The Supreme Court may have the last word. We will continue to follow any further developments in this case.
How can this problem be avoided?
In some cases it may be possible to agree with the creditor that the payment itself is not to affect priority, or that funds are held in escrow. In other cases a rapid application to Court might be possible. If neither of those options is available, it may be possible to structure the payment so that it is not a “debtor initiated” payment.
Our earlier commentary on the High Court decision can be found here. A copy of the decision can be accessed here.