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Brief Counsel

Strength of PPSA protection over debtor-initiated payments tested

23 November 2010

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The strength of the protection that the Personal Property Securities Act 1999 (PPSA) offers the recipients of monies paid by an insolvent debtor was tested recently in Stiassny and Ors v Commissioner of Inland Revenue – and failed to support the IRD’s right to retain funds paid to it. 

This Brief Counsel looks at the judgment and examines its implications for the PPSA.

Section 95 of the PPSA

Section 95 of the PPSA provides creditors who receive payments initiated by a debtor with priority over any security interest in:
  • the funds paid
  • the intangible that was the source of the payment (e.g. a bank account), and
  • any negotiable instrument used to effect the payment (e.g. a cheque).
The protection applies whether or not the creditor knows of any such security interest at the time the payment is made.
The intention of section 95 is to “leave money and cheques largely free from security interests to preserve the integrity of the payment system”.1 Creditors can receive payments initiated by debtors, safe in the knowledge that no-one has a security interest in those funds.
In Stiassny and Ors v Commissioner of Inland Revenue, the Commissioner unsuccessfully argued that section 95 was a complete answer to any claim, whether by the debtor or by secured creditors, for the reimbursement of GST which the plaintiffs argue was paid under a mistake.

Background to the case

The Central North Island Forest Partnership (CNIFP) – consisting of the Forestry Corporation of New Zealand Limited and CITIC New Zealand Limited (BVI) – defaulted in early 2001 on its loan obligations.  In February 2001, Messrs Stiassny and Graham were appointed as the receivers of FCNZ and CITIC.  Each of those companies then appointed one of the receivers as its representative on the management board of CNIFP.
CNIFP subsequently agreed to sell its assets for approximately USD $621 million plus GST.  As the partners in CNIFP, FCNZ and CITIC were named as the vendors in the sale and purchase agreement.
It was clear that the sale proceeds would be insufficient to repay CNIFP’s secured debt in full, let alone the GST on the sale, so the secured lenders wrote to the Commissioner, each claiming a security interest ahead of the Commissioner’s unsecured claim for GST on the sale price. 
The receivers, however, were concerned that they would be exposed to ruinous interest and penalties should they be found personally liable for the GST.  Their legal advice was to the effect that this was (or, at least, might be) a risk.  They therefore considered that they had little option but to pay the GST (approximately $123.4 million), which they did in late January 2004.
The receivers, FCNZ, CITIC and the security trustees subsequently commenced proceedings against the Commissioner, seeking to recover the GST amount.  The Commissioner responded by applying to strike out the claims on several grounds, including that section 95 of the PPSA conferred on the IRD a priority to the amount of the payment.

What is a debtor-initiated payment?

In order to qualify for the protection of section 95, a payment must be debtor-initiated.  The PPSA defines a debtor-initiated payment as being a payment by a debtor through the use of a negotiable instrument (e.g. a cheque), an electronic funds transfer, or another written payment mechanism.
The plaintiffs argued that a payment cannot be “debtor-initiated” if it is made under compulsion or pressure (in this case created by the GST regime and the receivers’ exposure to interest and statutory penalties) and under protest.2    
The High Court disagreed, concluding that a party’s motives for making a payment are irrelevant.

So why does section 95 not apply to the GST payment received by the IRD?

The High Court held that section 95 applies only to proprietary interests in the funds or the mode of payment (such as a claim to a security interest in a particular cheque).  This ensures that business can be carried on in situations where a broadly based security interest exists.  Section 95 does not apply to any other legal claim that might be made against the recipient of the payment – damages claims, for example.
In the CNIFP case, the plaintiffs are not seeking to recover the particular cheque sent by the receivers to the Commissioner, or the specific funds which were transferred into the Crown account when the cheque was banked.  Rather they are seeking damages against the Commissioner for money paid under a mistake (the mistaken belief that the receivers were personally liable for the GST on the sale of CNIFP’s assets).  On the High Court’s analysis, such a claim is not barred by section 95 of the PPSA.

Conclusion

The Court has provided a sensible and pragmatic interpretation of the claims to which section 95 applies.  It cannot have been Parliament’s intention to remove all recourse against creditors who may otherwise receive a windfall.
Does this mean that the protection provided by section 95 is illusory?  Not at all.  In the majority of cases, the High Court’s judgment is unlikely to affect the ability of creditors to retain payments initiated by their debtors.  It is only if a separate, identifiable claim can be maintained against a creditor that section 95 will be inapplicable.  Based on the unusual circumstances of this case, the High Court considered that the plaintiffs have arguable claims under the Tax Administration Act and for money paid under a mistake.
This may not be the last word on section 95 - the Commissioner has filed an appeal against the High Court’s decision.
For further information, please contact the lawyer featured.
Footnote
  1. Flexi-Coil Limited v Kindersley District Credit Union Limited (1993) 107 DLR (4th) 148
  2. This argument was supported by commentary in Widdup and Mayne, Personal Property Securities Act: A Conceptual Approach (revised edition, LexisNexis Butterworths, Wellington, 2002).

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