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Brief Counsel

Supreme Court - important win for creditors over liquidators

18 February 2015

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The Supreme Court has today considerably expanded the “good faith” defence for voidable transactions. 

Where a creditor “gave value” through the original transaction, that creditor can now defeat a voidable transaction claim by proving only that it acted in good faith, with no suspicion of insolvency. 

The Supreme Court has unanimously overturned the Court of Appeal’s decision in the Farrell v Fences and Kerbs Limited litigation on the “gave value” limb of the good faith defence in section 296(3)(c) of the Companies Act 1993. 

Allowing the appeal, the Supreme Court has decided that value given by a creditor at the time of the original transaction is sufficient to engage the good faith defence.  In a typical transaction, that would be the original credit sale.  A creditor need not have given “new” value at the time of or after the payment was made. 

The value must be “real and substantial”.  That will be measured at the time the value was given by the creditor, rather than at the time the payment is received by the creditor.  In typical transactions (supply of goods or services on credit), we would expect the value will always be “real and substantial”. 

Policy decision

While the Court carefully examined the language of the statute and precedent from here and overseas, it recognised that the decision was fundamentally a policy one.

The Court had to decide between two competing policy aims.

  • Is the purpose of the voidable transactions regime to protect the creditors as a whole?  Should the pari passu principle reign supreme?  If the liquidators’ argument were to be upheld, creditors could make use of the defence only if the “value” they had provided was new value.  That is, value provided in exchange for the payment, rather than the value originally supplied by the creditor when the debt was created.  Favouring this outcome would give legal certainty because the test would be clear.  It would, however, create commercial uncertainty, particularly because of the lengthy two-year clawback period.
  • Alternatively, is it more important that individual creditors be protected in their dealings with companies of questionable solvency?  That is, should “primacy … be accorded to fairness to individual creditors”?  Should the law promote the “broader social interest” in not disrupting commercial transactions, even if this is at the expense of the body of a company’s creditors as a whole?

Ultimately, the Supreme Court favoured the second policy aim: the protection of individual creditors.  It has ruled that the intention of the reforms (by which the defence was amended) was to create greater certainty for individual creditors and to align the New Zealand position with Australia.

Chapman Tripp Comments

It should be remembered that the defence has two other limbs.  Creditors wanting to use the defence will still need to show that:

  • they received the payment in good faith (without an intention to gain a preference), and
  • they had no suspicion, or reasonable grounds to suspect, that the company making the payment was insolvent.

But the result of this decision is to widen considerably the scope of the defence.  Many more creditors will now be able to take advantage of it.  In every case where a debt is being paid, there will have been an earlier supply of goods or services, so the “gave value” element will be satisfied. 

The decision will be particularly welcomed by suppliers who provide goods and services to companies in a one-off, credit-based transaction - particularly suppliers who are not familiar with the debtor company.

The law on this point has been unclear for some time.  Today’s decision follows a hearing on 18 March last year.  We understand that many liquidators have been waiting on this decision before taking action on existing claims.  We expect that they will now need to consider those pending claims carefully. 

It may be that the market will now see fewer voidable transaction claims as a result of this decision. 

Another important voidable transaction decision is on its way from the Court of Appeal.  While it is on a different point (peak indebtedness), it too may have the effect of increasing or decreasing liquidators’ claims.  We will comment on that as soon as it is available.

Click here for a copy of the judgment.

Click here, here and here for our previous commentary on this litigation.

For further information, please contact the lawyers featured.