Voidable transactions – the new regime

Parliament’s efforts to improve New Zealand’s corporate insolvency laws finally came into effect on 1 November this year.

The Companies Amendment Act 2006 has ushered in the voluntary administration regime, prohibitions on phoenix companies, further restrictions on those qualified to act as liquidators and various improvements, or at least amendments, to the liquidation rules.

By introducing a new regime for voidable transactions, the new rules affect all those who deal with companies facing potential insolvency. As a solvent creditor seeking payment or security from a company in difficulty, will you later be forced to hand over to a liquidator the money received or security granted?

In an insolvent liquidation, unsecured creditors are treated equally if the company’s assets are shared pro rata between them. The voidable transactions regime is intended to ensure that preferential payments to one favoured creditor, in the months leading up to liquidation, do not undermine that pro-rata sharing.

Until now, specific payments made in the two years before liquidation could be set aside if they were made when the company was unable to pay its debts and they enabled the creditor to receive more than in a liquidation. However, a payment received “in the ordinary course of business” could not be set aside. The question of what constituted ordinary course of business created much litigation and uncertainty.

Charges granted by the company in the 12 months before liquidation could also be set aside unless the creditor gave new value for the charge, the charge replaced an earlier charge, or the company was able to pay its debts at the time.

These rules have been changed, in an attempt to make them more certain, and therefore reduce the costs of enforcing them. However, although the new provisions borrow heavily from the Australian legislation, there will inevitably be new issues of interpretation, and it will be some time before their application is clearly understood.

The new rules

Under the new rules, a payment or other transaction within two years of the liquidation may be set aside if it was made when the company could not pay its debts, and if it enabled the creditor to receive more than it would have in a liquidation. The ordinary course of business test has been abandoned. In its place, where there is a “continuing business relationship”, the liquidator must look at all transactions as if they were one. This is the running account principle.

For example, in 2000 a supplier commenced trading with a customer company. By November 2005, the customer owed the supplier $50,000. Six months later, the customer owed $100,000. In November 2007 the customer was placed into liquidation, owing the supplier $20,000. On this scenario, the liquidator could argue that the supplier has been preferred by $80,000, being the difference between the highest point of indebtedness ($100,000) and the amount owed to the supplier by the customer when it was liquidated.

The new rule prevents a liquidator from cherry picking a single payment and ignoring the fact that the creditor continued to trade with the company as a result of that payment. However, it creates its own anomalies and difficulties. Particularly, when does the running account start? In the above example, should it start at $50,000 or $100,000? Some Australian decisions have said that the liquidator is free to choose the highest point, but is that fair?

Some commentators have suggested that it is wrong in principle to provide a liquidator with the discretion to choose a starting date within the two year period. It enables the liquidator arbitrarily to disregard the value of goods or services supplied after the commencement of those two years, but before the date chosen by the liquidator, even though the continuing business relationship existed at both times.

The changes to the voidable charges regime are not so radical. Charges given up to two years are now vulnerable, rather than 12 months under the previous law.

Both types of claim could previously be defended if the creditor acted in good faith and altered its position in reliance on the payment or charge being valid. That defence remains, although Parliament has added the further qualification that there must have been no reason to believe that the company was insolvent. Whether that requirement adds anything to the notion of good faith is yet to be seen, but it certainly emphasises that creditors in New Zealand may be better off not knowing that their debtor is insolvent. Not only is that at odds with prudent credit management, but such knowledge will usually be hard to avoid.

The transitional rules create a temporary extra burden on liquidators. For transactions prior to 1 November 2007, liquidators must prove that the payment or charge is voidable under both the old and new law. The new law does not render a transaction voidable if it would not have been voidable under the old law.

New procedure

One change that will be welcomed by creditors is that liquidators must now issue the court proceedings, as long as the creditor objects in writing to the liquidator’s notice within 20 working days. Previously, the liquidator could issue a notice and the creditor was required to commence court action if it disagreed with the notice.

In summary, the new voidable transactions regime has the capacity to increase uncertainty until the Courts set some guidelines for its application. However, it does seem that it will now be easier for liquidators to claw back payments made by insolvent companies. There will be no need to grapple with the ordinary course of business defence.

 Instead, a simple arithmetical exercise will show whether the net balance on the debtor’s account has been reduced while the debtor was insolvent. That net reduction will be voidable unless the creditor can show that it did not know of the insolvency, had no reason to know, and acted in good faith. A little knowledge of the debtor’s position will make that defence hard to run.

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Related topics: Restructuring & insolvency; Voidable transactions; Liquidation

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