Sense prevails on appeal in two New Zealand insolvency cases

David Craig, Journal of Banking and Finance Law and Practice, January 2006

In two judgments delivered on appeal in December 2005, the New Zealand courts have restored order in two important areas of insolvency law.

Trans Otway

The Court of Appeal decision in Trans Otway1 was profiled by David Craig in the Journal of Banking and Finance Law and Practice last year2. That decision was appealed to the Supreme Court, New Zealand 's highest court. The Supreme Court upheld the Court of Appeal's decision but, in doing so, it addressed an obvious gap in the lower court's reasoning.

The facts

The facts of Trans Otway were simple. Trans Otway and Newman, both operators in the freighting business, entered into an agreement to set off mutual debts owed between them. Newman subsequently went into liquidation. Its liquidators sought to set aside Newman's "payment" under the set-off agreement as a voidable transaction that preferred Trans Otway.

Court of Appeal's judgment

The Court of Appeal agreed with the Newman liquidators. Significantly, the Court accepted that the set-off did indeed prefer Trans Otway as it enabled it to receive more in Newman's liquidation than the general liquidation rules would permit.

Commentators criticised the Court of Appeal's decision for its failure to consider section 310 of the Companies Act 1993, which provides for the mandatory set-off of mutual claims involving a company in liquidation. How, they asked, could Trans Otway have been preferred when the transaction impugned produced the same result as mandatory law?

Supreme Court's judgment

Section 310 was considered on appeal by the Supreme Court. The Court acknowledged that there could be no preference where section 310 applies. However, unfortunately for Trans Otway, on the facts of this case, section 310 did not apply. At the time the set-off agreement was made, Trans Otway had reason to suspect that Newman was unable to pay its debts. This knowledge disentitled Trans Otway from being able to rely on section 310.

Interestingly, if Trans Otway's agreement with Newman was a "bilateral netting agreement" under New Zealand 's netting legislation (which it may have been), it would have prevailed in the Supreme Court. The set-off regime under the netting legislation, unlike that under section 310, does not require the solvent party to prove it was unaware of its counterparty's insolvency.

Building Depot

The Building Depot Limited (BDL) had granted security over its assets in favour of ANZ Bank and, subsequently, Fletcher Distribution. Under a priority agreement, the two secured parties agreed that ANZ would have first priority up to $2.5m and Fletcher would have second priority up to $5m.

BDL defaulted to ANZ. ANZ appointed receivers, who sold most of BDL's assets. ANZ was paid in full from the sale proceeds. The receivers then sought directions from the High Court as to how to apply the surplus.

High Court's judgment

In delivering its judgment3, the High Court gave effect to the apparently clear (but obviously unintended) meaning of a provision of the Receiverships Act 1993. The result was that Fletcher's security was extinguished by the sale by the ANZ receivers. It therefore ranked alongside BDL's unsecured creditors, not ahead of them.

Court of Appeal's judgment

Fletcher appealed to the Court of Appeal4, which reversed the lower court's decision. It did so by adopting a narrower interpretation of the relevant provision and "having regard to the Act as a whole and the legal system generally". As a result, the Court reinstated the long-standing principle of law that, in an insolvency, all security interests are satisfied in priority (according to their ranking), leaving unsecured creditors to share equally in any surplus.

The correct interpretation of this provision has now been clarified by amending legislation that was passed in December 2005. However, the Court of Appeal's judgment is still welcomed as establishing the position for receiverships that occurred prior to this amendment coming into effect.

 

1 [2005] 3 NZLR 678

2 (2005) 16 JBFLP 387

3 (2005) 9 NZCLC 263,830

4 Agnew v Pardington, CA 109-05, Dec 22 2005

Enquiries and information

For more information on any of the cases, articles and features in Financial Services Quarterly, please email Rachel Gowing or call on 64 9 916 8825.