Ignorance is bliss: trade creditors find it easier to hold on to payments received

Thursday 19 February 2015

Authors: Murray Tingey, James Gibson and Nick Moffatt

​​​​The Supreme Court released its decision yesterday in the long-running Fences & Kerbs litigation concerning voidable transactions.1 The Court adopted an interpretation of the voidable transaction regime that it acknowledged was against the “generally accepted view in New Zealand”.

The Court’s decision means that it will now be significantly easier for a creditor to defend voidable transaction claims made by a liquidator. It provides greater certainty to suppliers that they will be able to retain payments received from debtors who subsequently go into liquidation. However, it will make it more difficult and expensive for liquidators to make recoveries on voidable transaction claims, which have been an important source of funds for conducting liquidations.

Background

If a liquidator seeks to avoid a transaction under the Companies Act, a creditor can raise a defence under section 296(3). That section gives a creditor a defence if, when the creditor received the property at issue, the creditor:

  • acted in good faith;

  • did not have reasonable grounds for suspecting that the debtor would become insolvent; and

  • either gave value for the property or reasonably altered their position in reliance on the transfer of the property.

If a creditor cannot show that they changed their position, they must show that they “gave value” for the property when they received it. Almost invariably, the creditor will have given value prior to a payment by the debtor, by providing goods or services on credit. The issue before the Supreme Court was whether value needs to be given by the creditor at the time of the payment, or whether it is enough for a creditor to show that value was given before the debtor made payment.

The Court of Appeal had taken the view that only value given at the time of the voidable payment was relevant.2 In practice, this interpretation makes it difficult for a creditor to make out the defence, as typically no further value is given by the creditor once the debtor has made payment.

The Supreme Court’s decision

The Supreme Court acknowledged that the decision it faced was “a stark one”. Should the Court prefer creditors as a whole, by allowing liquidators to challenge large numbers of pre-liquidation payments? Or should the Court prefer individual creditors, allowing them to retain payments received without notice of the insolvency of the debtor?

The Court decided in favour of individual creditors, ruling that a creditor can give “value” prior to the payment being made.

The Court found that the purpose of the 2006 amendments to the law was to provide greater certainty for creditors as to whether transactions could be void. The Court concluded that as creditors generally cannot establish the defence if value must be given at the time of payment, creditors are often at risk of having to repay amounts that they received in good faith with no reasonable suspicion of the company’s insolvency. They said that this undermines creditor certainty.

The Supreme Court also said that Parliament had intended to follow the Australian regime, despite differences in the wording. Significantly, the requirement for “valuable consideration” in the Australian defence is satisfied if a creditor has provided goods and services prior to the relevant payment. The Supreme Court ruled that the interpretation of the New Zealand legislation should be aligned with Australia.

What is “value”?

The Court also said that the “value” given must be real and substantial, and not merely nominal or trivial. While there is authority in Australia that the consideration need not be “full”, the Supreme Court said that it did not need to address this issue. However, the Court did doubt whether this would ever be an issue in cases which generally involve routine commercial transactions between unrelated parties dealing at arm’s length.

Are cash on delivery transactions potentially voidable?

The Court also considered whether prepayment or cash on delivery transactions are within the scope of the voidable transaction regime. Chief Justice Elias expressed reservations as to the view that such transactions could not be voidable. However, the remaining four judges said that such transactions are not voidable. We consider that this is correct. As Justice William Young explained, the voidable transaction regime is concerned with repayment of debt, and as no credit is extended under a prepayment or cash on delivery transaction, there is no debt.

What this means

The Supreme Court recognised that the Court of Appeal’s interpretation had been the generally accepted view in New Zealand. Consequently, the decision represents a significant change for both creditors and liquidators.

The decision will provide significant relief for creditors aggrieved at the perceived unfairness of having a liquidator seek repayment of transactions when they had no knowledge of the debtor’s insolvency. It will now be much more likely that they will be able to establish the defence in section 296(3) to such claims. The result is that less applications to set aside transactions are likely to be brought by liquidators.

Conversely, the Court’s decision will require a significant change in how liquidators approach voidable transactions. In practice, the focus of argument will now be the creditor’s knowledge of the company’s insolvency. It is important to remember that it is for a creditor to prove that they did not have reason to suspect the company’s insolvency, and that a reasonable person in their position would not have so suspected. Consequently, where a liquidator considers a transaction to be voidable, they still need to pursue this with the creditor who received payment.

Where the creditor raises their lack of knowledge of insolvency in response, the liquidator will need to carefully consider the likelihood of the creditor being able to establish this in court before bringing an application to set aside the transaction. It can often be very difficult for a liquidator to negate a claim by the creditor that there was no reason for them to suspect insolvency. In practice, this may result in a greater use of discovery and cross examination in voidable applications as the creditor’s knowledge becomes more important.

Practically speaking, it will be in a creditor’s interests to know as little as possible about the debtor’s financial position prior to receiving a payment. Creditors should seek to avoid making reference to the potential insolvency of the debtor in writing. The decision may also deter creditors from taking enforcement action, which subsequently may be used as evidence of their knowledge.

Settlements and judgments from voidable transaction claims had been important source of funding for liquidators. They will have to consider alternate sources to fund liquidations.


1 Fences & Kerbs v Farrell [2015] NZSC 7.

2 Farrell v Fences & Kerbs Limited [2013] NZCA 91. For more details, see our earlier client update.


Disclaimer

This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

For more information
  • James Gibson

    Partner Auckland
  • Mike Colson

    Partner Wellington
Related areas of expertise
  • Restructuring and insolvency
  • Litigation and dispute resolution