Lotus Gardens: a new shortcut for liquidators, or the long way round?

Thursday 10 April 2014

Authors: David Friar and Wayne Hofer

The Court of ​Appeal last week extended the armoury available to liquidators seeking to unwind a voidable transaction. Although the Companies Act sets out a procedure for liquidators to follow, the Court held that this is not exclusive, and that liquidators can also serve a statutory demand seeking payment of a voidable debt. Is this a shortcut likely to save costs, or is it a false economy?

The voidable claim

The case, Grant v Lotus Gardens Limited [2014] NZCA 127​, concerned the liquidation of Quantum Grow Ltd. The liquidators alleged that a payment made by Quantum Grow to Lotus Gardens Ltd was voidable. They served a notice on Lotus Gardens under s 294 of the Companies Act, but no objection was made by Lotus Gardens within the 20 working day time limit. As a result, the payment was automatically deemed to be set aside.

Ordinarily, a liquidator would then apply for orders under s 295 that the recipient repay the amount to the company. The recipient could seek to defend that claim by relying on a s 296 defence, arguing that it gave value or reasonably altered its position, and that it acted in good faith and did not suspect insolvency.

Here, however, the liquidators chose to serve a statutory demand on Lotus Gardens. Lotus Gardens did not respond or apply to set aside the demand, and so the liquidators applied to liquidate Lotus Gardens on the basis that Lotus Gardens was presumed to be unable to pay its debts. Lotus Gardens then took steps for the first time, opposing the application for liquidation.

Did the liquidators follow the right procedure?

Associate Judge Bell ruled that the liquidators had followed the wrong procedure. He said that a liquidator’s only remedy for a voidable transaction is to seek orders under s 295, and he therefore refused to make an order liquidating Lotus Gardens.

The Court of Appeal disagreed. It said that “the s 295 procedure is not exclusive. The setting aside of a transaction gives the liquidator a basis for recovery. That will usually be under s 295, but a liquidator may seek to recover a debt by different means”, such as a statutory demand.

What of the s 296 defences? The Court of Appeal ruled that the statutory demand procedure could not be used to avoid these defences. It said that s 296 is a defence not only to a claim under s 295, but would also justify setting aside a statutory demand or opposing an application for liquidation. Further, the Court said that if there were factors that would not justify an order for payment under s 295, those factors would also justify setting aside the statutory demand.

The Court of Appeal found that here, Lotus Gardens had no defence. It quashed Associate Judge Bell’s order, and ordered that Lotus Gardens be placed into liquidation.

Should liquidators now serve statutory demands for voidable transactions?

Although the Court of Appeal allowed the liquidators to use the statutory demand procedure, it warned liquidators against using it. The judges said that “we would not wish to be seen as encouraging the use of s 289 processes as a remedy for liquidators claiming recovery for set aside transactions” and that “it is good practice to utilise” s 295 instead.

As serving a statutory demand is quicker, cheaper and more effective than filing a court application, liquidators may wish to use this procedure, particularly if they have concerns about the financial position of the recipient.

However, there are increased risks in serving a statutory demand:

  • A statutory demand should not be issued if the liquidator knows that the voidable claim is disputed. Increased costs may be ordered against the liquidator personally if the demand was improperly issued.

  • Even if a liquidator does not know whether the voidable claim is disputed before serving a statutory demand, a recipient may raise a change of position defence in response to the demand. Given the Court of Appeal’s warning, the demand would likely be set aside and costs would likely be ordered against the liquidator personally.

  • It is difficult to know in advance whether a recipient may raise a change of position defence.

As JRR Tolkien said in The Fellowship of the Ring, “short cuts make long delays”. Where it is clear that there is no real dispute, a statutory demand will be the quickest and easiest procedure. But where there may be a dispute, serving a statutory demand may be the long way round, requiring a liquidator to incur additional costs before applying for orders under s 295. Where there is a potential dispute, liquidators should think carefully about whether it will be cheaper and more efficient to apply for orders under s 295, rather than seeking to shortcut the process by serving a statutory demand.​


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.

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