liquidator may be able to claw back pre-liquidation payments if the company was
“unable to pay its due debts” at the time of that payment.
But just what is a due debt? The Supreme Court ruled last week in David Browne Contractors v Petterson
that a disputed claim against a company for damages may be a due debt, even
though in one sense such a claim is neither a debt nor due.
The liquidators of Polyethylene Pipe Systems Limited (In Liquidation) (PPS) claimed that NZ$912,937 of payments made by PPS to David Browne Contractors Limited and David Browne Mechanical Limited (David Browne) in September 2008, less than a year prior to PPS' liquidation, were voidable and could be clawed back for the benefit of all creditors.
At the time of the payments, PPS was facing separate claims from McConnell Dowell in relation to defective welding that PPS had carried out. PPS contested its liability in relation to those claims. In the course of correspondence between the parties, McConnell Dowell quantified its losses at a level that would have left PPS insolvent.
McConnell Dowell's claims were not adjudicated until July 2009 to David Browne, many months after the payments had been made. In that adjudication, PPS's defence was found to be without merit.
Under section 292 of the Companies Act, the payments to DBC and DBM were voidable if PPS was "unable to pay its due debts" at the time of the payments to David Browne. The question for the Supreme Court was whether the then undetermined claims for damages by McConnell Dowell could be taken into account in assessing whether PPS was able to pay its due debts at the time of the challenged payments.
The Supreme Court's decision
The Court ruled that "debt" includes not only actual debts, but also contingent debts. It also ruled that a debt is due if it is "reasonably temporally proximate". As a result, if a "reasonable and prudent business person" would be satisfied that there is sufficient certainty that a contingent debt will become legally due, then it must be taken into account in assessing whether a company can pay its due debts.
The Court held that no reasonable prudent business person would have considered that PPS had any defence to McConnell Dowell's claim. The adjudication of that claim could also have occurred relatively swiftly under the Construction Contracts Act 2002. Accordingly, the Court found that the McConnell Dowell claim must be taken into account in assessing whether PPS could pay its due debts at the time that it made the payments to David Browne. That meant that the payments were voidable, and could be clawed back by the liquidators.
While the Court's decision extends the words "due debts" beyond their usual meaning, the Court's interpretation reflects the realities of many near-insolvency situations. It can be artificial to treat a company as being able to pay its due debts when there is a claim against it for which it has no arguable defence and which could be determined relatively quickly. In our view, it is consistent with the purpose of the voidables regime for a company to be treated as being insolvent at that point.
Although the decision is consistent with the purpose of the regime, it does pose practical difficulties for insolvency practitioners and company directors. The threshold for voidability now depends on a very fact-specific test: whether a "reasonable and prudent business person" would consider that a claim will become due within a "reasonably temporally proximate" time. This will require a realistic assessment of the merits of a claim. If a defence is weak (albeit advanced in good faith) then the company may still be unable to pay its due debts for the purposes of the voidables regime. But if the defences are genuinely arguable, and with lengthy litigation required to resolve them, then the likelihood of them being treated as a debt is much lower.
If you or your business would like further
information or advice on this update, please do not hesitate to contact your
usual Bell Gully adviser.
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.