Creditors of Insolvent Companies
The Fences & Kerbs case may help you
As we approach the first anniversary of the Supreme Court’s decision in what is known as the Fences & Kerbs case1 where three appeals were heard and ruled on together by the Supreme Court, we revisit the significance of the decision for creditors of insolvent companies and voidable transactions.
Allied Concrete Ltd, Fences & Kerbs Ltd and Hiway Stabilizers NZ Ltd each had a debtor (two of which were the same) to which they had been supplying goods and services, on the basis of a running account. Each debtor company had a liquidator who was seeking to claw back payments made to the three different companies while the relevant debtor was insolvent under the clawback provisions of the Companies Act 1993.
Sections 292–296 of the Act allow liquidators to claw back payments made by insolvent companies to individual creditors, up to two years before the date of a debtor company’s liquidation. The purpose of such provisions is to prevent debtor companies from preferring one creditor over another. The Supreme Court, however, acknowledged the importance of protecting individual creditors who unknowingly have traded with, and been paid by, an insolvent company.
Section 296(3) of the Companies Act was amended in 2006 to provide a defence to the recovery of voidable transactions by liquidators of debtor companies. In order to rely on the defence a creditor has to prove that when they received payment from a debtor company:
- They acted in good faith.
- A reasonable person in their position would not have suspected, and did not have grounds to suspect, that the company they received the money from was or could become insolvent, and
- The creditor gave value for the payment or they altered their position in the reasonably-held belief that the payment was valid and would not be set aside.
The meaning of value
The focus of this case was on s296(3)(c) the last of the three elements of s296(3). Specifically whether ‘value’ meant ‘new value’ given at or after the time a creditor received payment from a debtor company or whether it could also include value given prior to the receipt of payment when the debt was created.
The Court of Appeal decision held that ‘new value’ had to have been given by a creditor, which meant that one-off suppliers were left particularly vulnerable to the clawback provisions as they would not be able to show ‘new value’ if payment was received after the goods or services were supplied (on-credit). The result of the Court of Appeal’s decision was that organisations in the construction industry in particular were left vulnerable to the clawback provisions.
To the relief of many, the Supreme Court held that there was no intention for s296(3)(c) to apply only in circumstances where ‘new value’ was given and that value given earlier to payment would suffice. The Supreme Court held that it was important that creditors not be dissuaded from providing goods or services to companies on-credit. The Supreme Court also felt that it was important to protect creditors who had unknowingly traded with insolvent companies. The Supreme Court’s decision has provided much-needed commercial certainty and the decision shows a judicial step-away from solely focusing on the pari passu approach (where each creditor is of equal ranking) to debts owed to creditors.
Protecting your business
From a practical perspective, it’s important to be aware that in order to depend on the s296(3)(c) defence you must be able to show that at the time you received payment you did so in good faith and that you did not, nor did you have any reason to suspect, that the company was or could possibly become insolvent. The threshold for the defence, therefore, is still quite high. In order to protect your company from a potential clawback, keep well informed about the companies with which you choose to do business.
If you find your business in the general pool of creditors of a company that has been put in liquidation, the Fences & Kerbs case could have a negative effect on your position as there are less resources for a liquidator to pool from to pay off a company’s debts.
One of the more effective ways to protect your interests is to make yourself a secured creditor. If you would like to secure any of your interests or if you have any questions as to how the outcome of the Fences & Kerbs case may affect your business, please get in touch with us and we can arrange a time discuss your options with you.
1 Allied Concrete Limited v Meltzer (SC 51/2013); Fences & Kerbs Limited v Farrell (SC 80/2013); Hiway Stabilizers New Zealand Limited v Meltzer (SC 81/2013)