A Clash of Principles? Voidable transactions and commerciality

Hugh Ammundsen 147X166                  Judges routinely cite commerciality as a factor in arriving at decisions. The problem is that commerciality means quite different things to different people in business.

By Hugh Ammundsen, BA LLB

Business people are apt to make commercial decisions according to what produces the most desired outcomes, and to view legal decisions as commercially sound or otherwise according to the same criteria. Fairness will rarely come into it.

In its final decision in Farrell and Rogan v Fences & Kerbs Limited [2013] NZCA 329 the Court of Appeal has expanded on its interim decision earlier in the year and come out resoundingly in favour of the principle of pari passu – the idea that when a company becomes insolvent all unsecured creditors should be treated evenhandedly according to how much they are owed, regardless of whether they later receive payments or their position is unsatisfied at the time liquidators are appointed.

The notion that all unsecured creditors should be treated evenly is fine in principle. However, it needs to be squared against the reality that in a large number of insolvent liquidations there are insufficient funds available to fully repay secured and preferential creditors, let alone unsecured creditors.

The pursuit of fairness?
In principle a liquidator is seeking to recover what has been paid in excess of what that creditor might expect to receive on a pari passu basis among all equal ranking creditors.

There are some obvious and not so obvious problems that arise from the way that the different components of the statutory regime for dealing with debt and insolvency have developed.

One problem is the fundamental clash between the pari passu principle and equity’s historic protection of the bona fide recipient of value, which governed the pre-2006 “ordinary course of business” treatment.

(Prior to the 2006 amendment, the relevant wording of s296(3) specifically provided for someone receiving payment “in the ordinary course of business” to have a defence against liquidator claims. These words were dropped in the amendment (after causing the Courts a few problems).)

Another problem is the broad issue of discrimination. In this context the issue is not discrimination between specific creditors, but discrimination resulting from the way that competing statutory regimes have created inequality between suppliers.

The effective use of the Personal Property Securities Act 1999 (PPSA) by trade creditors is an example of this. Goods suppliers are routinely advised to include security requirements in their terms of trade.

However, what is a trade creditor’s claim of a security interest over goods supplied if it is not an attempt to circumvent the pari passu provisions on insolvency? To make matters worse, this practice is only available to a limited number of creditors, but not to project contractors or to suppliers of services.

The question of Trans-Tasman alignment
If two recent judgments are to be believed, in passing the Companies Amendment Act 2006 Parliament deliberately chose to align New Zealand law with that applying in Australia with respect to one section, and deliberately chose an opposite path in another case. To make matters worse, on the face of things both appear to be justified interpretations.

The earlier of the two was the High Court decision in Shephard v Steel Building Products (Central) [2013] NZHC 189 on “running accounts”. Section s 292(4B) of the Act provides that where a creditor has been in an ongoing trading relationship with a company that becomes insolvent and operates a “running account” that may rise and fall over time, the series of transactions may be viewed as a whole, rather than as discrete transactions, and therefore the issues are changes in the balance and unusual payments.

This was introduced in the 2006 Amendment Act. The clear intention, as accepted by the Court, was to bring New Zealand statute law into line with that in Australia. Contrast this with the Court of Appeal’s finding in Fences & Kerbs that Parliament’s choice of words, and the clear context of the change enacted, suggested an intention to diverge from the Australian approach.

On the matter of the time when the debtor “gave value”, the Court of Appeal quite aptly points out that if the requirement for value included antecedent debts it would largely render the second limb of s 296(3)(c) for alteration of position redundant.

While true, in the wake of the decision the problem becomes that of thinking of actual circumstances where value might be given “at the time”.

In its interim decision, the Court of Appeal cited as an example of giving value at the time the agreement to provide further goods and services. However this, like most other possibilities, such as the “cash on demand” transaction, tends to give rise to the presumption that there was a reasonable suspicion of insolvency which would invalidate the defence under s 296(3)(b).

The position of the litigious creditor
If commerciality is a genuine concern, it is perhaps instructive to look at the role of a company credit manager in decisions about how to deal with problem debtors. Credit managers monitor and collect debts. If a problem debtor is seeking additional goods or services they will be involved in any decision to provide further credit, including terms. It is credit managers who will commonly oversee relations with debt collectors or with solicitors engaged to pursue debts.

The paradox of the credit manager is that the manager who is responsible for pursuing an order to have a debtor placed in liquidation nevertheless wishes that they were the manager of the creditor who managed to extract payment from that same debtor earlier, notwithstanding that the liquidators may seek the return of that payment. This is also notwithstanding the possibility that there may be no final dividend for either creditor or that added costs are incurred paying debt collectors and lawyers, neither of which will have been recoverable on handing money back to the liquidators.

So what does this all mean?
On reviewing the different issues raised above, it is difficult to reconcile the fact that there are competing principles at stake. As a result they do not form a cohesive framework.

It is clear that the different regimes, including the effects of the PPSA, create disparities with respect to potential recoveries for creditors who end up competing for priority that is simply not available to all. This is something that the courts should not be required to resolve.

The different regimes have evolved very differently and the underlying principles are equally different; it is only the consequences that are, arguably, out of equitable balance. What may be warranted is a bigger picture review of how the various creditors’ remedies and commercial practices work together.

Hugh Ammundsen is the Business Law Analyst for CCH New Zealand Limited when he is not consulting to business clients on value, strategy and problem solving. 

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