Two recent cases on voidable transactions

This article discusses two recent insolvency law cases dealing with the question of voidable transactions. Insolvency practitioners and lawyers who advise insolvency practitioners should take note of the impact of these decisions, particularly the second (currently under appeal), which has the effect that liquidators can void transactions to secured creditors (which was previously believed not to be possible by the industry) and that creditors can position themselves to avoid the voidable preference regime.

Is a shortcut to debt recovery for voidable transactions okay? The Court of Appeal says yes …

The liquidators of Quantum Grow Limited served a voidable transaction notice on a related company, Lotus Gardens Limited, seeking to set aside $25,576. The notice was issued pursuant to the process prescribed in section 294 of the Companies Act 1993 (the Act). Lotus Gardens neglected to object to the voidable transaction notice within 20 working days.

The liquidators therefore considered that by operation of section 294(3) of the Act, the transactions had been automatically set aside. Demand was made by the liquidators against Lotus Gardens setting out that $25,576 had automatically been set aside and payment of $25,576 was due. Again, Lotus Gardens failed to respond.

The debt remained undisputed and the liquidators then served a statutory demand on Lotus Gardens. No dispute was raised nor was any application made to set aside the statutory demand pursuant to section 290 of the Act.

The liquidators then filed proceedings to liquidate Lotus Gardens. If Lotus Gardens wanted to defend the liquidation proceedings, it was required to file and serve its defence within 10 working days of service. It did not. Lotus Gardens filed an application to extend time to file its defence just a few working hours before the hearing. The High Court granted this extension and the issue went to a defended hearing.

The common director of Lotus Gardens and Quantum Grow gave evidence regarding the payments from Quantum Grow to Lotus Gardens. His first story was that there was no connection between the companies other than him being a common director and shareholder.

His second story was that Lotus Gardens had advanced a loan to Quantum Grow and that the funds were to satisfy that loan. His third story was that Lotus Gardens was simply a conduit of the funds in relation to a loan to the Bank of New Zealand. All three versions were given under oath at different times.

This case was heard in the High Court by Associate Judge Bell and on 17 May 2013 His Honour released his decision.

The learned Associate Judge was of the view that the liquidators were relying on a common law right to enforce a debt that had arisen from the transaction being set aside, a right that had been legislated away in the changes from the 1955 Act to the 1993 Act.

Accordingly, the liquidators were told they should have applied to the Court under section 295 of the Act to seek an order before issuing a statutory demand.

Because the liquidators had used the wrong procedure, the learned Associate Judge held that Quantum Grow was not a creditor and therefore had no standing to liquidate Lotus Gardens. The liquidation application failed. 

The key points to note from the High Court decision were:

  • Although a transaction is automatically set aside when a recipient of funds does not object, a debt does not arise under a claim for money had and received, but under a Court Order. Accordingly, a liquidator must first obtain an order under section 295 of the Act before a debt is due.
  • Lotus Gardens was free to contest whether there was a transaction under section 292 of the Act and to raise the defence outlined in section 296(3) of the Act.
  • On the basis that the liquidators did not obtain a Court Order pursuant to section 295 of the Act, they were not creditors and could not liquidate Lotus Gardens.

The liquidators appealed the decision of the learned Associate Judge and the recently released decision of the Court of Appeal (O’Regan P, Stevens and Asher JJ) confirmed the liquidators’ submissions in full (Damien Grant and Steven Khov as liquidators of Quantum Grow Limited (in liquidation) v Lotus Gardens Limited CA399/2013).

The Court of Appeal confirmed that the voidable transaction provisions of the Act are not a code and a liquidator may set aside transactions by other means. The Court of Appeal further confirmed that the procedure in the Act is not exclusive.

Accordingly, when a creditor receives funds from an insolvent company and a liquidator serves a notice to set aside those transactions, if the creditor does not reply, a liquidator may pursue the recovery of those funds as a debt and/or for money had and received. Further, a liquidator may serve a statutory demand on the non-payment of that debt.

The Court of Appeal caveated the right of a liquidator to invoke this process. In particular, if the creditor could make out an arguable defence under section 296(3) of the Act or argue that it did not in fact receive a transaction, then the Court ought not make a liquidation order. In the circumstances of this case, Lotus Gardens sought to argue that it had a defence pursuant to section 296(3) of the Act and said it was simply a conduit of the funds and therefore no order ought to be made. The Court of Appeal dismissed these defences and considered they were not arguable.

The Court confirmed that best practice is to utilise the process under section 295 of the Act (the orthodox recovery route). However, the Court of Appeal allowed the appeal by the liquidators and made an order placing Lotus Gardens into liquidation together with costs on appeal and at the High Court.

So, whilst liquidators can shortcut the usual process, they should invoke this process with caution as it is limited to certain circumstances, namely where the creditor does not seek to object to transactions being set aside and it has no realistic defences under section 296(3) of the Act. Liquidators should consider whether the creditor may stump up a defence at a later stage and pre-empt those defences. If those defences are arguable, the orthodox procedure ought to be utilised as the short route may prove to be a longer route as confirmed by the Court of Appeal.

Can a creditor position itself to evade the voidable transaction regime? Apparently so according to the High Court …

Maclean Computing Limited was placed into liquidation on 13 July 2012. In March 2011, Maclean reached an agreement between the IRD and its three major suppliers. Westcon Group NZ Limited was among this select group.

Between March 2011 and April 2012 Maclean paid Westcon $274,617.49. The liquidators sought to set aside these transactions (totalling $274,617.49) received by Westcon in accordance with the repayment arrangements.

In relation to the restructuring proposal between the major creditors of Maclean, the parties attempted to ring-fence the existing debt owed and to have the debt paid off by regular monthly instalments. These select creditors of Maclean were paid within 12 months of the deal. The IRD and other creditors were not.

Aside from the IRD, which was owed debts dating back to July 2009, the creditors in the liquidation related to debts incurred by Maclean from March 2012 until the liquidation of Maclean. This was the “restricted period”, a period where a company is presumed unable to pay its due debts.

At the High Court, the focus was on two issues:

•       Was Maclean unable to pay its due debts?

•       Did Westcon receive more than it would otherwise receive, or would be likely to receive in Maclean’s liquidation?

In terms of the first question (i.e. was Maclean unable to pay its due debts?), Westcon submitted that by entering into rescheduling agreements, Maclean was able to pay its due debts as the major creditors had relinquished their right to call for payment or are estopped from recovering the debt. 

It was the liquidator’s position that those agreements amounted to little more than indulgences and did not affect the payment obligations to creditors because at all times those debts were due for repayment in accordance with the original contractual commitments.

Further, the liquidators were provided with correspondence from Westcon indicating that they sought to give merely the “perception of support”. The liquidators were of the view that this strategy allowed select creditors to obtain an advantage over other creditors of Maclean before it failed.

 

Furthermore, the liquidators submitted that a balance sheet analysis evidenced corporate insolvency. During the relevant period Maclean was operating at a $2 million deficit.

Accordingly, notwithstanding the willingness of major creditors to defer repayment obligations, the liquidators submitted that Maclean was unable to pay its debts as they fell due.

In addition, although Maclean entered into an instalment arrangement with the IRD, its failure to pay GST and PAYE and other tax obligations was further evidence of insolvency.

Maclean was unable to keep up to date with its tax obligations from July 2009 until liquidation. The liquidators submitted that this was a sure sign of a company who is unable to pay its due debts.

Westcon argued that the rescheduling agreement was more than a mere indulgence.

In particular, those agreements were reached after a careful and thorough exchange of correspondence; the solutions were not originally proposed by Maclean and it appeared that Maclean would have had enough support to obtain approval to a Part 14 compromise under the Act which would have had the effect of binding minority creditors. The Court agreed.

The Court held that a debt becomes due when it is payable. Further, whether it is payable is a matter of considering what obligations bind the company; it is not about the fact that the creditor might not be prepared to insist on payments strictly in accordance with agreed terms (Grant and Khov v Westcon Group NZ Limited 2013 [NZHC] 3419 [17 December 2013]).

The Court accepted Westcon’s submission that a creditor who agrees to formally reschedule its debt goes further than just forbearing to sue; it relinquishes its right to call for payment of the debt which has previously been due and owing.

Having entered into the agreement, Westcon was required to abide by the terms of the agreement and await payment of the debt over 12 monthly instalments, as each instalment fell legally due.

On this basis, the Court found that Maclean was able to pay its due debts as a result of these agreements.

In terms of the second key issue (did Westcon, as a secured creditor, receive more towards the satisfaction of its debt?), Westcon held a registered security interest in the goods it supplied to Maclean, which extended to the proceeds of the sale of the goods (a PMSI).

Westcon held the view that it did not receive a preference. This view was based on its status as a secured creditor – it argued that it was entitled to the funds over the other creditors of Maclean.

The bank account of Maclean into which the proceeds were received was both comingled funds and overdrawn. As such, the liquidators were of the view that the funds Westcon received did not fit the definition of “proceeds” as it could not identify the funds, nor could it trace the funds.

In effect, Westcon received the bank’s money, not the proceeds from Westcon’s supplied goods.

The Court accepted the liquidators’ view and determined that although Westcon’s security interest attached to the proceeds of the sale of its product, Maclean’s bank account was in overdraft and was intermingled funds.

The Court accepted that no property existed in those overdrawn accounts which were capable of sustaining a claim of a security interest.

This is consistent with the Court of Appeals’ decision in Rea v Russell.

Accordingly, Westcon’s security interest was defeated and the Court confirmed that a secured creditor can in fact receive a preference capable of a liquidator clawing back the funds.

Although Westcon had received a preference over other creditors of Maclean, the Court declined to set the transactions aside on the basis that Maclean was able to pay its due debts. The liquidators are appealing this decision.   

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