How creditors can protect themselves against the claw-back regime

To set the scene we introduce a hypothetical example of Paver John (PJ). PJ enters into a contract with XYZ Builders (XYZ) to perform stone paving works at a development XYZ was working on for a contract price of $100,000. PJ and his team worked tirelessly over several months to complete the paving works to a high standard. PJ rendered invoices to XYZ for the work performed. After some chasing XYZ paid PJ’s invoices eventually, and PJ moved on to focus on other projects. 18 months later XYZ went into liquidation after not paying its tax bills. After reviewing XYZ’s accounts and records the liquidator finds that XYZ has debts in excess of $2m. The liquidator also sees that XYZ had made payments to PJ totalling $100,000. The liquidator has since contacted PJ requesting he pay $100,000 back to the liquidator or face Court proceedings.

How can this happen?

The situation described above for PJ is common. Sections 292 – 296 of the Companies Act provide liquidators with tools to gather in payments made by a company in the lead up to its liquidation as “voidable transactions”. The claw back period is not open ended but allows the liquidator to look at payments made in the 2 years prior to liquidation. Under New Zealand law, on liquidation, unsecured creditors paid and unpaid are in effect treated similarly. Company funds are then distributed to pay liquidators’ fees, preferential creditors such as the Commissioner of Inland Revenue and employees before the balance is divided proportionately amongst company creditors. The rationale behind this is that a party receiving funds should not receive more toward payment of its debt than it would have otherwise received in the liquidation.

Creditors across the board find this system unfair. Clawing back funds can cause significant detriment to innocent and deserving creditors. It often penalises those who have bothered to chase their debtors to get paid. Liquidators do not always have adequate records or resources to pursue recovery of every single payment, so the fact that a company has gone into liquidation is not determinative that payments will be clawed back. Voidable transaction claims can therefore be random and uncertain for creditors.

What can creditors do?

The law does provide some relief to creditors in limited situations. Section 296(3) of the Act provides a defence to creditors who in receiving payments:

• Acted in good faith; and
• Did so without actual suspicion or reasonable grounds of suspecting the company’s insolvency; and
• Gave value for the payment or altered its position in the reasonably held belief that the payment was valid and would not be set aside.

In order to successfully establish this defence all three limbs must be met. Interpreting the meaning of the statute and the availability of this defence can be less than straight-forward for creditors. The Supreme Court and Court of Appeal have also given decisions on the interpretation of the statute in various scenarios that are not expressly mentioned in the Companies Act. The applicability of the defence will heavily turn on the facts of each case.

In PJ’s case, relevant factors might include:

• Whether the liquidators’ allegations were factually correct;
• The precise timing of each payment and the timing of XYZ’s insolvency;
• The identity of the party who made the payments to PJ;
• What PJ actually knew about XYZ’s insolvency and financial position in the lead up to payments being made and at the time payment was made;
• Whether there were events or public statements which could have reasonably brought XYZ’s insolvency to PJ’s attention;
• What steps PJ took to try and recover payment, including whether he knew of any unsatisfied statutory demands;
• What PJ did with the funds after receiving payment.

Whilst it may not be practical to test the solvency of every party a creditor wishes to contract with at the start of a trading relationship, creditors may also improve their position by insisting on provision of personal guarantees or additional security as a condition of their contract. Having such protection may provide alternative avenues for payment in the event a liquidator attempts to claw back payments.

Overall, if you are a creditor who is facing a voidable transaction claim, or you have questions as to your position on any of the matters set out above we invite you to contact a member of our insolvency team to assist.