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voidable transactions

Voidable transactions

Commercial, Your Own Business
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Liquidator can claw back payments

The number of companies going into liquidation in New Zealand is on the rise after a Covid lull. According to Centrix,[1] 642 companies were placed into liquidation during the second quarter of 2024. This represents a year-on-year increase of 19%.

 

Most people in business know there is a substantial risk of not being paid by a company that goes into liquidation unless they have a secured debt. However, a payment made by a company before it goes into liquidation may also be at risk.

 

The liquidator can ‘claw back’ a payment made by the company to a creditor up to six months before the company was placed into liquidation by its shareholders or liquidation proceedings were filed in the High Court.[2] The liquidator may claw back the payment if it was made at a time when the company could not pay its debts, and the payment enabled the creditor to receive more than they would have received in the liquidation. Such a payment is known as a ‘voidable transaction.’

 

Pari passu rule

If a company has insufficient assets to meet all its debts, its available assets should be divided between its creditors in proportion to the debts they are owed. This is known as the pari passu rule.

 

There are several limits on the liquidator’s power to unwind voidable transactions. These are intended to strike a balance between upholding the pari passu rule and the conflicting objective of encouraging businesses to continue to trade out of their difficulties when facing financial problems.

 

Running account exception

The running account exception is one significant limitation on the liquidator’s power to claw back voidable transactions. It requires the liquidator to consider the net effect of a series of transactions between a creditor and the company, and to treat this as a single transaction.

 

In practice, if a company has a trading account with your business before it goes into liquidation, then any amount your business receives during the six months prior to liquidation that exceeds the value of any goods or services supplied during this period may be treated as a voidable transaction. For example, suppose your business supplies $10,000 worth of goods to a company during the six months before it is placed into liquidation, and you receive payments totalling $15,000 during the same period. Of that $15,000, $5,000 of the money you received went towards the debt that existed before the start of the six-month period. In that case, it is possible that a payment of $5,000 to your business was a voidable transaction, but the rest is safe.

 

The effect of the running account exception is that your business can keep any payment received for any goods or services supplied during the six months before liquidation.

 

Section 296 defence

This section[3] contains a ‘good faith’ defence available to creditors facing a claim to repay a voidable transaction. This statutory defence has three elements that must be satisfied:

 

  1. The creditor must have acted in good faith
  2. There was no reason for them to suspect the company was insolvent, and
  3. They gave something of value for the payment or changed their position due to the payment. The value does not have to be provided at the same time as the payment.

 

The claw back procedure

The Companies Act sets out the procedure a liquidator must follow when seeking to claw back a payment.

 

If the liquidator cannot resolve the issues through correspondence with the creditors, the liquidator may issue a formal notice to set aside the transaction. The recipient has 20 working days to respond to the notice. If they do not respond, the payment automatically becomes a voidable transaction at the end of this period and must be paid back. If the recipient does respond, then the liquidator may still apply to the court to set aside the payment.

 

It is difficult to fully protect your business from claw backs for voidable transactions. One option is to seek a security or personal guarantee at the start of any trading relationship. You should talk with us before continuing to trade with a company you suspect may have financial difficulties,

or if you are contacted by liquidators seeking to claw back a payment.

[1] Centrix August 2024 Credit Indicator Report.

[2] Section 292, Companies Act 1993.

[3] Section 296, Companies Act 1993.

 

 

DISCLAIMER: All the information published in Commercial eSpeaking is true and accurate to the best of the authors’ knowledge. It should not be a substitute for legal advice. No liability is assumed by the authors or publisher for losses suffered by any person or organisation relying directly or indirectly on this newsletter. Views expressed are those of individual authors, and do not necessarily reflect the view of Edmonds Judd. Articles appearing in Commercial eSpeaking may be reproduced with prior approval from the editor and credit given to the source.
Copyright, NZ LAW Limited, 2022.     Editor: Adrienne Olsen.       E-mail: [email protected].       Ph: 029 286 3650

Voidable Transactions – Can be a significant risk for businesses

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When an insolvent company goes into liquidation it’s accepted that not all creditors will get paid 100 cents in the dollar. However it often comes as a shock to creditors when the liquidator requires them to refund payments that had been made up to two years before the company was liquidated.

The liquidator of a company has an obligation under the Companies Act 1993 to fairly distribute the company’s assets to its creditors. In doing so the liquidator may choose to claw back payments which the company made from up to two years before the liquidation. The liquidator then makes those funds available to the general body of creditors. The payments that are clawed back are called ‘voidable transactions’.

Voidable transactions pose a significant risk for businesses that trade on a credit basis; the construction industry is a particularly good example. In the last six years following the 2008 property market collapse, there have been numerous liquidations of companies throughout the construction industry and, consequentially, many demands for repayment of transactions considered ‘voidable’.

It’s about fairness to all

The voidable transaction regime, as contained in ss292-296 of the Companies Act, operates on the assumption that a liquidated company trades while insolvent for some time before it’s placed into liquidation. It’s therefore considered fair that all parties who traded with the company during that period of insolvency bear an equal burden of having traded with an insolvent company. While a demand from a liquidator to refund a, usually long overdue, payment may not seem that fair when you receive it, the overall objective of the voidable transaction regime is not to penalise creditors but to achieve fairness to all. This fairness is achieved by, in the words of the Court of Appeal, “swell[ing] the pool of funds available to the company to be shared rateably amongst all creditors”1.

Transactions are considered voidable under s292 if two criteria are met. First, the payment must have been made when the company was unable to pay its debts. Second, the payment must allow the recipient to receive more than they would have received in the company’s liquidation. During the six months immediately preceding the start of the liquidation, the company is presumed unable to pay its due debts. In other words, the first criteria is presumed to be met. Outside this period the liquidator must show evidence that the company was unable to pay its bills. Whether a payment allows the recipient to obtain more in a liquidation than they would have otherwise received is a straight comparison between the amount the recipient actually received and the amount that the recipient would have as part of the general body of creditors in the liquidation, had the payment not been made.

Transaction perhaps not voidable?

Under s296(3) transactions are not voidable if the recipient can demonstrate all three of the following when they received payment: they acted in good faith, a reasonable person in their position would not have suspected that the company was (or would become) insolvent, and they gave value for the property or altered their position in the reasonably held belief that the payment was valid.

While there‘s no sure way to avoid having payments clawed back under the voidable transactions regime, the following may limit your exposure:

  • If you supply goods on credit, ensure that those goods are the subject of a security interest properly registered on the Personal Property Security Register, and
  • If you have any reason to suspect that a company is facing financial difficulties, insist that all future transactions are conducted on a cash on delivery basis.

 

It’s also important that you respond promptly to a demand for repayment of a voidable transaction. If you don’t file and serve an objection notice within the statutory period of 20 working days, it may result in the liquidator’s decision being unchallengeable2 and, by default, you will required to make the repayment.

 

1 Farrell v Fences & Kerbs Limited [2013] NZCA 91

2 Bond Cargo Ltd v Chilcott (1999) 13 PRNZ 629