Published on 18/02/2015
The Supreme Court has today ruled in favour of three appellants that new value is not required for creditors to rely on the section 296 defence to voidable transactions under the Companies Act 1993.

This means that creditors unfortunate enough to find themselves a party to a voidable transaction that a liquidator is attempting claw back are in a much better position to resist the liquidator's claim.

The Supreme Court heard three appeals in March 2014. The appeals concerned the operation of the voidable transaction regime under the Companies Act 1993, particularly section 296(3). The appellants in the Supreme Court were creditors of companies in liquidation and the respondents were the liquidators.  Jared Ormsby and Charlotte Webber of Wynn Williams represented one of the appellants, Allied Concrete Limited, a creditor in the appeal.

What is a voidable transaction?
A voidable transaction is a transaction made by an insolvent company to a creditor which results in that creditor receiving more than they would have in the liquidation of the company. Liquidators have the ability to 'claw back' voidable transactions paid to creditors up to two years prior to their appointment. (Click here to read a previously published article on voidable transactions)

Section 296(3) was amended by the 2006 amendments to the Companies Act 1993 and provides a defence to recovery of a voidable transaction. If a creditor can establish the three cumulative criteria set out in section 296(3) the court must not order the creditor to make payment back to the liquidator.

The three criteria that the creditor must establish are that when the creditor received payment
  • a) the creditors acted in good faith;
  • b) a reasonable person in the creditor's position would not have suspected, and that the creditor did not have grounds for suspecting, that the company was or would become insolvent; and
  • c) the creditor gave value for the payment or altered the creditor's position in the reasonably held belief that the payment was valid and would not be set aside.

The first two elements of the defence were not in issue for the Supreme Court. The High Court held that the three creditors had acted in good faith and without suspicion. These findings were not challenged in the Court of Appeal.

The principal issue in the Supreme Court was whether, for the purpose of s 296(3)(c), "value" means new value given at, or after, the time payment is received from the debtor company, or whether it also encompasses value given prior to receipt of the payment when the debt was created, for example at the time of supply of goods or services.

The Court of Appeal, in Farrell v Fences & Kerbs Limited held that s 296(3)(c) required new value given at the time of the impugned payment and that value given at the time of supply was not sufficient.

The Court of Appeal's decision meant that the creditors in this appeal could not rely on the s 296 defence because two creditors were only one off suppliers (and therefore could not provide new value), and the third creditor's new value was less than the payment they had received.

In reaching its decision the Court of Appeal largely relied on the wording of the section requiring value to be given when the payment was received. The Court said that the use of the word "when" indicated that a temporal restriction was intended.

The Supreme Court disagreed that the use of the word "when" had the significance that the Court of Appeal gave it. Rather the Supreme Court held that s 296(3)(c) simply requires that there be a link or connection between the impugned payment and the requirements of s 296(3)(a), (b) and (c). Therefore the value provided at the time of supply was sufficient to meet the requirements.

As well as the text of s 296, the Supreme Court also analysed the legislative background of the voidable transaction regime in New Zealand, the intention behind the 2006 amendments to the Companies Act 1993 (which intended to adopt the position in Australia) and policy considerations.

While creditors, liquidators and insolvency practitioners alike have waited with baited breath for eleven months for the Supreme Court to release its decision, it is obvious that the Supreme Court was acutely aware of the consequences of its decision. The Supreme Court said:

If the [Liquidators] argument is accepted, primacy will be accorded to the interests of creditors as a whole, but that will be at the expense of fairness to individual creditors who have accepted payments in good faith and in circumstances where there was no reasonable basis to suspect that the debtor company was technically insolvent. In other words, what seemed at the time they were effected to be routine commercial transactions would be set aside. On this basis, there would be legal certainty in the sense that there would be a clear rule, routinely applied; but there would be commercial uncertainty in the sense that routine transactions would be vulnerable to challenge for up to two years after they occurred.

On the other hand, if the[creditors] argument is accepted, primacy will be accorded to fairness to individual creditors. Creditors who receive what appear to be routine payments in circumstances where they did not, and had no reason to, suspect insolvency will have certainty. This reflects the broader social interest in not causing any disruption to the routine flow of credit in commercial transactions. But that will be at the expense of the class of creditors as a whole and to the concept of collective realisation.

 
Ultimately the Supreme Court favoured the Creditor's argument. The Supreme Court held that the Court of Appeal's interpretation of s 296(3)(c) significantly curtailed creditors' ability to avoid voidable transactions and that there was nothing in the background materials which suggested that Parliament intended that result. In fact the contrary was true and the new (2006) regime was intended to create certainty for creditors by giving clearer protection.

However the Court was keen to point out that it must be remembered that before a creditor can take advantage of the s 296(3) defence, it must show that it acted in good faith and there were no reasonable grounds for a creditor in its position to believe that the company was technically insolvent. The Court noted that these are significant requirements, not easily met.

Therefore the threshold for the s 296 defence is still high, however the Supreme Court's decision means that it is at least now realistically available to creditors, where it was not under the Court of Appeal's interpretation.

Click here to read the Supreme Court's own press release on this decision.



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