The recent decision of the Court of Appeal in Farrell and Rogan as Liquidators of Contract Engineering Limited (In Receivership and In Liquidation) v Fences & Kerbs Limited
 NZCA 91 has implications for those trading on credit. Previously the defence in an insolvent liquidation, if the liquidator tried to claw back a payment, was available when prior value was given for the payment received. This is no longer the case.
The Court of Appeal has recently considered the proper interpretation of section 296(3)(c) and held that all three elements of section 296(3) must be established at the time the payment or other company property was received. This means that prior value given is not sufficient to satisfy section 296(3)(c) which departs from the recent approach taken in the High Court and in Australia.
Section 296(3) of the Companies Act 1993 provides a defence to creditors who have been unfortunate enough to find themselves a party to a voidable transaction that a liquidator is attempting to claw back. If a creditor can make out the three cumulative criteria set out in section 296(3), the Court must not order the recovery of the property, or payment back to the liquidator as the case with typically be.
The three criteria are:
296 Additional provisions relating to setting aside transaction and charges
(3) A Court must not order the recovery of property of a company (or its equivalent value) by a liquidator, whether under this Act, any other enactment, or in law or in equity, if the person from whom recovery is sought (A) proves that when A received the property –
(a) A acted in good faith; and
It is the third element of section 296(3) which has received increased attention by the Courts of late and with which the Court of Appeal was concerned in Farrell.
The Court of Appeal dealt with three appeals from the High Court1 by liquidators where section 296(3) had prevented them from recovering payments made by debtor companies to three creditors – Fences & Kerbs Limited, ACME Engineering Limited and Highway Stabilizers New Zealand Limited. Each of the creditors provided services to the debtor companies for which they later received payment.
In a nutshell, the High Court held that the creditors had given value in accordance with section 296(3)(c) at the time they provided the services to the debtor company. The High Court looked at the Australian equivalent, section 588FG(2) of the Corporations Act 2001, on which the 2006 amendments to the Act were based and the corresponding case law, and held that there was no intention for New Zealand to depart from the Australian position where it is well settled that prior indebtedness is good consideration for a payment made in the discharge of that indebtedness. Therefore, the High Court held that the Court could look at the value provided at the earlier time and was not confined to circumstances occurring at or beyond the time payment was received.
Prior to these three High Court decisions, the High Court2 and Court of Appeal3 had accepted, without much discussion, that section 296(3)(c) required new value provided after the impugned payment was received, i.e. goods or services given earlier did not constitute giving value for the purposes of section 296(3)(c).
This issue was all brought to a head in the Court of Appeal in Farrell where the sole focus was whether the High Court was right to conclude that the creditors "gave value" under section 296(3)(c) merely by receipt of the payments in satisfaction of the pre-existing debt owed to them by the debtor companies. Ultimately, the answer was no.
In coming to this conclusion the Court thoroughly examined:
(b) a reasonable person in A's position would not have suspected, and A did not have reasonable grounds for suspecting, that the company was, or would become, insolvent; and
(c) A gave value for the property or altered A's position in the reasonably held belief that the transfer of the property to A was valid and would not be set aside.
When looking at the purpose and text of section 296(3), the Court reiterated the well-established pari passu principle, whereby the creditors of a company who in the same class share on a pro rata basis in the companies fund available for distribution.
The Court accepted the liquidators' submission that the objective in an effective voidable preference regime is not to do justice or achieve fairness between a particular creditor and the debtor company but rather it is to achieve fairness amongst all creditors, and accordingly, unless all of the elements of section 296(3) can be established, the amount received by a particular creditor must be paid back for the benefit of all creditors. The Court did not accept the creditors' argument that it would be inequitable for an insolvent company to be able to retain the benefit of goods or services as well as to recover what was paid for those goods and services. The Court held that the general policy was that all creditors should be treated equally.
The creditors' argued that the words of section 296(3)(c) "gave value" were sufficiently wide to include value given at the time the pre-existing debt was created and that this was supported by the fact the term was expressed in the past tense. The Court did not accept this because:
the text of s 296(3)(c) in the light of its statutory purpose by analysing the voidable preference regime in New Zealand as far back as the Companies Act 1908; and
the Parliamentary materials which may reveal what was intended by the 2006 amendments – namely the Ministry of Economic Development review on insolvency law and the Insolvency Law Reform Bill 2005 explanatory note.
The Court then turned to look at the Parliamentary materials to ascertain the intention behind the 2006 amendments to the Act. The 2006 amendments sought to, among other things, remove the uncertainties and inconsistencies that were seen to exist in the earlier regime. One measure to achieve this purpose was to adopt a defence for creditors (to avoid making a transaction void) that focuses more objectively on the knowledge of the creditor that has transacted with the debtor.4
The Insolvency Law Reform Bill explanatory note5 went on to state that:
the section is expressed in the past tense because it would not otherwise read grammatically with the rest of the subsection. The section should in fact be read in the present tense.
The subsection is explicit in providing that all three elements are to be proved when the relevant property is received, which means that the creditors have to prove that when the payments were received value was given for the payment at that time;
If the legislature had contemplated that value given could include value given at the time the pre-existing debt was created, it would have said so and it did not; and
The transaction impugned is the payment of money not the creation of a pre-existing debt.
There will be an initial period of uncertainty regarding the meaning of the new tests, but this will reduce over time and will be mitigated by basing the new test on an Australian test, allowing the Courts to have the benefit of the Australian Courts' experience in interpreting those provisions.
It was this comment on which the High Court and the creditors in the Court of Appeal sought to place reliance on for their position that Parliament's intent in the 2006 amendments was to adopt the Australian approach in relation to voidable transactions and to rely upon case law developed in Australia for guidance.
When discussing the equivalent Australian section 588FG(2) the Court considered that there were material differences between the Australian and New Zealand regimes. These included the difference in the definition of a "transaction" and also that the range of transactions in Australia were identified in a different way from New Zealand. The Court saw the critical difference between the two regimes was the time at which the three elements in each defence must be proved.
The Court said6
In section 296(3) all three elements are to be proved "when A received the property …". In contrast, under s 588FG(2), of the Corporations Act, proof under paragraph (c) that "the person has provided valuable consideration under the transaction" is not linked to payment at the time when the person received the property.
The Court saw the lack in the Australian legislation of any temporal link to the time when payment was to be received, combined with the non-exclusive definition of transaction, to be crucial, and that both of these differences showed that the New Zealand Parliament did not follow the broader approach of the Australian legislation but elected instead to adopt a more constrained approach whereby giving of value is limited to any value given at the time the payment or other property is received.
The Court also considered that the reliance by the High Court and the creditors on the Australian legislation was misplaced and that the comment in the insolvency bill explanatory note did not show an intention for New Zealand to adopt the voidable preference regime in Australia to the letter, and in fact concluded that the Australian position had not been replicated in New Zealand.
Accordingly, the Court found that all elements of section 296(3) are to be established at the time the payment or other company property was received and specifically in relation to section 296(3)(c) said that the giving of value must be proved to have occurred at that time and does not include value given to the company at the time the pre-exisitng debt was created.
However, the creditors did raise an alternative argument, also based on the Australian position, that the requirement for value to be given when the payment is made can be satisfied by the creditor forbearing to sue at the time of payment or by the creditor receiving the payment in satisfaction of the pre-existing debt. Under this argument value is given because the company is given further time to pay or because the company is discharged from liability for the debt. There is Australian case law7 and commentary8 which supports the proposition that valuable consideration may be given by the satisfaction and release of an pre-existing debt. The Court said that there would be further argument on this remaining issue.
Therefore it remains to be seen whether a creditor can be said to have given value under section 296(3)(c) by giving time to pay or credit or discharging the debtor company's liability for the debt. However, it is now clear that value given at the time the pre-existing debt was created is not sufficient. Creditors will need to be wary of this position as the Court's recent decision will make it increasingly difficult for individual creditors to successfully invoke the section 296(3) defence.
1 Farrell and Rogan v Fences & Kerbs Ltd  NZHC 2865; Farrell and Rogan v ACME Engineering Ltd  NZHC 2874; Meltzer and Hayward v Hiways Stabilizers New Zealand Ltd  NZHC 3181
2 Blanchett v The Roofing Specialists Ltd  NZCCLR 42 (HC); Blanchett v McEntee Hire Ltd  NZCCLR 4 (HC); Jollands v Mitchell Communications Ltd  NZCCLR 20 (HC)
3Levin v Rastkar  NZCA 210
4Insolvency Law Reform Bill 2005 (explanatory note) at 14-19
5 Insolvency Law Reform Bill 2005 (explanatory note) at 14-25
6Farrell and Rogan as Liquidators of Contract Engineering Limited (In Receivership and In Liquidation) v Fences & Kerbs Limited  NZCA 91
7 Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd  NSWCA 109, (2011) 277 ALR 189
8 M Gronow and R Mason (eds) McPherson's Law of Company Liquidation (looseleaf ed, Thomson Reuters) at [11.1650]