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Supreme Court ruling favours preferential creditors

Supreme Court ruling favours preferential creditors


A highly anticipated Supreme Court ruling has given the business community some much needed clarity over the contentious issue of insolvent transactions, (or claw back payments by a liquidator), in the event of a liquidation.

However, the decision leaves it open for company directors to choose which creditors get paid and which creditors don’t when paying out final funds from an insolvent company.

Leading Hamilton law firm, Harkness Henry, and Rotorua and Auckland-based insolvency practice Kelman & Co., have been at the forefront of a protracted legal battle to determine if preferred creditors can stop liquidators from clawing back payments by showing that “value” was given to the liquidated company in the form of the supply of the original goods and services.

The status quo, which continued to be applied by lawyers and the Courts after a law change in 2006, was that the preferred creditor must have provided new value by, for example, supplying further goods and services after or at the same time as the preferential payment.

However, in its judgement in Allied Concrete Limited v Meltzer; Fences and Kerbs Limited v. Farrell [2013] SC 80/2013, the Supreme Court has found that the creditor does not need to provide “new value” and that value provided when the debt was originally created is sufficient to qualify for the defence.

The decision was essentially decided on a policy basis, with the Supreme Court having to choose between fairness and certainty for individual creditors who receive payment for their debts without any reason to suspect that the company is insolvent and the interests of the insolvent company’s creditors as a whole, many of whom will receive significantly less or nothing at all as a result of payments to the select group of preferred creditors. Ultimately, the Supreme Court decided in favour of fairness and certainty for individual creditors.

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Harkness Henry litigation partner, Kevin Bond, says the ability to set aside insolvent transactions has been a major weapon in the arsenal of a liquidator for more than a century and provided a simple and effective process to set aside transactions which have unfairly benefitted a few creditors at the expense of the general body of creditors.

Mr Bond says the Supreme Court decision will make it much harder for liquidators to use this process.

He says the decision aligns the New Zealand process more closely to that in Australia, but without the equivalent protections which are designed to discourage the directors of insolvent companies from making preferential payments.

"It is likely that a substantial number of preferential payments, which would previously have been set aside, will now be retained by preferred creditors. Further, directors of insolvent companies may now actually be encouraged to make such payments to those creditors who have leverage over them personally."

A number of liquidators have been awaiting the outcome of the case before progressing in relation to insolvent transactions identified in various current liquidations. The decision could have a significant impact on some high profile business failures such as Mainzeal and Ross Asset Management.

“In the case of Ross Asset Management, the liquidators have already signalled their intention to utilise the insolvent transaction regime to claw back payments from investors, who received what ultimately turned out to be fictitious profits in the months before Mr Ross’ Ponzi scheme came to light. This decision will make that process much more difficult for the liquidators,” says Mr Bond.

Kelman & Co. partner Peter Farrell says as a result of the Supreme Court decision, the defence is now almost entirely knowledge based.

Mr Farrell says in practice this will require a liquidator to demonstrate that the receiving company had a reasonable suspicion the insolvent company may have been insolvent when the payment was made.

“Most liquidators would consider it too risky to take legal action if they couldn’t prove the receiving company had a reasonable suspicion of insolvency. The type of proof a liquidator would have to rely on would include erratic payments, coupled with demands and correspondence between the two parties.

“However, it is difficult to assess how a judge will interpret that correspondence in the face of a preferred creditor’s explanations. That results in uncertainty, which ironically, is something that the law change was meant to address.”

He believes the result is not good for the general body of creditors as it undermines the pari passu principle which is that all creditors should share proportionately in the assets of an insolvent company.

“The law now does not do enough to discourage directors from treating creditors unequally or to discourage creditors from seeking to obtain a preference.

"I really believe that it will contribute to directors picking and choosing who gets paid and there won't be too much to stop them if the law is not changed In Australia there are measures against directors who play this game and we will now need something like that here.”

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