Voidable Transactions
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, 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. 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 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.
DISCLAIMER: All the information published 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 article. Views expressed are those of individual authors, and do not necessarily reflect the view of this firm. Articles appearing in this newsletter may be reproduced with prior approval from the editor and credit given to the source. Copyright, NZ LAW Limited, 2019. Editor: Adrienne Olsen. E-mail: adrienne@adroite.co.nz. Ph: 029 286 3650 or 04 496 5513.