David Broadmore, Partner at Buddle Findlay, discusses the major issues of third-party payments and the voidable transaction regime. He also analyses liquidation, assets, inflation and more.
- Rising interest rates, inflation and general economic uncertainty may all contribute to a rise in company liquidations this year. One issue ripe for further litigation is the circumstances in which payment by a third-party to the creditor of an insolvent company (to discharge the company’s debt to the creditor) will be treated as payment by the company, such that it is potentially voidable. The issue is crucial for creditors trading with entities on the edge of solvency – they need to understand when such third-party payments might be voidable. Recent judgments provide some clarity but, ultimately, the current approach requires a factual analysis that turns on a pin head.
- A payment by an insolvent company to a creditor will be voidable upon liquidation if it meets the requirements of s292 of the Companies Act 1993. One of those requirements is that the payment was “by [the] company”. At first glance, it might be assumed that payment by a third-party to a creditor of an insolvent company could not be voidable. However, that is not the case.
- This issue of third-party payments has been the subject of numerous judgments. Uncontentious principles include that:
- It is the substance, as well as the form, of the transaction that is relevant (Westpac Banking Corporation v Merlo).
- A third-party payment using money owed to the company (in reduction of the third-party’s debt to the company) will ordinarily be a payment by the company (Chilton Saint James School v Gray).
- A third-party payment by an agent on behalf of the company using the company’s money will ordinarily be a payment by the company (Westpac Banking Corp v Nangeela Properties Ltd).
- A third-party payment using the third-party’s own money (without creating a debt owed by the company to the third-party) should not be a payment by the company (Grant v Il Forno Ltd).
- However, other principles are more difficult to reconcile. In the following three scenarios, the payments do not diminish the assets of the company and simply replace one creditor with another creditor. However, whether it is a payment “by the company” for the purposes of s292 varies:
- A third-party payment using money loaned by the third-party to the company for that purpose has been held to be a payment by the company (Levin v Market Square Trust and Jones Holdings Limited v McCullagh (CA, not challenged on appeal)).
- A third-party payment under a direct agreement (under which a financier was required to make payments owed by the company, with such payments being drawn against the company’s loan facility) has been held not to be a payment by the company (Ebert Construction Ltd v Sanson). In that case, it was relevant that the particular direct agreement required the financier to make payments even if the developer was in default under the facility. It was not relevant that the financier was a secured creditor such that the payments reduced the assets available to unsecured creditors.
- A third-party payment by a guarantor of the company, in discharge of indebtedness under the guarantee, should not be a payment by the company (Ebert Construction Ltd v Sanson). This is despite the company becoming indebted to the guarantor pursuant to the guarantor’s right of indemnity.
- In Ebert the Court of Appeal recognised that “it is of essence in the avoidance of preferential payments ‘by the company’ that the funds (or asset conveyed) are from resources available to the company to pay its general creditors“. However, in Robt Jones the Court of Appeal concluded that a third-party payment using money loaned by the third-party to the company (for the purposes of the payment) would be a payment by the company even though it did not diminish the assets available to creditors.
- There are other payment structures that could be adopted, and it is uncertain whether they would be payments “by the company”. For example, a third-party could pay a debt owed by a company in return for an assignment of the debt from the creditor. In substance, the outcome would be no different to a third-party payment using money loaned by the third-party to the company (which would likely to be voidable). However, there appears to be no basis to deem a third-party payment in return for an assignment of the debt to be a payment by the debtor company.
- There is a fine distinction between a third-party loan for a specified purpose (to pay a creditor), a payment in return for an assignment of the debt, and/or a direct agreement. In all cases, the payments do not diminish the assets of the company, they simply replace one creditor with another. There seems little justification to treat them differently for the purposes of the voidable transaction regime. It is notable that in other contexts the Court of Appeal has been similarly unconcerned about the effect of a transaction on a company’s balance sheet. Specifically, in Yan v Mainzeal Property and Construction Ltd (In Liq) the Court of Appeal adopt the “new debt approach” to quantifying a director’s liability for trading while insolvent (expertly analysed by Buddle Findlay’s Luke Sizer in the latest New Zealand Law Journal [2022] NZLJ 33), which quantifies the loss to the company by reference to the gross value of the obligations the director agreed to the company undertaking, with no allowance for any benefits or value received by the company as a consequence.
- The potential rise in company liquidations may be an opportunity for further clarity in this area. Greater certainty would be achieved if it were recognised that a transaction could not be “by the company” unless the funds conveyed diminished the assets of the company.
David specialises in commercial litigation. He has almost 20 years’ experience in litigation and dispute resolution in both New Zealand and the United Kingdom. He has particular expertise in resolving banking and finance, insolvency, insurance, construction, property, professional negligence and a wide range of contractual disputes. The most recent contractual disputes that David has acted on include defective goods claims, shareholder disputes, claims arising from mergers and acquisitions and claims under construction contracts, management contracts, agency contracts, IT contracts, and sale and purchase contracts. He is an experienced advocate, having appeared as counsel in the Supreme Court, Court of Appeal and High Court in substantive proceedings and applications for urgent relief. He is also experienced in a broad range of alternative dispute resolution, including mediation, arbitration and expert determination. David advises and acts for a number of clients across a range of sectors, including financial institutions, insolvency practitioners, public bodies, insurers, developers, contractors, manufacturers, vendors and purchasers. David is also admitted as a Solicitor of the Supreme Court of England and Wales. You can speak with David on LinkedIn.
