Lessons from a liquidator
A niche area of insolvency law has become a hot topic for New Zealand businesses, thanks to a recent spate of court action.
Most businesses will have never heard of voidable transactions - sometimes called insolvent transactions - unless they've had the misfortune to be hit by one.
But three High Court rulings in a row and a Court of Appeal decision overturning them have thrown this little-known technique used by liquidators into the spotlight.
A voidable transaction is where a liquidator goes back and reclaims a payment made by a company prior to its collapse.
The regime is designed to combat creditor queue-jumping, so that a struggling firm doesn't pay its mates ahead of other creditors.
But if you happen to be the business on the receiving end of a voidable transaction demand it can feel profoundly unfair.
Under Section 292 of the Companies Act a liquidator can claw back payments made by a failing firm up to two years before it finally falls over.
It means that suppliers which, in all good faith, bill and collect payment from a troubled company can end up facing a demand to hand that money back.
The law is based on the principle that all creditors are created equal and any available funds in a failure must be pooled and paid out on a pro rata basis.
But three times in 2012 this law was challenged, with aggrieved creditors facing voidable transactions winning their case each time - much to the chagrin of insolvency practitioners.
Then in March the Appeal Court threw the cat among the pigeons by overturning the rulings.
Now various factions of the construction industry - as two of the key cases involved construction companies - intend taking the matter to the Supreme Court.
In one case roading contractor Hiway Stabilisers was ordered to repay $13,000 to the liquidators of Auckland underground construction firm Window Holdings, which collapsed in July 2011 owing $4.2 million.
Hiway Stabilisers had carried out the work two years prior.
Graham Burke, president of the Specialist Trades Contractors Federation, says his sector is more prone to failures than others, and he knows of firms which have faced voidable transaction demands several times.
In some instances it can be enough to tip a business over."It's a very dangerous thing."
The law as it stands is "ridiculous" and there is industry talk of lobbying for legislative change, he says.
"We can't have this situation, where you're working for a company and you've got no way of knowing they're trading insolvently... and you have no certainty over those payments for a period of two years."
Voidable transactions are so much the issue du jour that Auckland practitioners Waterstone Insolvency held a seminar last month to better inform the market on how they work, and - more importantly from a business owner’s point of view - how to avoid them.
Waterstone principal Damien Grant says the first rule is, don't ever not take the money out of fear that your trading partner is in trouble and you may face a voidable transaction demand.
The firm may not fail, he says. And if it does the liquidator has to notice the payment to you.
Thirdly, almost all liquidators will settle. "We very rarely get 100 cents in the dollar."
Successful voidable transactions are the exception rather than the rule, Grant says. "It's a very, very small risk but it's a bit like sharks - we tend to overestimate the risks, so people avoid getting into the water."
It is possible to defend a voidable transaction demand, but it's tricky. There are three grounds for defence and all have to be met simultaneously.
You must have traded with the ultimately troubled firm in good faith, not suspected it was insolvent, and given value for the property received (i.e. you provided goods or services in return for payment).
This third part seems the simplest, but it's the bit which has caused all the consternation.
The High Court ruled that it didn't matter when the goods and services were supplied.
In one of the other key cases, Taupo fencing contractor Fences and Kerbs was paid $50,000 in instalments by industrial engineering business Contract Engineering in 2010. Contract failed the following year owing $5.2m, and its liquidators went back and claimed $457,000 in voidable transactions including Fences' $50,000.
But the Appeal Court said the three arms of the defence must be proved at the same time - so because it got paid out over three months Fences was out of luck.
This harsh part of the regime provides the most salutory lesson for business owners, says Waterstone which also runs a debt collection agency.
The moral of the story is do not extent credit beyond 30 days under any circumstances, it says.
Extending credit to a trading partner will not necessarily help it survive, nor will it keep you in the good books. The client will feel embarrassed and may go to another supplier they don't owe money to.
It's a bit like throwing your child down a well to retrieve a dog which ran off with a chicken, Grant argues. "At some point all you end up with is your entire family down a well."
If a client owes you money, continue trading with them on a cash-only basis, he says.
These transactions cannot be deemed voidable because the value and the payment have been exchanged simultaneously.
But that's not a realistic option for the building industry, Burke says. "You can't run a construction site paying everyone upfront. Everything from carpentry to concrete... it's all sub-contracted out."
Insights from a liquidator
- Gaining a personal guarantee from the company director does not protect you against a voidable transaction. It's a good sign that they are willing to back their enterprise and it boosts you up the creditor rankings should the company fail, but if you threaten to invoke it as a means of eliciting payment that transaction will immediately be considered voidable.
- Payments from a firm's directors personally can also be clawed back.
- If you engage in a string of emails with a debtor about an unpaid bill these are the property of the company, and a liquidator can use them as proof you knew the firm was in trouble.
- You have 20 days to respond to a voidable transaction demand, so take it straight to your lawyer and object. If you respond outside the 20 days you will make life much harder for yourself.
Do you feel better off than at this time last year?