10_cents_jpgQueen City Law have published a new commercial law article to the Law Library by Ross Dillon. In this article Ross examines the Court of Appeals rulings on companies in distress. Read Ross’s full article as a tablet and print friendly PDF here.

It can be hard to pay the bills when a company is falling into distress, however it is better to take preemptive action rather than have outcomes forced upon you by creditors. If you have a company in distress please don’t hesitate to contact our team and get our team on your case. Contact Us. To read more articles by Ross click here.

In August 2013 I wrote about recent law concerning the powers of a Liquidator to recover money you thought you had successfully recovered from a debtor. While the case referred to then was bad news for a creditor (having to refund the money and thus becoming “unpaid”), a recent further case has bought some good news – albeit reinforcing how very fact specific such cases can be.

In Masden-Ries and Anor (as Liquidators of Giant Engineering Ltd) v Rapid Construction Ltd [2013] NZCA 489 the Liquidators sought recovery of a payment made by Giant to Rapid. Rapid no doubt thought it was doing well to get paid, and there can be few more frustrating things to face than a claim of this nature.QCL-MEDIA-FINAL_4804-ross

However, Rapid disputed the request by the Liquidator to refund the money on the basis of what is known as the “change of position” defence set out in s.296 of the Companies Act. This required Rapid to prove (1) it had received the payment in good faith, (2) that it did not have reasonable grounds to believe Giant was insolvent, and (3) that Rapid either gave value for the payment ( see the prior blog on this element) or altered its position in the reasonable belief that the payment was valid. Rapid focused on this second limb of the third aspect of the test.

The facts behind the case included that Giant had suffered a fire at its premises, which was known to Rapid. Also, that Giant had performed services for Rapid (so that Giant owed Rapid $129k, but Rapid owed Giant $90k).  The parties swapped cheques for these amounts, but when Giant went into Liquidation, the Liquidators wanted to recover the $129k Giant had paid Rapid (but would be entitled to keep the $90k Rapid had paid Giant).

You may think that a rather unfair outcome. So did the Court of Appeal. Most importantly, had the cheque swap not occurred, Rapid would have been entitled to an automatic set off of the mutual debts under s.310 of the Companies Act, meaning if it had done nothing at all, it would only be looking for $39k in the Liquidation – being the shortfall after the automatic set off of the claim by each against the other. The Court held that by making the payment, Rapid had foregone the right of set off, and thus had altered its position to its detriment, thus meeting the third aspect of the test.

This was an unusual outcome, as change of position defences are notoriously hard to establish. It does suggest that the way to make a payment stick, is to take goods in kind from the creditor, rather than cash. However, the other limbs of the test also have to be made out, so this is not a panacea where actual insolvency is reasonably suspected.

For the record, the Court of Appeal found that although Rapid was aware that cash was tight, it accepted that Rapid was only aware of a cash flow problem that Giant had. The Court decided that knowledge of liquidity problems were not the same as knowledge of insolvency  That is a very fine line, but got Rapid across the first hurdle of the test.

In this case there was a fire on Giant’s premises, email between the companies regarding Giant’s late payments, and the cheque swap arrangement was made specifically to assist Giant with meeting its payment obligations.

In fairness and by way of comment, the fire probably meant any reasonable creditor could suspect cash flow problems in the short term being addressed eventually with an insurance payout some time down the track.  That, however, underlines the “fact specific” nature of this decision.  It is not something that will recur often.

The Court of Appeal also found that Rapid did not have reasonable grounds to suspect insolvency. That cash was tight did not address any other ways that Giant might be able to fund its obligations (an insurance pay out, for instance). The Court accepted that Rapid saw Giant’s problems as “logistical and not financial”. Thus the second part of the test was met.

By way of comment, not having cash is usually seen as “financial”, but it is useful for creditors to have a precedent that suggests such a problem can, in circumstances such as these, not amount to a reasonable suspicion of insolvency. This may therefore help creditors to defend claims by Liquidators, and thus remain “paid”. It also shows that when facing a claim for a voidable preference by a Liquidator, it is important to provide all the relevant background facts to your legal advisor.   If you do face a claim and the prospect of being “unpaid”, please contact us for advice.

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