Case law on the new insolvent transactions regime is scarce, even though the changes were introduced three years ago. The High Court's recent decision in Blanchett v McEntee Hire Holdings Limited examines, for the first time in New Zealand, central principles in the new voidable transactions regime.
The most important changes to the regime in 2007 included a re-wording of the creditor's statutory defence so that creditors who suspect insolvency are not able to use the defence, and the introduction of the running account principle. McEntee Hire considered both of these changes.
Failed company Taupo Paving and More Limited (in liquidation) had made five payments totalling $21,384.35 to McEntee Hire in the two years prior to its liquidation. The liquidators claimed, on conventional grounds, that these payments constituted voidable transactions under the Companies Act 1993 as they were made at a time when Taupo Paving was unable to pay its due debts, and they enabled McEntee Hire to receive more than it would have received in the liquidation.
Defence for creditors
McEntee Hire claimed that it was protected by the creditor's defence under section 296(3) of the Companies Act as it had (i) acted in good faith, (ii) had no reason to suspect that Taupo Paving was or would become insolvent, and (iii) it had given value and altered its position by continuing credit to the company and providing further hireage services.
Although McEntee Hire had issued a stop credit notice to the company, it argued that this was a mechanism to "rebalance" and "preserve" the trading relationship, and did not reflect any concerns about the company's solvency. McEntee Hire gave evidence that when it was concerned about solvency, it would refer the debt straight to a collection agency - which had not happened in this case. Unfortunately for McEntee Hire, the liquidators were able to produce an invoice from Debtworks Limited showing that McEntee Hire had in fact referred the debt to a collection agency.
Associate Judge Christiansen referred to Australian case law, noting that a creditor's suspicion of insolvency could be "a slight opinion, but without sufficient evidence", based on the commercial circumstances at the time of the transactions. His Honour held that while McEntee Hire may have acted in good faith, it could not claim that it had no reason to suspect that Taupo Paving was insolvent: it had issued a stop credit notice, and, by its own admission, taken steps that it would only take if concerned about solvency. It could not satisfy the third limb of the defence either, as it had not extended any further credit to the company until all outstanding debt had been paid. This was not giving value or altering its position.
Running account principle
McEntee Hire then argued that the five transactions were part of a "continuing business relationship". Section 292(4B) of the Companies Act now provides that when a transaction is part of a continuing business relationship between a company and its creditor and the company's indebtedness fluctuates (for example, as part of a running account), then the individual transactions must be considered as one single transaction. If this single transaction may be classified as an insolvent transaction, then the liquidators can only claim the difference between the first transaction and the last, rather than attacking the value of each individual transaction.
In McEntee Hire, the liquidators submitted that although there had been a continuing business relationship between the parties, this relationship ended after McEntee Hire issued the stop credit notice. From that point, the liquidators argued, the payments were not being made to induce further supply - the relationship between the parties changed to one of pure debt collection. Associate Judge Christiansen again drew on Australian case law and agreed with the liquidators' analysis that there was no continuing business relationship after the issue of the stop credit notice. He concluded that the liquidators were entitled to claim the full sum of the individual transactions from McEntee Hire.
Associate Judge Christiansen even went further, noting that if there had been a continuing business relationship, that the liquidators were entitled to "cherry pick" the date that the continuing relationship began. He recognised that liquidators would of course choose the date when the indebtedness was at its highest, but that liquidators should be able to act in a manner that benefits all creditors of the liquidated company. While this "peak indebtedness rule" is uniformly applied in Australia, this is the first indication that the rule could be applied in New Zealand.
It is understood that McEntee Hire has appealed the High Court decision. Whether the appeal proceeds or not, creditors and liquidators alike now have some guidance from the New Zealand courts as to how to apply the new voidable transactions regime.