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Once a company goes into liquidation, its liquidators consider whether the com pany engaged in any

voidable transactions prior to liquid -ation. A voidable transaction is: ❚ entered into within a specified period (2 years before the liquidation commenced)

❚ an insolvent transaction (a transaction entered into at a time when a company is unable to pay its due debts and enables one person to receive more towards the satisfaction of a debt than they would have received, or would have been likely to receive, in the company’s liquidation).

The Companies Act defines several company actions as a transaction, including the payment of money. The purpose of the voidable transactions provisions is to prevent a company from favouring certain creditors when it’s aware it’s in financial difficulty. The voidable transactions regime is designed to ensure that unsecured creditors of an insolvent company are all treated equally.

Running account exception

The Companies Act used to include a defence that transactions made in the ordinary course of business were not voidable. The Companies Amendment Act 2006 abolished this defence because it was creating too much uncertainty.

However, the amendment also introduced a running account exception where there is a continuing business relationship between a company and a creditor and where the level of indebtedness to the creditor increases or decreases over time. With the running account exception, all the transactions undertaken as part of that relationship are treated as a single transaction.

Jollands v Mitchell Communications Ltd

In Jollands v Mitchell Communications Ltd, the High Court considered a situation where an electrical subcontractor – Mitchell – sought to rely

on the running account exception. Mitchell had carried out work supplying and installing cabling at a Christchurch mall for Aden Electrical Ltd (in liquidation). Mitchell carried out services to the value of $84,215. Aden was placed into liquidation on 5 March 2010, and its liquidators applied

to set aside the payments that Aden made to Mitchell, which totalled $59,454.

There was no issue that Aden made the payments to Mitchell in the specified period (2 years before liquidation), but payments were also made within the restricted period (6 months before liquidation). Under the Companies Act, there is a presumption that transactions within the restricted period are voidable and the onus switches to the creditor to prove that the company was solvent in this period. On the other hand, the liquidators have to prove the company was insolvent in the specified period. In this case, the Court found that there was clear evidence of Aden’s insolvency dating back to April–May 2008 and that it was insolvent when it made all of the payments to Mitchell.

BUILDING CONTRACTS NOT USUALLY RUNNING ACCOUNTSMitchell sought to rely on the running account exception. Here, the High Court considered Australian authorities, which had found construction contracts do not give rise to running accounts or continuing business relationships. An essential feature of running accounts is that they contemplate a continuing relationship of debtor and creditor and an expectation that further debits and credits will be recorded. Australian authorities said this description did not fit the concept of a building contract where progress claims are made separately and in isolation from each other.

NO RUNNING ACCOUNTThe Auckland High Court found there was no running account in the case of Jollands v Mitchell Communications Ltd as: ❚ the subcontract was a one-off dealing between the parties

LEGAL

Insolvency and voidabletransactionsThe High Court recently ruled that building contracts are not running account cases under the voidable transaction provisions in the Companies Act 1993. As a result, an electrical subcontractor had to repay a significant portion of what they had been paid to a company’s liquidators.By Karen Shaw, Associate, Harkness Henry, Hamilton

If there is no history with the company, it may be wise to seek personal guarantees from the directors and shareholders of the company.

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❚ Mitchell had never worked for Aden before and there was no expectation of continuing work

❚ Mitchell issued payment claims for the work and the payments made by Aden generally matched the invoiced amounts. The payments were then for past services and on the basis that future work under the contract would be the subject of fresh invoices and fresh payment schedules.

ACTED IN GOOD FAITH SO RETAINED SOME OF PAYMENTSHowever, Mitchell was able to retain a portion of the payments it had received from Aden because they were able to rely, in part, on the good faith defence under section 296 of the Companies Act. Under the good faith defence, a creditor may prevent recovery if they can establish that they acted in good faith, that a reasonable person would not have suspected, and they did not suspect, that the company was or would become insolvent and that they gave value for the property or altered their position on the reasonably held belief that the transaction was valid.

Each of the elements of section 296 has to be established before a Court will grant relief. In Mitchell’s case, the Court accepted that Mitchell acted in good faith and, despite slow payment, they did not suspect Aden’s insolvency. However, Mitchell was only able to establish that they gave value following the payments to the sum of $16,910 (this was in the form of further services). The net result was that Mitchell was required to repay $41,338 plus interest and costs to the liquidators.

Be proactive in new dealings

It is important for creditors dealing with companies to be aware of the voidable transactions provisions. As the ordinary course of business defence no longer exists, creditors should be proactive before entering into transactions with companies.

If there is no history with the company, it may be wise to seek personal guarantees from the directors and shareholders of the company.

If payment issues do become evident during the provision of work or services, it is important to seek advice on the best strategy for managing that situation. In some instances, the only prudent option is to cease performing the work or offering services to that company.