Just what is an account receivable has been the subject of much debate, because it determines what assets are used to satisfy preferential claims, i.e. who gets paid first in a receivership or liquidation. In 2008, the High Court judgment in Commissioner of Inland Revenue v Northshore Taverns (in liq) confined "accounts receivable" to "book debts". Although since criticised, that judgment was the only judicial authority on the point.
Now, in the case of Burns v Commissioner of Inland Revenue1, the High Court has adopted a much broader interpretation of "account receivable". In our opinion, the broader interpretation is preferable, and is more likely to be followed in the future.
The Court also gave more helpful guidance in affirming the long-held view that an "account receivable" should be classified as such at the time that receivership or liquidation starts. If an asset only becomes an account receivable part-way through a receivership or liquidation, it will not have to be used to satisfy preferential claims.
Burns v Commissioner of Inland Revenue
In a dispute between a secured (GSA) creditor and the IRD, the Court considered the meaning and scope of "accounts receivable" for the purposes of preferential claims under Schedule 7 of the Companies Act 1993. The case will apply equally to section 30 of the Receiverships Act 1993.
Historically, preferential creditors (such as the IRD and employees) had priority over secured claims in respect of "floating charge assets". "Floating charge assets" were typically book debts and stock in trade, but were not limited to those categories.
The Personal Property Securities Act 1999 (PPSA) did away with the concept of fixed and floating charges. Instead, the PPSA created a unitary concept of a "security interest", eliminating the need for a distinction between fixed and floating charges. All security interests are now statutory fixed charges, including those over circulating assets (e.g. inventory and accounts receivable).
To allow for preferential claims, Schedule 7 was amended to give preferential creditors priority over most security interests in "inventory" and "accounts receivable". An "account receivable" was defined, using the new PPSA definition, as "a monetary obligation" (with specific exceptions for chattel paper, investment securities and negotiable instruments). In submissions before the Act was passed, the Law Society noted that the PPSA would fundamentally change the earlier system of fixed and floating charges, and described the proposed change to Schedule 7 as the "best approximation of the status quo".
Despite the broad PPSA definition, in 2008 Associate Judge Hole in Commissioner of Inland Revenue v Northshore Taverns (in liq)2 decided that "accounts receivable" meant "book debts" (ordinary trading debts) only, significantly limiting the scope of assets subject to preferential claims. Under the "book debt" definition, the scope of assets in which preferential claims had priority was narrower than when it had been limited to "floating charge assets".
The Court in Burns has adopted a much broader interpretation of "account receivable". Based on Canadian law and near-unanimous academic commentary in New Zealand, the Court found that "accounts receivable" included more than just book debts. Instead, the Court adopted a broad definition of "accounts receivable", which gives more weight to the language of the PPSA. Essentially, any monetary obligation is an account receivable (with exceptions for chattel paper, investment securities and negotiable instruments).
The Court went further and considered that "accounts receivable" should be read in light of section 23 of the PPSA, even though Schedule 7 only refers expressly to the definition section of the Act. Section 23 excludes certain security interests from the scope of the PPSA – for example, interests created or provided for by a transfer of a right to damages in tort. On that basis, a monetary obligation arising out of a transfer of a right to damages in tort will not constitute an account receivable.
Our view is that the Court adopted a logical approach to avoid any inconsistency in operation between the Companies Act and the PPSA.
On that basis, the Court in Burns considered that each of the following sets of funds constituted "accounts receivable":
- refunds following overpayment – the company, before liquidation, had overpaid certain development contributions due to the Council
- bond refunds – the company, before liquidation, had paid bonds to the Council, which were later refunded, and
- funds held in a solicitor's trust account on behalf of the company in liquidation – the funds were from various sources, but that was irrelevant. What mattered was that the solicitors had an obligation to pay the money to the company on demand.
The Court's finding in Burns had long been expected following the criticism of the Northshore Taverns decision, and will provide some welcome certainty to receivers and liquidators. While Burns does not overrule Northshore Taverns, our view is that the Courts are more likely to adopt the broad Burns approach in the future.
When should an account receivable be classified?
The Court also offered some helpful guidance to receivers and liquidators dealing with assets that become accounts receivable part-way through a receivership or liquidation. A receivable will only be available to preferential creditors if the "monetary obligation" was owed to the company at the time that the receivership or liquidation started.
Burns is therefore the first decision to approve the commonly understood approach. We agree with the Court. The decision is also in line with the pre-PPSA rules on the crystallisation of floating charges at the time that receivership starts.
What does the result mean?
The pool of assets available to non-preferential creditors (both secured and unsecured) will shrink in many cases. Most monetary obligations owing to the company will now have to be applied first in satisfaction of preferential claims. The Burns case makes it clear that any refunds owing to the company, and any funds held by solicitors for the company, fall into that category.
As the Court commented, the scope of "accounts receivable" is of significant interest to the commercial community and the public. The decision may therefore be appealed.
Reminder: liquidators not entitled to retain a GST refund mistakenly paid by IRD
Aside from considering the scope of accounts receivable, the Court also considered whether the liquidators could retain a wrongly paid GST refund. Just after the liquidation started, the IRD released a GST refund to the liquidators without realising that the liquidated company had outstanding GST debts.
The Court affirmed that it would be unfair and unconscionable for the liquidators to retain the GST refund which they received as a windfall. As officers of the Court, liquidators are subject to a high standard of conduct which requires them to abstain from asserting legal or equitable rights in certain circumstances (there was no suggestion that the liquidators had fallen short of this standard; indeed they had asked for the Court's directions). The Court ordered the liquidators to return the refund to the IRD on the basis that this high standard did not permit them to retain the funds.
Our thanks to Janko Marcetic, Solicitor, for writing this Brief Counsel.
- (unreported) 10 August 2011, Auckland High Court, CIV-2010-404-7387, Associate Judge Gendall.
- (2009) 10 NZCLC 264,429 (HC).
The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.