New Zealand: Voidability of third-party payments in insolvency

Last Updated: 5 October 2018
Article by Shane Campbell and Jordan Halligan

Introduction

A company is teetering on the verge of insolvency. Its creditors are numerous. The company arranges for a third party to settle some of its debts on its behalf, but nonetheless tips over into liquidation. Can the liquidators recover the monies paid to the company's creditors? The courts have said yes, in certain circumstances. Such payments can be voidable under ss 292–296 of the Companies Act 1993 (Act).

The latest statement on the scope of this power is the decision of the Court of Appeal in Robt. Jones Holdings Limited v McCullagh [2018] NZCA 358. In holding that the transactions in question were insolvent transactions and should be set aside, the Court made several important pronouncements about the application of these provisions. This comment will highlight some of these key points, with a view to better defining the contours of the voidable transaction provisions of the Act.

Background

Robt. Jones Holdings Limited (RJH) received a total of $751,941.42 from Columbus Property Marketing Pty Ltd (Columbus) and MSH No 2 Pty Ltd (MSH). The payments were made by Columbus and MSH to satisfy debts owed to RJH by Northern Crest Investments Ltd (Northern Crest). The payments were therefore not made directly from Northern Crest to RJH.

Northern Crest was placed into liquidation in 2011. The liquidators of Northern Crest claimed that the payments made by Columbus and MSH were actually payments made on behalf of Northern Crest to satisfy debts that Columbus and MSH respectively owed to Northern Crest.

The Columbus payments were on account of licensing fees due by Columbus to Northern Crest. The MSH payments were either a redirection of licensing fees or inter-company loans. Because the payments were made either at the direction of the directors of Northern Crest, or at least with their consent, these were voidable transactions.

The association between the parties was as follows:

  1. MSH was an Australian-registered company that was a wholly-owned subsidiary of Northern Crest. The sole director of MSH was also a director of Northern Crest.
  2. Columbus was also an Australian-registered company. At the time of the payments being made, Mr Robert Hughes was Columbus's sole director. Mr Hughes had an association with a former director of, and consultant to, Northern Crest.

Legislative framework

Having stepped through the events culminating in the appeal, the Court of Appeal began its judgment in substance by summarising the law relating to voidable transactions. In brief:

  • Section 292(1) of the Act provides that a transaction is voidable by the liquidator if it is an insolvent transaction entered into within the two-year period before the date of commencement of the liquidation.
  • An "insolvent transaction" is defined in s 292(2) as a transaction that: (a) is entered into at a time when the company is unable to pay its debts; and (b) enables another person to receive more towards satisfaction of a debt owed by the company than the person would receive, or would be likely to receive, in the company's liquidation.
  • "Transaction" is defined in s 292(3) and includes, inter alia, "paying money" and "anything done or omitted to be done for the purpose of entering into the transaction or giving effect to it."
  • Payments by third parties may constitute insolvent transactions where the payment is made at the direction or with the consent of the insolvent company, and: (a) the third party makes the payment in discharge of an obligation it owes to the insolvent company; or (b) the money is not the third party's, but is paid from funds belonging to the insolvent company or to which that company has rights.
  • Section 294 confers on the court the power to set aside an insolvent transaction, whilst s 295 details the range of orders a court may make as a result.

There was no dispute that the Court had jurisdiction to set aside payments made by third parties in certain circumstances. In summary:

  1. Substance will prevail over form when assessing third party payments (Re Matthew Ellis Ltd [1933] 1 Ch 458 (CA) at 469; Re Mataura Motors Ltd [1981] 1 NZLR 289 (CA) at 291; Westpac Banking Corporation v Merlo [1991] 1 NZLR 560 (CA) at 564; Re Yukich Brothers Ltd (in liq); Porter Hire Ltd v Blanchett (2006) 9 NZCLC 264,070 (HC) at [92]).
  2. Payments by third parties may constitute insolvent transactions for the purposes of s 292 of the Act when the payment is made at the direction of, or with the consent of, the insolvent company and:
    1. the third party makes that payment in discharge of an obligation it owes to the insolvent company (Levin v Market Square Trust [2007] NZCA 135, [2007] 3 NZLR 591 at 595–596; and Chilton Saint James School v Gray (1996) 9 PRNZ 349 (HC) at 354); or
    2. the money is not the third party's but is paid from funds belonging to the insolvent company or to which the insolvent company had rights (Westpac Banking Corporation v Nangeela Properties Ltd [1986] 2 NZLR 1 (CA)).

In the High Court the liquidators succeeded in their claim. RJH was directed to repay the sum of $751,941.52. The appeal against the decision was dismissed by the Court of Appeal.

Payments by Columbus to RJH

The Court then turned to consider RJH's first ground of appeal, which was that the liquidators had failed to prove the payments made by Columbus to RJH were a redirection of licensing fees otherwise payable to Northern Crest, because:

  1. the licensing arrangements the liquidators built their case on were a sham; or
  2. the accounting records relied upon were unreliable and did not prove that the transactions were from licence fees owed to Northern Crest.

Licensing arrangements

The licensing arrangements in question related to four separate agreements entered into between January 2009 and October 2010.

The first agreement (the January 2009 Agreement) was between MSH as licensor and Columbus as licensee. It granted Columbus a non-exclusive license to the "System"—intellectual property relating to the sale of residential property and other investments—for the whole of Australia. Columbus was required to pay a monthly licence fee reflecting the properties underwritten and settled for the relevant month.

The second agreement (the November 2009 Agreement) was the agreement the liquidators say generated the licence fees ultimately redirected to RJH. It was expressed to supersede all previous agreements and was between Northern Crest as licensor and Columbus as licensee. The fee structure was more complex than the January 2009 Agreement and provided for a fixed fee of $3.5 million with an annual licence fee payable thereafter.

The amount of this license fee was subsequently reflected in Northern Crest's 2010 financial statements as an impaired asset. The reason given was that Northern Crest had entered into another licence agreement, which had the effect that Columbus no longer had any exclusivity over distribution. A settlement had been reached whereby the licence fees payable by Columbus would be reduced, resulting in an impairment of licence fee receivables.

The third agreement (the April 2010 Agreement) was between MSH as licensor and Columbus as licensee. It was also expressed as superseding all previous agreements. The licence fee was $25,000 in respect of each property sold by the licence.

The fourth agreement (the Rutherford Agreement) was between MSH as licensor and Rutherford Franchising Pty Ltd as licensee, and was the agreement referred to above as the reason for the impairment of the $3.5 million licensing fee.

Sham

This argument proceeded on the basis that the agreement under which the licence fees were payable by Columbus to Northern Crest was a sham, because neither party intended that there be a licensing of intellectual property, nor that there be payment of the licence fee. The motivation underlying this purported sham was said to be Northern Crest's need to create a licence fee income stream in order to comply with the working capital requirements for relisting on the Australian Stock Exchange.

The Court took as its starting point the following definition of a sham, from the decision of the Supreme Court in Ben Nevis Forestry Ventures v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2 NZLR 289 at [33]:

A document will be a sham when it does not evidence the true common intention of the parties. They either intend to create different rights and obligations from those evidenced by the document or they do not intend to create any rights or obligations.

As regards this particular agreement, the Court rejected as speculative RJH's explanation as to why Northern Crest and Columbus would set up a sham licensing agreement. The intellectual property that was the subject of the agreement was also not illusory.

The fact of a lack of supporting documentation was required to be viewed in the context that Northern Crest's management/directors had undertaken a "sanitisation" process prior to the liquidators obtaining custody of the relevant documents and records. In any case, the most relevant evidence was the statements made and actions taken by the parties around the time the licensing agreement was entered into, which showed that the intellectual property did in fact exist. Such contemporaneous evidence also tended to show that Northern Crest was the true owner of the intellectual property.

Finally, although the fee arrangements were unusual and showed Columbus having committed to a wildly optimistic deal, this was not sufficient to show the agreement was a sham; Northern Crest expected the fee to be paid, and part of the fee was paid. Therefore, the Judge was correct to conclude that the agreement was not a sham.

Unreliable accounting records

In the event the agreement was not a sham, RJH argued that there was inadequate evidence to prove that the payments made by Columbus were of licensing fees due under the agreement. In concluding to the contrary, Gordon J attached weight to documentary evidence and accounting records that supported the theory that the payments made by Columbus were a redirection of licence fees. On appeal RJH challenged this finding, arguing both that the accounting records were unreliable and that they did not support the conclusion reached by Gordon J. This dual-challenge failed to sway the Court, which concluded that weight could be attached to the treatment of the transactions in the accounting records, and that, although open to differing interpretations, the records were supportive of the conclusion reached by the Judge.

Parting comment

RJH therefore failed in respect of its first ground of appeal. However, even if it had succeeded, it would still have had to succeed on its third ground of appeal. As the Court pithily commented, if the arrangements between Northern Crest and Columbus were a sham or the accounting records were unreliable, such that the payments made were not of licence fees, what instead were they?

The inevitable inference would be that the payments made by Columbus were by way of loan to Northern Crest; an even clearer case of a "transaction" for the purposes of s 292. Success in respect of this first ground of appeal would, therefore, have been pyrrhic.

Payments by MSH to RJH

RJH's second ground of appeal concerned Gordon J's finding that the payments made by MSH were in the nature of a loan to Northern Crest; which were therefore a transaction for the purposes of s 292. Again, RJH argued that the Judge had placed undue weight on the accounting records.

It also questioned the Judge's failure to draw adverse inferences from the liquidators' failure to call as witnesses the people involved in arranging the alleged loan, and to attach no significance to the liquidators' rejection of MSH's proof of debt filed in the liquidation.

The Court rejected RJH's argument regarding the accounting records for the same reasons as above. It also agreed with Gordon J's assessment that the contemporaneous documents, not the absent loan documentation, was the best guide to the nature of the transaction, given that this was a loan purported to be made by a wholly owned subsidiary of Northern Crest.

RJH also faced the significant difficulty that it could not identify any basis, other than by way of loan, on which MSH would make the payments in discharge of Northern Crest's debt, and which would not amount to a transaction for the purpose of s 292­—whether in the nature of a loan or the redirection of licence fees the payments would still be transactions of Northern Crest.

Finally, while it was necessary to show that Northern Crest had either directed or consented to the payment, such consent could be readily inferred from the contemporaneous evidence that showed Northern Crest having been involved in the transaction and proceeding on the basis that its debt was discharged as a result. Therefore, this ground of appeal also failed.

Payments were not insolvent transactions

This was the key tenet of RJH's appeal. RJH argued that it was an element of the definition of "insolvent transaction" that the transaction must have the effect of diminishing the net pool of assets available to creditors—here, the transactions had effectively swapped one creditor for another but had in no way affected the net pool of assets available to other creditors.

In pursuing this line of argument, RJH placed itself firmly in conflict with the Court's prior decision in Levin v Market Square Trust [2007] NZCA 135, [2007] 3 NZLR 591, where the Court refused to read in any such additional requirement. As affirmed by that case, s 292(2)(b) is concerned, not with the overall effect of the transaction, but with whether a particular creditor has received a greater payment than it otherwise would have.

RJH invited the Court to depart from this authority. It argued that the Court in Levin had mistakenly concluded that the voidable transaction regime's purpose had undergone a metamorphosis with the passage of the Companies Act 1993 and had also misconstrued the approach taken by the Australian courts to similar legislation.

The Court of Appeal gave short shrift to this argument, for the following reasons:

  • First, it could see no error to the Court's analysis in Levin and the plain words of s 292 did not in any way support the importation of an additional requirement. If Parliament had intended to include an additional limb to the section, it was reasonable to expect that it would have expressly provided for this.
  • Second, there were good policy reasons for not tacking on an additional requirement to the existing comprehensive provisions of s 292. Chief among them was that the voidable transaction provisions of the Act are a code intended to simplify the law.
  • Third, the core policy underlying the voidable transaction regime is to ensure equality of treatment of creditors and by that means to ensure fairness between them. Although other policy considerations are at play in respect of certain other provisions of the regime, allowing these to apply more broadly would substantially undermine the policy objectives of the regime as a whole.
  • Fourth, the purported leading Australian authority cited by RJH was not persuasive in this context: it concerned a different issue altogether and later authority had tended to view the decision as confined to its particular facts.

Accordingly, there was no basis upon which the Court could, or would, depart from its earlier decision in Levin and this ground of appeal was dismissed.

Relief under s 295

RJH also failed in respect of its final ground of appeal, namely, that Gordon J had erred in not granting it at least some form of relief under s 295. The Court considered that RJH's argument that the liquidators had failed to properly exercise their investigative powers was irrelevant to the exercise of the discretion under s 295; the discretion only becomes operative where a transaction has otherwise been set aside.

Moreover, there was nothing objectionable in the fact that the recovery would be used to pay the costs of the liquidation, including the liquidators' fees. Because there is a public interest in the orderly winding up of insolvent companies, the Act expressly recognises that priority is to be given to payment of liquidators' fees in a liquidation.

Conclusion

RJH's appeal was dismissed and the decision of Gordon J in the High Court upheld; the payments made by Columbus and MHS No 2 were set aside and RJH was required to pay Northern Crest the sum of $751,941.52.

The decision is notable for the fact that it affirms the correctness of the Court's earlier decision in Levin as to the elements of s 292. The Court of Appeal has now twice confirmed that s 292 means what it says—there is no basis upon which to read into the section an additional requirement that the transaction must also have the effect of diminishing the net pool of assets available to creditors.

Also of significance, is the Court's comments regarding sham agreements and the s 292 definition of "transaction". As the Court observed, even had RJH succeeded in its argument that the licensing agreement was a sham, it would still have been faced with the problem that the payments made to it were transactions of Northern Crest. The message for litigants is clear: one must do more than simply allege that a transaction is a sham in order to escape the operation of s 292; a valid alternative characterisation, outside the purview of s 292, must also be provided.

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