A recent decision from the Court of Appeal, Ebert Construction Ltd v Sanson and Bridgman  NZCA 239, will reassure parties to construction contracts about the validity of a type of three-way financing arrangement known as a "direct agreement" (also known as direct payment agreements or tripartite agreements). This is a three-way agreement between developer, builder and financier. The agreement empowers the financier to step in and complete the project if the developer defaults, and may either permit or require the financier to make payments directly to the builder during the ordinary life of the project.
The agreements became popular in the 1990s, with financiers wanting the "step in rights" that the agreements typically provide, meaning that the builder could not immediately terminate the construction contract if the developer defaulted on its obligations. From a builder's point of view the direct payment obligation from the financier would also provide security for the possibility of the developer's insolvency.
In this case, the High Court had set aside two payments made from the financier to the builder just prior to the developer being placed into liquidation. This decision was appealed. The primary question before the Court of Appeal was "if the developer is put into liquidation, are such payments made to the builder by the financier voidable preferences recoverable by the liquidator?"
A transaction is voidable if it was made by a company at a time when the company was able to pay its due debts, and enabled the party receiving the money to receive more that it would otherwise have done in a liquidation.
In answering the question of whether the payments were voidable, the Court of Appeal needed to decide whether the transactions were made "by" the developer.
The Court of Appeal said that:
- the financier was directly liable to the builder; "that, of course, is the whole point of a direct payment agreement";
- the financier's liability to the builder was as principal in its own right, not as agent for the developer;
- at the time of the challenged payments, the financier's obligation to make payment under the direct agreement was owed to the builder, not to the developer;
- it was implausible to suggest that the financier would have made the payments to the builder on the eve of the developer's liquidation in the absence of a direct obligation to do so, and even the liquidator's own evidence confirmed that the financier would not have permitted money to be drawn down for the payment of any other creditors; and
- "it is of essence in the avoidance of preferential payment 'by the company' that the funds (or asset conveyed) are from resources available to the company to pay its general creditors", but in this case the facility could not have been used to make payment to any other person.
The Court of Appeal concluded that the challenged payments were not made by the insolvent developer, but rather by the financier pursuant to its own obligations.
Although not required to do so, the Court of Appeal also considered whether the builder received more than they would otherwise have received in the liquidation. They decided that this was not the case, saying that since the builder had rights against the financier in any event under the direct agreement:
"it was always entitled to seek to recover against [the financier] whether before or after liquidation. That was the principal benefit to it of the direct agreement. Its position would have been just the same if the payments had not been made pre-liquidation. It would not have bothered with the general pool. It would simply have claimed against [the financier], as it plainly was entitled to."
The Court of Appeal therefore decided that the builder was entitled to retain the payments that it had received from the financier.
This decision will provide comfort for other parties to construction contracts who use a direct agreement. Insolvency is unfortunately a common event in the construction industry, which can be difficult to protect against. This decision ensures that one method of protection, which has been in place for years, has not been eroded. It also provides clarity for liquidators in the voidable preference area.
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