The New Zealand Court of Appeal, in a judgment it expects will be “significant for both liquidators and creditors generally”, has unanimously found that the peak indebtedness rule is not part of the law in New Zealand.
A voidable transaction claim is made when liquidators seek to recover payments made by a company to its creditor at a time when that company was unable to pay its debts, where the result of the payment is to allow the creditor to receive more than it would in liquidation.
At issue in the Timberworld Ltd and Z Energy Ltd appeal against the liquidators of Northern Construction Ltd was section 292(4B) of the Companies Act 1993, a provision which is modelled on and materially similar to section 588FA of Australia’s Corporations Act 1992 (Cth).
The effect of these provisions is that individual transactions that are integral to a continuing business relationship between the company and the creditor (for example, as in a “running account”) are treated together as a “single transaction” to determine whether there has been a net improvement or deterioration in the creditor’s position during the debtor company’s insolvency.
The Court’s focus was on which transactions should be included in this assessment. The liquidators argued that they could select the point at which the “single transaction” starts. This would have allowed them to maximise their recoveries by picking the point at which the company’s debt was the highest (the point of peak indebtedness).
The peak indebtedness rule originated in Australia in Rees v Bank of New South Wales (1964) 111 CLR 210. New Zealand adopted the continuing business relationship concept from Australia in 2006 in what has been described as “drop in pitch” legislation (Farrell v Max Birt Sawmills Limited [2014] NZHC 3391 at [62]). The question for the Court of Appeal was whether New Zealand had adopted only the continuing business relationship concept, or the continuing business relationship concept and the peak indebtedness rule.
The Court of Appeal accepted that the New Zealand Parliament had intended for New Zealand to benefit from the experience of Australian jurisprudence but rejected the peak indebtedness rule. Relevant to this finding was that its analysis of Australian case law had led it to conclude that the Australian courts had “assumed the rule had the weight of authority and sufficient pedigree to warrant its direct application….without analysing its relationship to the legislation.”
In service of this argument, the Court of Appeal made the following points in relation to the Australian position:
- the legislative history of section 588FA showed that the provision was based on the High Court of Australia’s decision in Air Services Australia v Ferrier. The High Court of Australia had viewed the calculation of preference as a consideration of the “ultimate effect of the course of dealings” which the Court of Appeal thought was inconsistent with the peak indebtedness rule because “[i]f the principle in Air Services Australia is that the ultimate effect must be considered in ascertaining the results of a running account, there is no doubt the peak indebtedness rule does violence to that principle”, and
- after the initial articulation of the peak indebtedness concept in Rees v Bank of New South Wales, although the rule had been applied in subsequent cases, “nothing further by way of explanation or policy justification was offered in any of these”.
We agree with the Court of Appeal’s approach. Failing to take into account all the transactions in the relationship would make it difficult to identify whether a creditor has received more than it would have in liquidation (i.e. an unfair preference) because arbitrarily excluding some transactions distorts the comparison between what the creditor did in fact receive and what the creditor should have received.
The Court’s view, however, that the correct starting point is the beginning of the specified period is only acceptable where, as on the facts, the company was insolvent during the entirety of the specified period.
The Court did not consider the important question of what the correct starting point should be in situations where the debtor company becomes unable to pay its debts
after the start of the specified period. In this situation, our view is that the correct starting point is the point of the company’s insolvency. All debts incurred after the point of the debtor’s inability to pay would be counted, but no debts prior to the debtor’s inability to pay would be counted.
The Court of Appeal’s judgment follows the recent decision in
Farrell v Fences & Kerbs, concerning a different aspect of the voidable transactions regime, where the Supreme Court was asked to interpret the “gave value” limb of the good faith defence in section 296(3)(c) of the Companies Act 1993.
The Supreme Court overturned the Court of Appeal and found that a creditor does not have to give “new” value at the time or after the debtor company’s payment was made. Acknowledging that the intention of the reforms was to “align New Zealand’s position with that of Australia”, the Supreme Court gave effect to that intention by adopting a wider meaning of the provision to include value given at the time of the original transaction.
We suspect that the market will now see fewer voidable transaction claims as a result of these decisions. Preventing liquidators from choosing the point of peak indebtedness as the starting point may reduce the quantum of some claims to the point that it is uneconomical to bring proceedings.
The Court of Appeal’s rejection of peak indebtedness and the broad gave value defence makes it harder for liquidators to recover payments as voidable transactions. There is potential for the Court of Appeal’s decision to be used by trade creditors in Australia trying to defend against voidable transactions claims. It remains to be seen whether the Australian courts will engage in full consideration of the application of the peak indebtedness rule as a result of this decision.
Michael Arthur is a partner at Chapman Tripp, specialising in restructuring and insolvency.
Nupur Upadhyay is a solicitor at Chapman Tripp.
