Levin v BCS Holding Account Limited
[2015] NZHC 1564
•15 June 2015
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
CIV-2015-404-12 [2015] NZHC 1564
UNDER the Companies Act 1993 IN THE MATTER OF
ZENITH KITCHEN & JOINERY LIMITED (IN LIQUIDATION)
BETWEEN
HENRY DAVID LEVIN AND VIVIEN JUDITH MADSEN-RIES AS LIQUIDATORS OF ZENITH KITCHEN
& JOINERY LTD (IN LIQUIDATION) Plaintiff
AND
BCS HOLDING ACCOUNT LIMITED Defendant
Hearing: 15 June 2015 Appearances:
R P Coltman and J C Muggeridge for Applicants
P W Michalik for RespondentJudgment:
15 June 2015
ORAL JUDGMENT OF ASSOCIATE JUDGE R M BELL
Solicitors:
Fortune Manning (R P Coltman/J C Muggeridge) Auckland, for Applicants
Lloyd Dodson Pringle (M Pringle) Dannevirke, for the Respondent
Counsel:
P W Michalik, Wellington, for Respondent
LEVIN AND MADSEN-RIES AS LIQUIDATORS OF ZENITH KITCHEN & JOINERY LTD (IN LIQUIDATION) v BCS HOLDING ACCOUNT LIMITED [2015] NZHC 1564 [15 June 2015]
Introduction
[1] In this voidable transaction case, the liquidators of Zenith Kitchen & Joinery Ltd apply for orders setting aside payments to BCS Holding Account Ltd and for payment of $95,177.61 plus interest and costs. For ease of reference, I refer to BCS Holding Account Ltd by the shorter name “Holding Account Ltd”. “BCS” is short for “Beauty Craft Surfaces”. That is the name of a business which was under the control of different people at different times. I refer to Holding Account Ltd as the company that had control over and ownership of that business during the times relevant to this proceeding.
[2] These questions arise:
(a) What payments did Zenith make to Holding Account Ltd?
(b)What preference, if any, did Holding Account Ltd receive from those payments?
(c) Was Zenith unable to pay its due debts at the times of those payments?
(d)Were payments before 1 November 2007 made in the ordinary course of business?
(e) Does Holding Account Ltd have a defence under s 296(3) of the
Companies Act 1993?
(f) What relief, if any, should the court order in its discretion under s 295 of the Companies Act?
Background
[3] BCS is the name of a business in Maungaturoto, Northland, that made bench tops. The original owner of the business was a Mr Hoyle. He did not have a company. In March 2005 Mr Brian Smith and his wife bought the BCS business
from Mr Hoyle. They incorporated a company which they called “Beauty Craft Surfaces Ltd”. That is the company I am referring to as “Holding Account Ltd”. The company supplied Zenith with bench tops and, with increasing supplies, became one of Zenith’s creditors. Zenith installed kitchens in Auckland apartments and similar developments.
[4] In 2006 Mr and Mrs Smith sold the business to a Mr and Mrs Cochrane. Mr and Mrs Cochrane incorporated a new company with the permission of the Smiths which was called “Beauty Craft Surfaces Ltd”. Mr and Mrs Smith changed the name of their company to “BCS Holding Account Ltd”. Mr and Mrs Cochrane’s company took over the business with effect from 1 September 2006. Holding Account Ltd did not make any supplies of bench tops to Zenith after 31 August
2006. The Smiths’ sale of the business to the Cochrane company did not include current account receivables and payables. At the time of the sale, Zenith owed Holding Account Ltd $95,708.74.
[5] In the trading up until the Smiths sold the business, Zenith’s indebtedness to Holding Account Ltd had steadily increased. The records of Holding Account Ltd show that Zenith did make payments in reduction of indebtedness, usually about the end of each month, but the payments made were never enough to reduce the debt to a nil balance. Zenith’s debt to Holding Account Ltd peaked at $101,255.08 in May
2006.
[6] On 28 January 2009, on the application of the Commissioner of Inland Revenue, Zenith was ordered into liquidation. The creditors claiming in the liquidation come to $340,941.30. Of that, $58,389.99 is preferential. The major preferential creditor is the Commissioner of Inland Revenue: there are also claims for wages by employees. The unsecured creditors came to $282,551.39. Those figures do not take account of the liquidators’ fees and expenses. So far, anything that the liquidators have realised has gone to pay their remuneration and expenses. There have not been sufficient funds available even to pay the costs of the Commissioner in applying for the liquidation order - the highest ranking claim after the liquidators.
[7] The Commissioner filed the liquidation application on 21 August 2008. Accordingly, under s 292(5) of the Companies Act, the specified period began on
21 August 2006. The restricted period under s 292(6) began on 21 February 2008. The specified period began only a few days before the Smiths transferred their business to the Cochranes.
[8] The liquidators’ case is that between 25 August 2006 and 19 December 2008, Zenith made 116 payments to Holding Account Ltd totalling $95,177.61. Zenith was insolvent throughout that period. They rely on the presumption of insolvency during the restricted period which began on 21 February 2008.
[9] The liquidators have served two notices under s 294 of the Companies Act. The first notice was addressed to Beauty Craft Surfaces Ltd. The payments to be set aside amounted to $165,167.72 made between 25 August 2006 and 19 December
2008. There was a notice of objection. The liquidators reconsidered matters and issued a fresh notice on 21 November 2014. That was addressed to Holding Account Ltd and set out the transactions the liquidators rely on in this application. That was answered by a notice of objection filed on 19 December 2014.
[10] The liquidators began this application on 7 January 2015. There is a six year limitation period running from the date of liquidation within which the liquidators can start an application under ss 294 and 295.1 That limitation period expired on
26 January 2015. The liquidators began this proceeding at a very late date.
[11] Some of the payments in this case were made before 1 November 2007. That is when the Companies Amendment Act 2006 came into force. Under s 27 of that Act, the current version of s 292 was substituted for the earlier version. This application was filed while the present version is in force. The current version of s
292 of the Companies Act applies to the transactions in issue, with one qualification. Section 27(5) of the Companies Amendment Act 2006 is a saving provision:
Nothing in this section makes voidable a transaction that was completed before this section came into force, and that transaction would not have been voidable if this section had not come into force.
1 Levin v Titan Cranes Ltd [2013] NZHC 2628.
[12] Accordingly, a transaction caught by the current version of s 292 may be saved if it was completed before 1 November 2007 and would not have been voidable under the old law. That is relevant to one of Holding Account Ltd's arguments, that the transactions before 1 November 2007 were in the ordinary course of business. That was a defence under the old version of s 292 but is not available under the current version.
What payments did Zenith make to Holding Account Ltd?
[13] There is no dispute that during the specified period Holding Account Ltd was a creditor of Zenith. Nor is there any dispute that during that period Zenith made payments to Holding Account Ltd to reduce its indebtedness. There is, however, a difference between the parties as to the particular payments made.
[14] The schedule to the liquidators’ s 294 notice of 21 November 2014 lists
116 payments. Most of them are for $500 each, although there are some for larger round sums (some for $10,000 some for $2,500, some for $1,000). There is one for
$17,177.61. The schedule has narrations for each payment. I understand that those narrations are taken from Zenith’s accounting records and bank statements. Some payments are described as follows:
TFR to Beauty Craft L Brian Smith Beauty Craft.
Others are in the form:
TFR to Beauty Crf Surfaces Beauty Craft.
The difference in narration is relevant to the question to whom Zenith made the payments. The evidence for Holding Account Ltd is that it did receive payments for “Beauty Craft L Brian Smith Beauty Craft” but it did not receive any payments identified as going to “Beauty Cr Surfaces Beauty Craft”. Mr Smith acknowledged receiving an additional cheque payment.
[15] Mr Smith was asked to provide an explanation. On his evidence, the payments of about $500 per week began only on 10 May 2007. His company had earlier received payments totalling $37,177.61 in September and October 2006. He
said that between October 2006 and May 2007 Zenith had been paying Mr Hoyle, so as to get rid of Zenith’s indebtedness to Mr Hoyle. When that debt was settled, Zenith then reduced its debt to Holding Account Ltd. In a contested application under s 294, the onus is on the liquidators to prove the transactions. Mr Smith was not challenged on this part of his evidence. In his submissions, Mr Coltman accepted that the liquidators did not have any evidence to contradict Mr Smith’s evidence.
[16] The liquidators have not shown that Mr Smith’s evidence as to the payments his company received is incorrect. In particular, Mr Smith identified a further payment of $500 (made on 26 November 2007) that his company had received and that had not been identified by the liquidators. That is important as showing that Holding Account Ltd has been careful to identify all payments it received.
[17] Accepting Mr Smith’s evidence, I find that the payments that Zenith made to Holding Account Ltd identified by the liquidators come to $76,677.61. In addition there is the $500 payment of 26 November 2007 which the liquidators did not identify. The payments identified by Mr Smith fall into two parts. There were three payments made in September and October 2006: $17,177.61 on 18 September;
$10,000 on 1 October; and $10,000 on 3 October. There is a gap until 10 May 2007 when there were regular payments made weekly or thereabouts up until
19 December 2008. Holding Account Ltd said that those payments did not fully extinguish the debt. It wrote the balance off as a bad debt.
[18] The payments made during the restricted period – that is, from 21 February
2008 until the date of liquidation – come to $14,000. The payments made after
1 November 2007 until the start of the restricted period total $10,500, also taking into account the payment on 26 November 2007 of $500 that the liquidators missed. That means that all the payments after 1 November 2007 totalling $24,500 cannot be subject to the saving under s 27(5) of the Companies Amendment Act 2006. The amount of payments before 1 November 2007 was $52,177.61. Of that, $37,177.61 was made in September and October 2006, shortly after the sale of the business to the Cochranes.
What, if any, was the extent of the preference Holding Account Ltd received on these payments?
[19] Under the liquidation, it is most likely that Holding Account Ltd would not have received anything because the payments it did receive would otherwise have been applied towards the liquidators’ expenses and to preferential creditors. Certainly, even if there were any funds available for unsecured creditors, there would be a relatively small dividend. It is clear from the claims of creditors, and from the liquidators’ reports, that Holding Account Ltd has received much more than it would have received in the liquidation.
[20] There is, however, a further matter: establishing the extent of the preference. That is relevant to the court’s powers under s 295 of the Companies Act. The purpose of an order under s 295 is to undo the preference, but no more. For that, it is appropriate to take into account any supplies that Holding Account Ltd made to Zenith during the specified period. The records of Holding Account Ltd show that in the short period between the start of the specified period and the transfer of the
business to the Cochranes, Holding Account Ltd made five supplies to Zenith:
22 August 2006 invoice 45527 $971.08 29 August 2006 invoice 646446 $117.27 31 August 2006 invoice 45529 $1,726.10 31 August 2006 invoice 45530 $1,068.64 31 August 2006 CASH 0963 $1,708.10 $5,591.19
[21] During this period, Holding Account Ltd was about to transfer its business to the Cochranes’ company, barring accounts receivable and accounts payable. It was a sale of a business as a going concern. That meant that the Smiths were required to ensure that orders continued to be placed and met so that the Cochranes could have the benefit of the business, including the ongoing relationship between Holding Account Ltd and Zenith. The transactions that took place in August 2006 do not differ in any way from all the other supplies by Holding Account Ltd to Zenith. They were part of an ongoing business relationship within s 292(4)(b) of the Companies Act. Supplies were made with a view to ongoing business with the expectation that payments would continue to be made to reduce debt.
[22] In short, the creditors of the company had the benefit of the supplies made up to 31 August 2006. Such a conferral of value should be taken into account under s
292(4)(b) of the Companies Act. Under the decision of the Court of Appeal in Timberworld Ltd v Levin the peak indebtedness approach is no longer followed.2 It is irrelevant whether the supplies were made before or after the date of peak indebtedness. I can therefore take into account these supplies totalling $5,591.19 as reducing the preference that Holding Account Ltd received.
Was Zenith unable to pay its due accounts at the time of the transactions?
[23] The liquidators are required to prove that Zenith could not pay its due debts outside the restricted period. Holding Account Ltd has the onus of showing that it could pay its due debts during the restricted period. The enquiry is as to cashflow solvency rather than balance sheet equity. In Re Universal Management Ltd (In Liq),3 Davison CJ summarised the principles established by Richardson J in
Re Northridge Properties Ltd (In Liq):4
(a) The expression covering the ability to pay debts is concerned with the position of the debtor at the time when the charge or payment is made or other specified act takes place. The concern is with the present, but in considering the present position regard may properly be had to the recent past – whether the debtor has in recent weeks been unable to pay debts as they become due.
(b) In determining ability to pay debts as they become due, account must be taken of outstanding debts.
(c) The words “as they become due” mean, as they become legally due.
(d) The reference to payment “from his own money” has not been interpreted strictly to require a debtor to keep sufficient cash on hand at all times for that purpose. It is a matter of striking a balance. It is not a matter simply of measuring assets against liabilities, and it is not a matter of whether if given sufficient time assets could be realised and debts paid. The section is concerned with solvency, so that there must be a substantial element of immediacy and the ability to provide cash from non cash assets.
2 Timberworld Ltd v Levin [2015] NZCA 111.
3 Re Universal Management Ltd (In Liq) (1981) 1 NZCLC 95-026 (HC) at 98,246.
4 Northridge Properties Ltd (In Liq) SC Auckland M46/75, 30 December 1977.
(e) If as is well established convertibility of non cash assets on hand may be taken into account in determining solvency, so too must debts become due while that conversion takes place. Moreover the words “as they become due” involve consideration of a debtor’s position over a period not at an incident of time.
[24] Those principles have been consistently applied in voidable transaction cases ever since.
[25] Holding Account Ltd has not adduced any evidence of its own to establish Zenith’s ability to pay its debts as they fell due. Instead, it attacks the liquidators’ evidence and invites the court to draw other inferences.
[26] The liquidators have put in evidence financial statements of Zenith for the years ending 31 March 2006, 2007 and 2008. They also rely on the creditors’ claims in the liquidation, especially the claim made by the Commissioner, and on the indebtedness to Holding Account Ltd. All the financial statements consistently show a working capital deficit. The accounts for the year ending 31 March 2006 show a working capital deficiency of $106,424.15 The current assets include stock on hand of $25,000 (which I take to represent work in progress), an advance by a related party of $22,267.85 and trade debtors of some $144,000. Against that, there are a bank overdraft of $35,000 odd, trade creditors of $170,000, GST of $52,000 odd, PAYE of $37,000 and a hire purchase debt of $2,600. The only fixed asset is a rather aged motor vehicle. The company made a profit of $1,300, although the profit and loss account also shows shareholder’s salary of $23,200. The balance sheet a negative equity of $103,000.
[27] The 2007 financial statements show a net loss of $245,000, without any
provision for shareholders’ salaries. The balance sheet shows negative equity of
$160,000. There is a working capital deficiency of $164,000: stock on hand was
$44,000, the related party’s advances to the company were increased to $41,500, trade debtors $157,000, the bank overdraft $60,000, trade creditors $279,000, GST
$22,000 and PAYE $31,000. In short, between March 2006 and March 2007, the
company’s financial position had deteriorated.
[28] The financial statements for 2008 show some improvement. The company had made a profit from trading of $73,000 but, again, there was no provision for a shareholder’s salary. There was a negative shareholders’ equity of $57,000. Current assets were $260,000 and current liabilities $320,000, giving a deficiency in working capital of $60,000. The liabilities of the company also included a loan by a Peter McGrane, a related party. The assets include an advance to a related party of
$30,000 odd – a reduction in earlier related party advances.
[29] The liquidators eliminated the advance made by related parties and the loans made by the company to shareholders in analysing the company’s ability to pay its debts. In my view, it is not necessary to consider matters in that way. I illustrate this by referring to the balance sheet for March 2008. The liabilities of the company included a loan of $52,000 to a related party, Peter McGrane. No doubt those funds were injected to help the company meet its liabilities on the basis that when the company’s position improved the loan would be repaid. While it is shown as a current liability, the company could take a more relaxed view towards that liability than would be required with other current liabilities such as the bank overdraft, trade creditors, and the Commissioner.
[30] Correspondingly, the liquidators invited me to draw an adverse inference from the fact that the related party advance of $30,000 was still outstanding. The liquidators asked me to infer that the related party must have been unable to repay the advances made because, if there had been an ability to repay, funds would have been put back into the company to ensure that ongoing tax liabilities were met. With due respect, the liquidators are asking me to draw too much of an inference from that matter. I regard it as more straightforward simply to consider the matter of working capital - surplus or deficiency - by having regard to the figures in the balance sheet. That is not against the liquidators’ case because, at all three balance dates, the company had a deficiency in working capital. Besides, there was negative equity as well.
[31] In addition, there is the increasing indebtedness to the Commissioner. The
Commissioner submitted a claim in the liquidation which shows Zenith’s debt at
2 February 2009. That does not record the amount of indebtedness at earlier dates.
All the same, a pattern emerges. I have particular regard to the accounts for GST and PAYE. The entries for income tax and Kiwisaver deductions are relatively small and insignificant. So far as GST is concerned, there are entries in some months, between March 2005 and November 2007. In only three of those months was there a complete failure to pay. For other months where there have been no entries, I infer that the company has paid its GST on time when due. In other cases the company did pay but there were also charges for penalties and interest. I infer from the entries for those months that the company paid late, thereby incurring penalties and interest.
[32] The analysis for PAYE works the same, except that there are more months where no payments were made at all. There are some months outside the specified period. There are entries where PAYE was paid late, with penalties and interest imposed in addition to the original assessment. The total assessed PAYE was
$220,000. Payments of PAYE come to $185,000. The outstanding balance for
PAYE was $102,000: that is because of charges for penalties and interest.
[33] I draw this from the Commissioner’s statement of account. Zenith was not paying its GST and PAYE when due, but paid late. In making delayed payments it was, in effect, using the Commissioner as a kind of banker, although incurring very heavy financing costs given the steep penalties and interest imposed under the tax legislation. That is a symptom of a company struggling to pay its debts as they fell due. It fell behind in paying GST and PAYE while paying other suppliers.
[34] Finally, there is the debt owed to Holding Account Ltd. That had started with a nil balance in March 2005 and steadily increased to a peak of over $100,000.
$100,000 was first reached in December 2005. The company did make payments to reduce the debt, but the debt continued at a very high level. Mr Smith said that he applied a credit limit, although he could not now accurately recall exactly what that debt limit was. The high debt over an extended period is an indicator that Zenith was not able to pay all its debts as they fell due.
[35] Taking those matters together, there is a clear picture that during the period of the financial statements – that is, up until March 2008 – Zenith was not able to pay all its debts as they fell due.
[36] Against that, Holding Account Ltd submitted that this was a case of a company which chose to park some debts while paying other creditors. The claims made in the liquidation were by and large for debts that had fallen due in 2008, with very few debts, barring the Commissioner, going back earlier than 2008. It was submitted that the evidence showed not an inability to pay but simply a business decision not to pay certain creditors on the basis that they could be kept to one side to be settled later.
[37] I do not accept that. If a company declines to pay debts as they fall due, it leaves itself open to the inference that it is unable to pay the debts as they fall due. The debts to the Commissioner and to Holding Account Ltd were not disputed or queried in any way. I find it useful to apply the approach taken by the English Court
of Appeal in Taylor’s Industrial Flooring Ltd v M&H Plant Hire (Manchester) Ltd.5
That was a case where a creditor applied for a liquidation order without relying on non-compliance with a statutory demand. The creditor was able to rely on the failure to pay an undisputed debt. Dillon LJ said:6
The first limb is that if a debt is due and an invoice sent and the debt is not disputed, then the failure of the debtor company to pay the debt is itself evidence of inability to pay. That appears from the judgment of Harman J in Cornhill Insurance plc v Improvement Services Ltd [1986] BCLC 26, [1986]
1 WLR 114. The headnote correctly states that ([1986] 1 WLR 114):
'Where a company was under an undisputed obligation to pay a specific sum and failed to do so, it could be inferred that it was unable to do so; that accordingly, the defendants could properly swear to their belief in the plaintiff company's insolvency and present a petition for its winding up.'
The judge refers in passing to a statement by Vaisey J in an earlier case:
'Rich men and rich companies who did not pay their debts had only themselves to blame if it were thought that they could not pay them'. It is not right to say, as was submitted to us by counsel for the respondent (Mr Sterling) 'Well, it may be just that they do not want to pay and so you cannot from non-payment of an undisputed debt deduce inability to pay'.
[38] That also applies when the court is considering ability to pay due debts under s 292(2)(a) of the Companies Act.7 Evidence that a company did not pay undisputed
debts goes to prove inability to pay debts at that time. Given the consistent delays in paying Inland Revenue and given the long periods during which the debt to Holding Account Ltd remained unpaid, I find that at all material times Zenith was not able to pay all its due debts as they fell due.
[39] There are no financial statements after March 2008. There were claims made in the liquidation by creditors for debts falling due after that date. That shows that between March 2008 and the date of liquidation the company was also unable to pay all its debts.
[40] There is also the question of the restricted period. What I have said so far is enough to show that I am satisfied that during the restricted period the company was insolvent. Mr Michalek submitted that Holding Account Ltd was relieved having to prove inability to pay debts because of the spoliator principle. That is the presumption “omnia praesumuntur contra spoliatorem” (all things are presumed against the spoliator). Reference was made to Burns v National Bank of New
Zealand Ltd.8 In that decision the Court of Appeal rejected a claim that there could
be a tort of spoliation of evidence. It cited The Ophelia:9
If any one by a deliberate act destroys a document which, according to what its contents may have been, would have told strongly either for him or against him, the strongest possible presumption arises that if it had been produced it would have told against him; and even if the document is destroyed by his own act, but under circumstances in which the intention to destroy evidence may fairly be considered rebutted, still he has to suffer. He is in the position that he is without the corroboration which might have been expected in his case.
[41] In the context of a voidable transaction case in which the creditor carries the burden to prove ability to pay debts in the restricted period, I regard that submission as very ambitious. No evidential foundation has been laid for the suggestion that the liquidators have wilfully destroyed evidence, or even wilfully refrained from giving evidence that might be relevant to the question of solvency. I regard the submission more as a protest against the tough position of requiring the preferred creditor to show solvency during the restricted period. Tough as that may be for the creditor,
the presumption allows for general efficiency in voidable transaction cases. It
8 Burns v National Bank of New Zealand Ltd [2004] 3 NZLR 289 (CA).
9 The Ophelia [1916] 2 AC 206 (PC) at 229-230.
provides a convenient presumption during the restricted period when, in most run-of- the-mill cases the company will be insolvent. It will only be in exceptional circumstances that in the six months before a creditor applies for liquidation the company may be trading solvently and yet suddenly fall into insolvency and end up the subject of a liquidation application. There is nothing in the circumstances of this case that suggests such a sudden collapse.
[42] Accordingly, I am satisfied that at the times of all the transactions in this case
Zenith was unable to pay its due debts under s 292(2)(a) of the Companies Act.
Were the payments before 1 November 2007 made in the ordinary course of business?
[43] I apply the saving under s 27(5) of the Companies Amendment Act 2006. Under the version of s 292 in force before 1 November 2007, there is an exception in the case of transactions that took place in the ordinary course of business.10 The creditor opposing has the onus of proving that the transaction was in the ordinary course of business.11
[44] The liquidators referred to Blanchett v Joinery Direct Ltd,12 where Associate Judge Faire referred to a number of leading authorities. I do not take issue with any of the authorities he cited. Among the cases he referred to is the Court of Appeal’s decision in Waikato Freight Storage (1988) Ltd v Meltzer. These passages in the decision assist: 13
Legislative purpose
[15] One of the important points made by Their Lordships in Countrywide was the need to approach the proper meaning and scope of the concept of the ordinary course of business in relation to the particular statutory context in which the concept appears. The meaning of the same or similar phrases in other contexts is not likely to be particularly helpful. The present context is of course that of avoiding transactions, here payments, which give the recipient a preference over other creditors of a company which is now in liquidation and was at the date of payment unable to pay its due debts.
[16] In 1993 New Zealand company law underwent a fundamental shift of emphasis in this area. The focus moved from intent to effect. Under the earlier law the focus was on whether the dominant intention of the insolvent company was to prefer the creditor concerned. Under the new law the initial focus is on whether the transaction has a preferential effect.
[17] But Parliament did not consider it appropriate to make payments having a preferential effect absolutely voidable. The recipient creditor was given two ways of avoiding that consequence; one as of right, and the other discretionary. If a payment is voidable under s 292(2) the creditor may, as of right, prevent recovery if able to show that it was made in the ordinary course of business. Even if the payment is otherwise voidable, the creditor can seek the exercise of the Court's discretion under s 296(3) to deny recovery, in whole or in part, if able to show receipt in good faith, alteration of position with a qualifying belief, and that it would be inequitable to order recovery or recovery in full.
[18] It is thus evident that Parliament thought it would be unduly harsh to make a transaction voidable simply as a result of its preferential effect. What is more, Parliament considered that the competing interests would not be properly balanced by allowing the creditor simply to seek the exercise of the Court's discretion in terms of s 296(3). An additional protection was given to creditors who had received a payment which was preferential in effect. The creditor can keep the payment if able to show, the onus being on it, that the payment was made by the debtor company in the ordinary course of business. Parliament thereby intended a commercially unremarkable payment to stand, even if having preferential effect. It must have been Parliament's view that otherwise the ordinary processes of commerce would be unduly undermined.
[19] As the Privy Council noted, the proper approach to the phrase “ordinary course of business” is an objective one but against the actual setting in which the payment or other transaction took place. The difficulties which seem to have emerged are not so much with the phrase itself. Rather they relate to the standpoint from which the Court identifies the “actual setting”. To show that a payment or other transaction took place in the ordinary course of business, the recipient creditor has to show that there was nothing abnormal – nothing out of the ordinary – about the payment or transaction in the commercial context in which it took place. As the Privy Council said, there are difficulties in trying to paraphrase statutory tests, or capture them in different words. Hence Their Lordships did not adopt any particular formulation, and it would be inappropriate to seek further to elaborate the phrase itself. But it has become necessary to consider further the proper ambit of the “actual setting” in which the transaction in question took place.
[45] In referring to “actual setting” the Court of Appeal summarised matters:
[31] In our view the judicial approach has become over-complicated and over-refined. The question is whether, at the time it was made, the relevant transaction was made in the ordinary course of business. That is a question of objective fact. General business practices are relevant to that question, as are any particular customs or practices within the field of commerce concerned. So too is the previous commercial relationship between the
parties. The observer spoken of in the Privy Council is in reality the Court which must look at the circumstances, as objectively apparent at the time of the transaction. The ultimate question is whether on the evidence before the Court the transaction or payment can be said to have been made in the ordinary course of business. Was it in its objective commercial setting an ordinary or an out of the ordinary transaction for the parties to have entered into?
[32] The mental approach of the parties to the transaction, as objectively apparent, may sometimes be relevant as an aspect of the circumstances in which the ultimate factual assessment must be made. That of course is subject to s 292(4) which, in itself, demonstrates the legislative purpose to keep subjective intent to prefer on the part of a debtor company out of the arena, unless known to the creditor. It should be noted here that Parliament has made the debtor company's intent or purpose to prefer relevant only if it is actually known to the creditor. The statutory words are “unless that other person [the creditor] knew that that was the intent or purpose of the company”. Parliament has thereby eschewed constructive knowledge in this context. It has not said “knew or ought to have known”. That being the legislative approach to knowledge in relation to intent to prefer, it is unlikely Parliament intended constructive knowledge to be relevant to other aspects of the transaction, save in the unlikely event that such knowledge is capable of influencing whether the transaction, in its actual setting, was objectively in the ordinary course of business. Intent to prefer is irrelevant unless such intent was known to the creditor. If known, such fact must be regarded as relevant but even then, although pointing towards the payment or other transaction being outside the ordinary course of business, such does not automatically follow. This is consistent with the objective assessment which the Court must make.
[46] It is beside the point that the company making the payments is insolvent at the time of payment. Inability to pay debts does not by itself take the transaction out of the ordinary course of business. That is because the enquiry whether the transaction is “in the ordinary course of business” does not start until there has been a finding that the company was unable to pay its due debts at that time.
[47] Mr Smith gave evidence as to the “actual setting” in his affidavit:
7.Like many sub-contractors in the construction industry, a portion of Zenith’s payments would be held in retention by the developers or head contractors for a period after completion of any given project. Because of this, it was not unusual for a portion of any payments owing to the respondent by Zenith to be over 60 days in arrears on our aged receivables list.
8.We accepted late payment as a normal part of being a supplier in the construction industry.
…
13.Since the sale in September 2006, Zenith has made irregular payments in reduction of this debt. The normal course of business between Zenith and the respondent involved Zenith making such payments as its cash flow would allow.
14.The respondent accepted this because we understood that Zenith would continue to trade with the company to which we sold the manufacturing business, and would continue to have to rely on its irregular cash flow both to pay us and to keep trading with our purchasers.
15.We saw nothing unusual in this relationship or our industry. We did not see any sign in this relationship that Zenith was insolvent or unable to pay its debts as they fell due. In effect we gave extended time to Zenith to pay for the goods we had supplied, running its account with us from the start, like a bank overdraft, that Zenith could repay at its convenience.
The liquidators did not give any evidence to challenge that.
[48] I put the payments made after 31 August 2006 into two groups:
(a) the payments totalling $37,177.61 made in September and October
2006; and
(b) the payments starting from 10 May 2007 and running through to
December 2008.
[49] The first payments were made in the ordinary course of business. In effect, those payments follow a pattern that had already been established during the period of trading beginning from March 2005. Holding Account Ltd made regular supplies almost on a daily or weekly basis. Zenith made payments spasmodically but usually once a month in partial reduction of the debt. The payments made in September and October 2006 did not differ in kind from those made at earlier stages in the trading relationship. The “ordinary course of business” between these parties was for Zenith to pay in the way that I have described. The payments made immediately after the sale of the business did not differ. The fact that the business had been sold did not change the character of these payments.
[50] The matter is different, however, for the payments beginning from 10 May
2007. By then there had been a gap during which Zenith had not made any
payments at all. As shown by Mr Smith’s answer in cross-examination, it turned out that during this period Zenith had been paying off the balance outstanding to Mr Hoyle. Zenith set about reducing its debt to Holding Account Ltd by drip-feed payments. Mr Michalek submitted that this was simply a transition into a new “ordinary”. But it is clear that from 10 May 2007 the payments were no longer made in the way that the parties had before. This was a new arrangement, by which the accumulated debt was reduced on a drip-feed basis. That was not done on the basis of expectation of future supplies from Holding Account Ltd. After all, it had sold its business. An indebted company was paying off a debt over time where the debt was long overdue. I do not regard that arrangement as being in the “ordinary course of business”.
[51] Against that, Holding Account Ltd submitted that this was not one of those cases where the creditor had applied any pressure on the debtor to pay. In Levin v Titan Cranes Ltd I dealt with a case of pressure.14 I held that service of a statutory demand in the construction industry by a credit controller used to acting in a robust manner did not take the case out of the “ordinary course of business.” In taking that approach, I have been influenced by the Court of Appeal’s decision in Stapley v Fletcher Concrete and Infrastructure Ltd,15 and by Randerson J’s decision in Chatfield v Mercury Energy Ltd.16
[52] This case is quite the converse. Holding Account Ltd did not apply any pressure at all but was prepared to await payment. Notwithstanding that, I am satisfied that the character of the payments changed between October 2006 and May
2007. Even without Holding Account Ltd applying any pressure, the parties entered into a fresh arrangement which was directed at reducing existing debt and was outside the ordinary course of business. Accordingly, the payments amounting to
$37,177.61 were in the ordinary course of business. The others were not and are voidable under s 292.
[53] I summarise the position so far. The total payments that Holding Account Ltd received came to $76,177.61. Payments of $37,177.61 were in the ordinary course
14 Levin v Titan Cranes Ltd, above n 1.
15 Stapley v Fletcher Concrete and Infrastructure Ltd [2008] NZCA 442 at [26]
of business and are to be deducted. That leaves payments of $39,000. There is a further deduction for the value added because of the supplies between 25 and
31 August 2006 amounting to $5,591.19. The amount of the preference is
$31,586.42.
Does Holding Account Ltd have a defence under s 296(3) of the Companies Act?
[54] Section 296(3) says:
(3) A court must not order the recovery of property of a company (or its equivalent value) by a liquidator whether under this act, any other enactment, or in law or in equity, if the person from whom recovery is sought-
(a) proves that when (A) received the property (A) acted in good faith; and
(b)` a reasonable person in (A)’s position would not have suspected, and (A) did not have reasonable grounds for suspecting, that the company was, or would become, insolvent, and
(c) (A) gave value for the property or altered (A)’s position in the reasonably held belief that the transfer of the property to (A) was valid and would not be set aside.
[55] It is well-established that a creditor relying on a defence under subsection (3)
needs to make out its case under all three subclauses.
Gave value
[56] There is no difficulty with subclause (c). Following the decision of the Supreme Court in Allied Concrete Ltd v Meltzer, Holding Account Ltd did give value through the original supplies it made.17 That part is not in contention.
Good faith
[57] In Levin v Market Square Trust, the Court of Appeal said:18
17 Allied Concrete Ltd v Meltzer [2015] NZSC 7.
18 Levin v Market Square Trust [2007] 3 NZLR 591 at [54]
… The first matter the trust must establish, therefore, is that it “received the property in good faith”. The test of “good faith” has been clearly established by this Court. The recipient of the property or money must show that he or she honestly believed that the transaction would not involve any element of undue preference either to himself or herself or to any guarantor. … The cases show that a creditor is likely to fail this test where he or she has actual or implied knowledge of the company’s financial difficulties, due to the company’s cheques being dishonoured, its failure to pay its debts on time, or other circumstances indicating serious cash-flow problems.
[58] The payments here are those running from 10 May 2007. The payments made earlier are not in issue. The question is whether Holding Account Ltd knew that it was receiving a preference by reason of the payments. It may well have appreciated that the company was indebted and may have had difficulty making its payments, but the good faith requirement goes to whether it knew, by receiving the payments, that it was getting some advantage over other creditors.
[59] Mr Smith’s evidence is consistent with his ignorance of the question of preference. While I would find against him on the question of suspicion, I am satisfied that at the time that payments were made from 10 May 2007 onwards, he did not appreciate that under the drip-feed arrangements he was getting an advantage over other creditors. All that can be held against him on this aspect is that he was dealing with a company which had difficulty paying its debts as they fell due, and that he had made an arrangement to accept payments over time. But the matter does not go beyond that. I do not find the absence of good faith by Holding Account Ltd.
Suspicion of solvency
[60] The matter is however different on the question of suspicion of solvency. By May 2007, Mr Smith must have appreciated that Zenith could not pay all its debts as they fell due. After the sale of the business, he received three payments in fairly short order - in September and in October 2006. Then there was a gap with no payments. At the same time, he arranged for Holding Account Ltd to charge Zenith interest for non-payment. He had not charged Zenith interest up until then. The charging of interest, when the business relationship had come to an end and he was not being paid, shows that he must have appreciated that Zenith was not able to pay all its accounts at that time. Indeed, the very fact that a drip-feed arrangement under
which payments were made in small amounts is a strong pointer that Zenith could not, there and then, pay all its debts as they were due.
[61] Accordingly, I find that a reasonable person in the position of Mr Smith at that time would have suspected that Zenith was insolvent. For these reasons, I find that Holding Account Ltd has not made out its defence under s 296(3). It fails only on the suspicion limb.
Exercise of discretion
[62] Holding Account Ltd submitted that I should exercise the discretion under s 295 in its favour. Its argument was that the court has a general residual discretion under s 295 whether to grant relief at all.
[63] In my view the discretion under s 295 is to be exercised in a principled way. In general, its purpose is to allow the court to mould its orders so as to remedy the preference that the creditor has received. Once the court reaches the position of considering what order to make under s 295, it has already rejected a defence under s 296(3). When the court dismisses a defence under s 296(3), the result is that settled and completed transactions may properly be disturbed in the interests of other creditors in the liquidation.
[64] The matters that Holding Account Ltd asked me to take into account in the discretion were:
(a) the general body of creditors would not benefit, as opposed to the liquidators who would apply the funds towards their remuneration;
(b)Holding Account Ltd had been singled out whereas other creditors may have escaped having to disgorge payments they had received; and
(c) the transaction had been completed for such a long time that Holding Account Ltd was entitled to believe that the transaction would no longer be disturbed.
[65] Holding Account Ltd would be understandably upset at the liquidators’ delay in taking action. This case is unusual in the delay in issuing the notice under s 294 and in filing the application almost on the eve of the six year limitation period. That, however, can be addressed by orders made as to interest. It does not provide a ground for not providing relief to the liquidators altogether.
[66] In Titan Cranes, I addressed the matter of the creditor who felt singled out.19
For similar reasons, I decline to apply the discretion in favour of Holding Account Ltd simply because the liquidators have chosen to pursue it for a voidable transaction as opposed to other creditors. It needs to be remembered that the liquidators should consider carefully what remedies are available to them. They face a considerable litigation risk when they try to recover from preferred creditors. It is to be expected that liquidators would take action only when they are reasonably confident of recovery. They will need to assess the cost-effectiveness of proceedings. The fact that they chose to pursue only a limited number of creditors (and maybe only one) should not lead to second-guessing by other creditors or by the court.
Conclusion
[67] Overall, I am not satisfied that it would be in order for me to use the discretion under s 295 in favour of Holding Account Ltd and to deny relief altogether to the liquidators when they have established that the transactions are voidable. The defence under s 296 is not available. The only area in which I can consider reduced relief is to limit the interest that the liquidators can recover. A remarkable feature of this case is the delay in taking proceedings. The liquidators have not offered any convincing explanation for the delay. I would have expected competent liquidators to identify the transactions and get the proceeding under way within two years of liquidation. Accordingly, I shall limit the interest recoverable by the liquidators to two years from liquidation.
[68] I make these orders:
19 Levin v Titan Cranes Ltd, above n 1, at [80].
(a) Under s 294 of the Companies Act I set aside the payments that Zenith made to Holding Account Ltd between 10 May 2007 and
19 December 2008 amounting to $39,000.
(b)Under s 295 of the Companies Act, I order Holding Account Ltd to pay the liquidators the sum of $31,586.32.
(c) I order the liquidators to pay interest on that sum at five per cent per annum for two years.
Costs
[69] Costs are reserved. Any memoranda as to costs are to be filed and served no later than six weeks.
[70] In this decision I have set out various calculations. I reserve leave to the parties to apply for re-call of this decision if there are any calculation errors.
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Associate Judge Bell
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