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«Gabrielle Smith A dissertation submitted in partial fulfilment of the degree of the Bachelor of Laws (Honours) at the University of Otago October ...»

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(a) The relation-back period As established, the race of diligence prevails during solvency and it is not until liquidation that the pari passu principle takes hold. No problems would arise, and the avoidance provisions would be unnecessary, if insolvency and liquidation were contemporaneous. The race model would continue until the point of insolvency at which time equality would take over in the context of the collective proceeding.

However, this convenient ordering of things does not exist in real life.47 A company is generally insolvent for some time before formal liquidation commences and any Belmont Park Investments Pty Ltd v BNY Corporate Trustee Services Ltd [2012] 1 AC 383 at [1].

The Football League Ltd, above n 38, at [69].

Belmont Park Investments, above n 44, at [14) and [80].

Tabb, above n 5, at 989.

transaction entered into during this period violates the pari passu principle.

The existence of this transition period, known as the relation-back, creates the need for voidable preference law in order “to impose equality on [preliquidation] behavior so that that behavior will not make the principle of equality in [liquidation] distribution meaningless”.48 The avoidance provisions shift the point at which the pari passu principle “bites back” from the date of formal insolvency to the date of technical insolvency, 49 thereby retrospectively halting the race of diligence and helping to ensure that more than “mere tag ends and remnants” remain to be distributed on liquidation.50 The issue is how far back in time voidable preference law should reach to set aside preferences. A regime that upholds equality absolutely would set aside all payments from the moment of technical insolvency. However, it is difficult to retrospectively establish the precise moment that a company became insolvent. Thus the law uses a set cut-off point to estimate the length of the transition period and to provide greater commercial certainty in terms of the finality of transactions.

The Companies Act provides for two relation-back or “vulnerability periods”: the specified period and the restricted period. The specified period is the period of two years prior to the date of commencement of the liquidation proceedings51 while the restricted period is the period of six months prior to the date of commencement of the liquidation proceedings.52 Thus any transactions entered into beyond two years from the date of commencement of liquidation are immune from challenge.

McCoid, above n 11, at 260.

Ministry of Economic Development), above n 7, at 54.

C Seligson "Preferences Under the Bankruptcy Act" (1961) 15 Vanderbilt LR at 115.

Section 192(5).

Section 192(6).

(b) The avoidance test Section 292(1) provides that a transaction is voidable by a liquidator if it was entered into in the specified period and is an insolvent transaction.53 An insolvent transaction

is defined in s 292(2) as a transaction by a company that:

(a) is entered into at a time when the company is unable to pay its due 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.

Unable to pay due debts The liquidator may only void a transaction if it was made when the company was unable to pay its due debts.54 As a concept this requirement is easy to express but the determination of the solvency of the company at a given point in time is a difficult task.55 Parliament recognised this challenge and created a rebuttable presumption of insolvency during the restricted period in order to assist the liquidator. However, if the transaction falls within the specified period, the onus falls on the liquidator to establish insolvency.

Section 292(3) provides an exhaustive definition of a transaction but given its width there does not appear to be any noteworthy limitations to its application. s 292(3): a transaction means any of the of

the following steps by the company:

(a) conveying or transferring the company’s property;

(b) creating a charge over the company’s property;

(c) incurring an obligation;

(d) undergoing an execution process;

(e) paying money (including paying money in accordance with a judgment or order of a Court);

(f) anything done or omitted to be done for the purpose of entering into the transaction or giving effect to it; and (g) a transaction by a receiver, except a transaction that discharges, whether in part or in full, a liability for which the receiver is personally liable under s 32(1) of the Receiverships Act 1993 or otherwise personally liable under a contract entered into by the receiver.

It should be noted that s 292 does not cover a situation where the company becomes insolvent immediately after entering into the transaction. This is in contrast with s 297 transactions at undervalue and s 293 voidable charges where the insolvency test is whether immediately after the charge is given or the transaction is made, the company is unable to pay its debts. Such a distinction can be justified on the basis that these provisions are aimed at depletions of the company’s assets rather than creditor equality.

Heath & Whale, above n 30, at [24.48] In assessing the company’s solvency, regard must be had to the company’s financial position in its entirety, including the nature of the company’s debts, its business, and the question of whether its assets are in a readily realisable form.56 For the purposes of this dissertation, insolvency is presumed and the methods of establishing inability to pay due debts are not examined.

Enables another person to receive more towards satisfaction of a debt

This requirement is known as the “preferential effect” test and requires the liquidator to make a comparison between what the creditor actually received and what the creditor would have likely received in the liquidation had the payment not been made. 57 The liquidation in this context is the actual liquidation as opposed to a hypothetical liquidation occurring at the time of the transaction.58 Further, the court need only satisfy itself that the transaction has given the creditor the means to Rees v Bank of New South Wales (1964) 111 CLR 210 at 218-219. Although not directly referred to

in the avoidance provisions, the court may also have regard to the test of solvency provided in s4:

(1) For the purposes of this Act, a company satisfies the solvency test if— (a) The company is able to pay its debts as they become due in the normal course of business;

and (b)The value of the company's assets is greater than the value of its liabilities, including contingent liabilities.

(2) Without limiting sections 52 and 55(3) of this Act, in determining for the purposes of this Act (other than sections 221 and 222 which relate to amalgamations) whether the value of a company's assets is greater than the value of its liabilities, including contingent liabilities, the directors— (a)Must have regard to— (i)The most recent financial statements of the company that comply with section 10 of the Financial Reporting Act 1993; and (ii)All other circumstances that the directors know or ought to know affect, or may affect, the value of the company's assets and the value of the company's liabilities,

including its contingent liabilities:

(b)May rely on valuations of assets or estimates of liabilities that are reasonable in the circumstances.

Levin v Market Square Trust [2007] NZCA 135. The Court of Appeal rejected previous judicial authority that the general body of creditors had to be worse off as a result of the transaction, see e.g., National Bank of NZ v Coyle (1999) 8 NZCLC 262,100 at 262. Such a proposition was based on the incorrect assumption that the avoidance regime operates to maximise the pool of assets available for distribution in liquidation. However, an inquiry of this nature is more appropriately directed at a transaction at under value, which is aimed at preventing a depletion of the company’s asset base.

A hypothetical liquidation would involve establishing the financial position of the company and the claims of its creditors at the time of the impugned transaction and thus subsequent events such as the accrual of preferential debts or new creditors are ignored. A hypothetical liquidation has been rejected, see Porter Hire Ltd v Blanchett HC Auckland CIV-2005-404-3056 1 June 2006 upheld in Levin v Market Trust, above n 58.

improve its position over that of other creditors, not that it will necessarily succeed in doing so.59

Procedure for setting aside an insolvent transaction

A liquidator who wishes to set aside a transaction that is voidable under s 292 must file a notice with the court and serve the notice as soon as practicable on the creditor.60 The creditor then has twenty days in which to submit a counter-notice of objection, or the transaction is automatically set aside. The creditor’s notice must contain full particulars of the reasons for objecting to the liquidator’s notice and those reasons must be supported with evidence. If the creditor does object, the onus lies on the liquidator to commence proceedings to set the transaction aside.

Effect of an insolvent transaction

An insolvent transaction under s 292 is voidable by the liquidator, not void ab initio.

The relief that the liquidator can obtain as a result of a breach of s 292 may vary, but the most appropriate order will generally be for the preferred creditor to pay or transfer money or assets to the company.61 E.g. the assignment of a cause of action by the company has the effect of ‘enabling’ a creditor to improve its position and the liquidator is not required to prove what the outcome of the cause of action will actually be, see Managh v Morrison HC Napier CIV-009-441-522, 5 September 2011.

See section 294 Appendix One. Both notices must satisfy the formalities set out in the section.

s 295 If a transaction or charge is set aside under section 294, the Court may make one or more of the

following orders:

(a) an order that a person pay to the company an amount equal to some or all of the money

that the company has paid under the transaction:

(b) an order that a person transfer to the company property that the company has transferred

under the transaction:

(c) an order that a person pay to the company an amount that, in the Court's opinion, fairly

represents some or all of the benefits that the person has received because of the transaction:

(d) an order that a person transfer to the company property that, in the Court's opinion, fairly

represents the application of either or both of the following:

(i) money that the company has paid under the transaction:

(ii) proceeds of property that the company has transferred under the transaction:

(e) an order releasing, in whole or in part, a charge given by the company:

(f) an order requiring security to be given for the discharge of an order made under this


(g) an order specifying the extent to which a person affected by the setting aside of a transaction or by an order made under this section is entitled to claim as a creditor in the liquidation.

The Act does not expressly state which parties should receive the benefit of any preference recoveries. The general position is that recoveries made by a liquidator are for the general body of creditors and not for the benefit of secured creditors. 62 However, where property is recovered by a liquidator that is subject to a specific charge in favour of the secured creditor, the property will again become subject to the prior charge and will not be available for distribution to the company’s unsecured creditors. If however, the charge is non-specific, the property recovered by a liquidator is not subject to the charge.63 This means that it is unlikely that a recovery by the liquidator will be available to a secured creditor with a General Security Agreement over all present and after acquired property of the company. Thus it is evident that the voidable preference provisions can have a significant impact on the dividend ultimately received by unsecured creditors.

–  –  –

A transaction is prima facie voidable when it is established that it is an insolvent transaction that occurred within the specified period. However, recovery by the liquidator is prevented if a creditor can satisfy the elements of an alteration of position defence.64 The running account principle also operates as a kind of exception to the pari passu principle. Essentially, where there has been a series of transactions between the company and the creditor, the liquidator must only allege a preference if the overall effect of the series of transactions is to confer an advantage on a creditor.65 The running account test is an element of a voidable transaction and thus a liquidator should only allege a preference in a running account context when there is a net Heath & Whale, above n 30, at [24.120] There has been some suggestion that this rule has changed following the 2006 amendments. The unamended s 295 provided that property recovered was payable or transferable to the liquidator, s 295 now states that the recovery is payable to the company. However, the Australian provision is worded the same as the current s 295 and the rule that a holder of a non-specific charge is prevented from benefitting from recovery applies, see Tolcher v National Australia Bank Ltd (2003) 174 FLR 251.

Thus it is unlikely that Parliament intended to change the general rule.

s 296(3). The defendant must establish it acted in good faith, did not have reasonable grounds for suspecting, and a reasonable person in the defendant’s position would not have suspected, that the company was insolvent, and the defendant gave value for the property or altered their position in the reasonably held belief that the transfer was valid and would not be set aside.

s 292(4B). See Appendix One.

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