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Assuming a creditor is aware of the provisions and the debtor’s financial health, the deterrence rationale further supposes that a creditor will choose not to take the preference because they will be ultimately forced to disgorge it. In reality, there are numerous reasons why a creditor might be able to retain a preference. Firstly, there are often insufficient funds available to the liquidator to commence proceedings to recover all payments believed to be preferential. Alternatively, a creditor may believe that they have an alteration of position defence or they may determine that liquidation is unlikely to eventuate at all. If liquidation does commence, the payment could fall outside the restricted period and be less susceptible to challenge or it may escape the Tamara M. Buckwold, Uniform Law Conference of Canada Reform of Fraudulent Conveyances and
Fraudulent Preferences Law (Transactions and Undervalue and Preferential Transfers) Part II:
Preferential Transfers (2008) at 17.
Keay, above n 15, citing Rin Nimmer "Security Interests in Bankruptcy: An Overview of Section 547 of the Code" (1980) 17 Houston LR 289 at 291.
specified period altogether. A calculating creditor aware of the details of the provisions might accept the payment and then assist the debtor to stay afloat just long enough to escape either relation-back period.94 Given these various intervening factors, a rational creditor will often judge that it is worth accepting the payment and running the risk that it might have to be returned.
Even if the payment is found to be preferential, the worst that can happen is the creditor must return the payment. There is no penalty imposed and the creditor is no worse off for having accepted it. The biggest loss the creditor stands to face is potential legal costs. 95 The deterrent effect would undoubtedly be much greater if creditors were penalised for accepting preferences but preference payments are prima facie legitimate transactions. Generally neither the debtor nor the creditor has engaged in any dishonorable behaviour and thus penalties have no place in preference law.
The knowledge or belief that a debtor is sliding into insolvency is important only if the purpose of preference law is to deter the race. If the law is incapable of having such a deterrent effect, then the consideration of creditor knowledge in a voidable preference regime cannot be justified. Furthermore, the essential notion of the creditor deterrence rationale is that culpability somehow matters. 96 Those creditors with knowledge of the debtor’s insolvency are treated as culpable while those without knowledge are protected. It is apparent that whether or not a preferred creditor was at fault in a moral sense bears no direct relationship to the overriding aim to uphold the principle of pari passu upon liquidation. Even if it is accepted that a creditor who has knowingly accepted a preference is guilty of some kind of morally culpable conduct, it is difficult to argue that an “innocent” creditor should be allowed to keep property received at the expense of others while a “guilty” creditor should not if the distinction does not produce any positive outcome in terms of deterrence.97 Keay, above n 15, at 78.
Tabb, above n 5, at 990.
Buckwold, above n 92, at 17.
Thus the fallacy of the deterrence is two-sided in that it simultaneously expects too much and too little from creditors.98 It asks too much in the sense that it expects creditors to behave in ways that are economically irrational. The collective regime is mandatory precisely because creditors cannot be expected to voluntarily forego their individual enforcement rights. At the same time, the deterrence rationale asks too little to the extent that it excuses “innocent” parties who accept property of the debtor oblivious to the debtor’s impending financial downfall.
Despite the overwhelming flaws of the creditor deterrence rationale, it has found its way into the Companies Act 1993 and the Companies Amendment Act 2006. The next chapter examines New Zealand’s attempts to create an avoidance regime that upholds both the creditor equality rationale and the creditor deterrence rationale.
L Ponoroff ‘‘Evil Intentions and an Irresolute Endorsement for Scientific Rationalism: Bankruptcy Preferences One More Time’’  Wisc L Rev 1439 at 1449.
Chapter III - The New Zealand Avoidance Regimes New Zealand has made concerted efforts since 1993 towards the creation of an avoidance regime that is upholds the policy of creditor equality. However, these attempts have been consistently undermined by the inclusion of the creditor deterrence rationale, which assesses creditor culpability on the basis of knowledge or suspicion of insolvency.
The 1993 Companies Act represented a radical change in preference law as it abandoned the debtor intention test and demonstrated a new commitment to creditor equality. However, Parliament also introduced an exception for payments made in the “ordinary course of business.” The explosion of litigation that ensued over the meaning of the phrase revealed that the ‘good’ and ‘bad’ preferences were being distinguished on the basis of the creditor deterrence rationale.
The Companies Amendment Act 2006 repealed the exception with the aim of creating a more certain regime. The amendments strengthened the policy of equality through the recognition of a running account test and it appeared that the creditor equality rationale would finally prevail. However, the alteration of position defence was also amended. The new defence explicitly recognises the creditor deterrence rationale by focusing on the creditor’s knowledge of insolvency. Although the reforms aimed to enhance certainty, the new defence has resulted in the litigation of the same factors that were prominent under the ordinary course exception. Thus although the 2006 reform represented another shift towards creditor equality, it also revealed parliament’s reluctance to abandon the notion of moral culpability.
A. The 1993 Companies Act: Towards Equality
The 1993 Companies Act moved New Zealand to an effects-based avoidance regime, consistent with that of Australia. 99 The objective was to “remove the evidential s 588FE Corporations Act difficulties associated with proving the state of mind of any party to the transaction and, more importantly, ensure that transactions are set aside on a basis that is consistent with the pari passu principle”.100 A transaction was now voidable if it had the effect of conferring a preference, regardless of whether the debtor intended such a result. The effects-based test was retained in the 2006 amendments and the elements and operation of the test has been detailed earlier.101 The effects-based test was referred to as a radical change that fundamentally altered the law of preferences.102 In terms of the creditor equality rationale, this sea change in New Zealand’s preference law provided a far superior regime to that which existed under the Companies Act 1955.103 However, the preferential effect of a transaction alone was not accepted as sufficient grounds for avoidance. In the words of the Court of Appeal, Parliament must have thought it “unduly harsh to make a transaction voidable simply as a result of its preferential effect”104 and therefore introduced an exception for transactions that take place in the “ordinary course of business”.
2. The ordinary course of business exception
The unamended section 292(2) provided that an insolvent transaction was voidable “unless the transaction took place in the ordinary course of business”. Transactions that occurred in the restricted period were assumed to have been entered into while the company was insolvent and otherwise than in the ordinary course. However, if the transaction occurred within the specified period the liquidator was required to establish it was outside the ordinary course of business.
The Law Commission did not provide any discussion on the inclusion of the exception in its Company Law Reform and Restatement report that formed the basis of the reforms. The incorporation of the exception was perhaps ill considered given that it was in 1993 that Australia abandoned the ordinary course of business as the key Ministry of Economic Development, above n 7, at 58.
See Chapter I C 3M Ross ‘‘Payments Made in the Ordinary Course of Business’’(2000) 8 Insol LJ 157.
M Conaglen ‘‘Voidable Preferences under the Companies Act 1993’’  NZ Law Rev 197 at 206.
Re Excel Freight Ltd (in liq)  2 NZLR 541 (CA) at 546. This was so even though the 1993 Act retained the alteration of position defence from the 1955 Act in section 296(3).
exception to its voidable preference regime. As Fisher J commented, “one of us must have gotten it wrong” and with the benefit of hindsight, one may safely say that it was New Zealand.105 (a) Possible policy justifications In absence of any further guidelines from Parliament, the courts were left to guess at the policy objectives of the exception in order to determine its meaning and scope.
The major policy objectives suggested by the courts are encouraging the provision of credit and the continuation of trade, and preserving the finality of transactions.
Although the importance of these objectives is not doubted, the ordinary course of business exception failed in its promotion of them.
(i) Encouraging the provision of credit to debtors The argument was that if ordinary course payments were not protected, credit would be withheld and debtors would be forced into liquidation at a faster rate. A company’s survival often depends on the ongoing supply of goods on credit and thus it is in the interests of all to have ordinary business routines continue up to the last minute.
Creditors are incentivised to continue dealing with distressed debtors if ordinary transactions are protected and it is in the interests of the general body of creditors to assist a company to trade out of financial difficulty. 106 The ordinary course of business exception can therefore be seen as aimed at the wider objective of business survival.107 However, the same argument can be made in relation to preference law generally. If the law allowed debtors to prefer certain creditors on insolvency then creditors would as a general proposition begin to require more security before advancing credit.
Where a debtor could not provide the requisite security, credit might not be given and so ordinary trade processes would be undermined.108 Fisher J recognised this role of Fisher J in Re Modern Terrazzo Ltd  1 NZLR 160.
Tabb, above n 5, at 1022.
Re Excel Freight Ltd (in liq), above n 103, at 546.
Conaglen, above n 102, at 203.
preference law generally in Re Modern Terrazzo Ltd (in liq):109 “Exposing creditors to the risk that one of their number might be preferred would normally be contrary to the public interest since it would be a disincentive to the giving of credit and the free flow of trade…It would promote immediate enforcement by each creditor in circumstances where time to pay might otherwise secure the company's future, and hence full payment of all.” It is difficult to see how the ability to set aside preferences and the ability to protect them can be seen as encouraging the provision of credit. In either case, the incentive argument is flawed. There is serious doubt as to whether an exception within a voidable preference regime will have any effect on the behaviour of creditors given that most small businesses and even some large ones have no knowledge of this area of law. 110 A creditor’s decision to extend credit will generally be based on their assessment of the likelihood of repayment, not on the possibility of insolvency and subsequent avoidance.111 Further, even if the ordinary course of business exception could have an incentive effect, some commentators argue that the incentive may be of a perverse nature. The creditor who gets paid in the ordinary course need not cooperate further with the debtor because if the debtor goes into liquidation, the creditor can simply keep the payment and not extend any more creditor to the debtor.112 (ii) Finality of transactions A second justification for the ordinary course exception is the need to uphold the finality of transactions.113 The assumption is that rights acquired prior to liquidation should be left undisturbed. Tipping J in Re Excel Freight Ltd (in liq) stated that by enacting the ordinary course exception “parliament thereby intended a commercially unremarkable payment to stand, even if having preferential effect…otherwise the ordinary processes of commerce would be unduly undermined.”114 Re Modern Terrazzo Ltd (in liq), above n 5, at 174.
Ministry of Economic Development, above n 7, at 57.
Tabb, above n 5, at 1022.
Charles Tabb The Law of Bankruptcy (Foundation Press, New York, 1997) at 384.
Brown & Telfer, above n 69, at 6.
 2 NZLR 541 (CA) at 546.
Allowing ordinary commercial transactions to stand is arguably more economically efficient than avoidance because the litigation and administration costs associated with setting aside payments are minimised. Further, the ordinary course exception arguably minimises the uncertainty cost associated with preference law. Without such an exception, creditor recipients in the vulnerability period cannot be sure of the finality of a payment and thus their ability to use the payment or property is hindered.
By excluding ordinary course transfers, this uncertainty cost is avoided by creditors who are viewed as having done nothing wrong. 115 However, given the huge interpretational issues surrounding the meaning of the exception, the exception could not have possibly formed the basis for business or credit planning decisions nor given any assurance of the certainty of a payment.116 Thus the ordinary course safe harbour itself did not reduce any uncertainty cost nor promote the finality of transactions.