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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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In saying that, the need to protect the finality of transactions is an important consideration that must be balanced against the desire for equality. If the policy of repose were to be given full weight, this would mean allowing all payments to stand and the abolition of preference law entirely. An intermediate position is to use a set vulnerability period as the law currently does. Prior to the vulnerability period, all payments are secure and thus the finality of transactions is preserved. Within the vulnerability period, there is no reason for the policy of creditor equality not to receive primacy.117 (b) The emergence of the creditor deterrence rationale Section 292(4) provided that in determining whether a transaction took place in the ordinary course of business, no account was to be taken of any intent or purpose on the part of a company except if the creditor or other recipient knew of the company’s intention. Thus if it could be established that the creditor knew that in accepting a payment it was receiving preferential treatment, the payment was outside the ordinary course. Establishing actual knowledge of preferential effect under section 292(4) was Tabb, above n 5, at 1027.

D Brown ‘‘Voidable Preferences on Liquidation - Steering the ‘‘Ordinary Course of Business’’ Test Back on Track’’ (2001) 7 NZBLQ 97 at 100.

Tabb, above n 5, at 1028.

a difficult task but the factors considered in the general litigation of the ordinary course exception demonstrated that suspicions of insolvency would distinguish between ordinary and extraordinary transactions.

Authority from the High Court either implicitly or explicitly supported such an inquiry. 118 Baragwanath J in Re Anntastic Marketing Ltd explicitly recognised the relevance of creditor knowledge and stated that the correct test was:119 “whether the trader subjectively was, or objectively ought in the particular circumstance to have been, alerted to a real risk that the transaction was abnormal for reasons of financial weakness. Other forms of want of ordinariness do not bear on the mischief at which the provision is directed”.

Baragawanath J explicitly recognised that the ordinary course exception aimed to treat those creditors who must have had knowledge of insolvency but nonetheless accepted a preference as culpable and undeserving of protection. However, a knowledge inquiry was rejected by the Court of Appeal in Waikato Freight and Storage (1988) Ltd v Meltzer on the basis that the creditor culpability line of reasoning “tends to draw attention away from the true inquiry which is whether, in its actual setting, the transaction was objectively ‘abnormal’.’’ 120 Despite the Court of Appeal’s ruling, the key considerations in an ordinary course inquiry were inextricably tied to a creditor’s knowledge of insolvency. Factors that often signaled that a transaction was outside of the ordinary course were the use of post-dated cheques and late payments,121 while payments in rounded sums have been referred to as a “hallmark” of a debtor in financial difficulty. 122 The existence of See Re Excel Freight Ltd, above n 103, at 827; Re Daytone Industries Ltd (in liq) HC Auckland, M13434/98, 27 November 1998.

[1999] 1 NZLR 615, HC Auckland, judgment 9 September 1998. Baragawanath J affirmed the test in Re Excel Freight, above n 103, at 827. The test set down by Baragawanath J was taken from the Australian alteration of position defence that would later form the basis of New Zealand’s defence after the 2006 Companies Act reform.

Waikato Freight and Storage (1988) Ltd v Meltzer [2001] 2 NZLR 541 (CA) at 550.

See Telfer above n 84, at 70 citing Re Island Bay Masonry Ltd (in liq); Firth Industries Ltd v Gray &Anor (1998) 8 NZCLC 261 at 751; Meltzer v Attorney General (1999) 8 NZCLC 261 at 958 (CA); Re Daytone Industries Ltd (in liq) HC Christchurch, CP 505/98, 17 May 1999.

Firth Industries Ltd v Gray &Traveller (1998) 8 NZCLC 261 at 751, Re Eastern Bay Forestry Contractors Ltd (in liq) [2005] BCL 164.

pressure was also a factor that negated a finding of an ordinary course transfer.123 Thus routine inquiries or requests for payments were often acceptable while threats of seizure or legal proceedings typically suggested that payment was outside of the ordinary course of business.124 These factors all suggest that the creditor must have had knowledge or suspicions of insolvency and therefore the ordinary course exception sought to deter only those creditors who knowingly engaged in the dismemberment the debtor. The fallacy of the creditor deterrence rationale has already been established and thus any focus on the creditor’s state of mind is unjustifiable.125 Further, even if the creditor deterrence rationale is accepted, creditor knowledge is a poor standard for setting apart good and bad preferences. In practice, the distinction between a liquidator’s successful recovery of a payment and a creditor’s successful defence of a preference claim is often marginal. For example, in Meltzer v Origo (The Source) Ltd the court considered that six payments amounting to $61,791.42 were made outside of the ordinary course of business.126 The payments were a result of the pressure exerted on the company to make payments or face discontinuance of supply.

Prior to the payments being made, there was a history of trading where credit was extended to the company over a considerable period of time, resulting in significant arrears. New credit terms and a personal guarantee were executed in order to secure continuing supply from Origo and reduce the debt. Despite the continuance of supply, one of the proposed policy objectives of the ordinary course exception, Origo was treated as culpable because of its extra vigilance in ensuring payment for that supply.

Conversely, in Re Wienk Industries Ltd (in liquidation), continuance of supply was found to negate knowledge or suspicion of insolvency despite strong evidence to the contrary.127 A preferential payment for $55,747.82 was held to have been made in the ordinary course of business despite the fact that the creditor had actually been negotiating with the debtor for the sale of its business, which it was able to acquire for just $1.00. Further evidence in the form of a letter from the creditor’s solicitors Chatfield v Mercury Energy Ltd; Contaminated Enterprises Ltd (in Liq) v Mercury Energy Ltd (1998) 8 NZCLC 261 at 645.

Telfer, above n 84, at 69.

See Chapter 2 C.

High Court Auckland M1015/97, 7/12/1998, High Court Auckland CIV-2003-404-816 17 September 2004.

acknowledged their client’s awareness of the debtor’s financial difficulty. However, the payments were found to be in the ordinary course because the creditor continued to supply the debtor with product valued at more than $23,000 which the court held must have meant the creditor was unaware of insolvency.

The arbitrariness of the exception lead to the conclusion that “liquidators rightly take the view that the outcome in a particular case will depend entirely upon who is the sitting Judge.” 128 The Law Commission in its 1989 report stated that the previous debtor intention test had lead “to the unsatisfactory situation where creditors may be treated differently according to the quirks of their circumstances. The purpose of a voidable transaction regime is to avoid this, yet the present law permits it”.129 The creditor knowledge inquiry under the ordinary course of business exception undoubtedly yielded the same result.

Despite the heavy litigation of the ordinary course exception, its meaning remained unclear. The Ministry of Economic Development in its 2001 report, recognised that the knowledge of the other party to the transaction was still a factor in establishing the voidability of a transaction and that the exception created an unacceptable amount of uncertainty. The ordinary course of business exception was repealed in the 2006 reforms but only to be replaced by another preference safe harbour that was similarly premised on the creditor deterrence rationale.

B. The Company Amendment Act 2006: Equality Achieved?

1. The running account principle

–  –  –

The ordinary course of business exception was repealed and replaced with a running account test which provided a “principled and consistent basis for determining which M Ross, above n 103, at 173.

New Zealand Law Commission, Company Law Reform and Restatement, NZLC Report 9 (1989) at [649].

transactions should be set aside”.130 Prior to the 2006 amendment, a liquidator had to establish that individual transactions had the effect of giving the creditor more (and thereby other unsecured creditors less) than they would receive on liquidation. No account was taken of other recent transactions between the creditor and the company.131 Given that the Companies Act 1993 had moved to an effects-based test, then arguably where there is a series of transactions between the debtor and creditor, one should look to the net effect of those dealings over the period of vulnerability. If the net effect is that the creditor continued to supply goods and services whose total value exceeds or is equal to the value of payments the creditor has received in that period, then the creditor cannot be said to have received an advantage over other creditors. It is only when one of the payments is viewed in isolation that it can be said to be a preference.

Parliament accepted that the running account principle was consistent with the effects-based test and that it would promote the continuation of supply on a credit basis to financially distressed debtors without having to rely on a broad standard such as the ordinary course of business exception.

The running account principle, like the statutory set-off regime, fits well with the notion that what matters in preference analysis is the aggregate impact of the transfer on the estate. A simple example may illustrate the significance of the principle in practice. Suppose that when a company became insolvent it owes its supplier $30,000.

The supplier is aware that the company has liquidity problems but agrees to continue to supply goods to a value of $10,000 per month so long as $10,000 payment is received the start of the following month. Assume that this pattern continues for the next six months and at the end of that period, a liquidator is appointed. In the absence of a running account principle, each of the six $10,000 payments would be vulnerable to attack as voidable preferences. This is so despite the fact that the total amount of debt outstanding at $30,000 remains unchanged at the time of liquidation. The commercial reality is that while the company’s assets have been depleted by $60,000 in payments, the assets have also been enlarged by $60,000 worth of supply.

Therefore there is no net reduction in the debt owed to the supplier or a net reduction Ministry of Economic Development, above n 7, at 59.

Brown & Telfer, above n 69, at 13.

in the debtor’s estate. In such circumstances, it would appear wrong to avoid the payments made to the supplier simply because they can be viewed as extinguishing an antecedent debt.

–  –  –

The New Zealand running account test in section 292(4B) is taken from section 588FA(3) of the Australian Corporations Act 2001.132 The essential elements of the section are:133

a) There is has to be a “continuing business relationship” between the creditor and the insolvent company, a running account being the primary example;


b) There has to be a “series of transactions” that results in increases and reductions of the company debtor's indebtedness to the creditor from time to time; and

c) If the factors in (a) and (b) are both present, the series of transactions will be notionally regarded as a single transaction, and will only be voidable (subject to the other elements and defences) by the liquidator, if that single transaction has preferential effect.

Section 292(4B) provides that where:

(a) a transaction is, for commercial purposes, an integral part of a continuing business relationship (for example, a running account) between a company and a creditor of the company (including a relationship to which other persons are parties); and (b) in the course of the relationship, the level of the company's net indebtedness to the creditor is increased and reduced from time to time as the result of a series of transactions forming part of the relationship;

then— (c) subsection (1) applies in relation to all the transactions forming part of the relationship as if they together constituted a single transaction; and (d) the transaction referred to in paragraph (a) may only be taken to be an insolvent transaction voidable by the liquidator if the effect of applying subsection (1) in accordance with paragraph (c) is that the single transaction referred to in paragraph (c) is taken to be an insolvent transaction voidable by the liquidator.

Brown & Telfer, above n 69, at 14.

(c) The “continuing business relationship” or “running account” The term ‘continuing business relationship’ is not defined other than to give a ‘running account’ as an example, which is also undefined. The Australian High Court in Air Australian Services v Ferrier acknowledged the “almost talismanic significance” that had attached to the phrase ‘running account’ but stated that it really required no more than an “active account running from day to day” as opposed to an account where no further debits are contemplated.134 In Sutherland v Eurolinx Santow J identified the essential characteristics of a running account or continued business relationship. 135 He held that must be a mutual and ongoing assumption between the company and the creditor of payment and reciprocal supply throughout the relevant period. The assumption need not be explicit in the sense that the parties do not need to have expressly agreed that their credit arrangement was to operate as a “running account”. Further, the payments must continue to have as at least one operative, mutual purpose, namely the purpose of inducing further supply. Such purpose must not become subordinated to a predominant purpose of recovering past indebtedness.

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