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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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Santow J went on to explain that actual suspicion of insolvency, though coupled with a purpose of getting a previous account paid, does not of itself preclude the running account or continuing business relationship defence provided there still remains at least a substantive mutual purpose of continued supply.136 However, where the debtor is known to be in financial difficulty, the creditor, by demanding payment, may signal that that this has now become its predominant purpose.137 (1996) 185 CLR 483; 14 ACLC 1403, at p 504; p 1416.

Sutherland v Eurolinx (2001) 37 ACSR 477 at [148].

Ibid, at [167] Ibid.

This means that a finding of suspicion of insolvency under an alteration of position defence may also bring a continuing business relationship to an end. This was the outcome in the recent case of Blanchett v McEntee Hire Holdings Ltd.138 The crucial factor was that the creditor had issued a Stop Credit Notice to the company stating that credit would no longer be extended if debts were not recovered. The court did not accept the creditor’s argument that this was part of the creditor’s usual credit control processes and a way of preserving the trade relationship. Instead, it established that the creditor, or a reasonable person in the creditor’s position, would have had suspicions of insolvency. This meant that the creditor was denied the protection of the defence and also that the continuing business relationship came to an end at the time the notice was issued. Payments made after that point were excluded from the running account test despite the continuation of supply.

The result in McEntee is inconsistent with the “ultimate effect” objective of the running account test. Suspicion of insolvency is irrelevant to the net economic impact on the debtor’s estate. Despite the fact McEntee may have had suspicions of insolvency, it continued to supply the debtor. The net effect of the series of transactions was that the creditor received a much smaller preference than it otherwise would have had the transactions been considered in isolation.

These difficulties with establishing a running account or continuing business relationship were recognised by the MED in the Tier One Discussion Documents. The MED stated that a test based on the Australian approach would require an examination of the parties’ state of mind with all the evidential difficulties associated with proving motive or knowledge.139 Such an approach was to be avoided after the previous difficulties with the ordinary course exception. The MED recommended that a running account principle based on the United States approach, rather than the Australian provision, be adopted. However, the United States approach also presents difficulties that were not addressed in the MED’s recommendations.

[2011] NZCCLR 4 (HC).

Ministry of Economic Development, above n 7, at 63.

(d) The United States “subsequent new value” exception The United States uses a ‘subsequent new value’ exception which does not depend on establishing a running account or a continuing business relationship.140 Thus the test avoids any examination of the purpose of payment and the intentions of the parties.

However, the United States approach is not a pure net effect rule. The exception only permits new value to the debtor that postdates the preferential payment to be offset against the preference. This means that if a preferential payment is made after the new value has been provided, that payment cannot be netted against previous supply and is instead vulnerable to avoidance. A pure net effect rule would permit a creditor to offset all advances made during the vulnerability period against the payments received.141 The availability of the exception rests on the timing of the transfers and the advances, not on the economic impact of the series of transactions. Two sets of transactions with exactly the same economic effect are treated differently, due merely to a fortuity of dates.142 Thus although the effectiveness of the New Zealand running account principle is limited by the factual assessment required to establish a continuing business relationship, the United States approach does not present a faultless alternative. Under the New Zealand test, where a continuing business relationship is in place, all transactions can be off-set regardless of timing. However, suspicions of insolvency may affect when the continuing business relationship ceases. The best way to address that concern is to amend the current running account test, rather than adopt the United States approach.

Section 547(c)(4) of the Bankruptcy Code provides that the trustee may not avoid under the section a transfer to or for the benefit of a creditor, to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor— (A) not secured by an otherwise unavoidable security interest; and (B) on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor;

Ponoroff, above n 97, at 1449.

Michael J Herbert “ The Trustee Versus the Trade Creditor: A Critique of Section 547(c)(1), (2) & (4) of the Bankruptcy Cod” 17 U Rich L Rev 667 at 676 (e) The peak indebtedness rule The advantage afforded to creditors through the running account principle is further undermined by what is known as the ‘peak indebtedness’ rule. Section 292(4B) states that the liquidator must treat all the transactions as if they form a single notional transaction and only allege a preference if that single transaction confers a net advantage on the creditor. However, the section is silent as to when the running account begins and ends and thus it is unclear which transactions must be considered in a series.

Australian and New Zealand courts have held that the liquidator is able to choose the commencement and termination points for the period in which the transactions will be netted out. 143 Accordingly, a liquidator is entitled to choose the period of peak indebtedness; that is, the starting date and end date, if not the date of liquidation, that will result in the greatest preference being shown to haven been conferred on the creditor. The peak indebtedness rule effectively allows the liquidator to “cherrypick” which transactions should be subject to the test and make possible largest recovery.144 The peak indebtedness rule was accepted in New Zealand in the aforementioned case of McEntee. 145 The liquidators challenged five payments made by the liquidated company to McEntee between 31 January 2008 and 12 June 2008. McEntee argued that the liquidators should have taken the running account as beginning on the date of the commencement of the voidable period. On this analysis, the net reduction of the company’s indebtedness to McEntee, and thus the net preference, was $6,720.68.

However, as previously established, the court found that the continuing business relationship between the company and McEntee had ended on 9 January 2008 when Rothmans Exports Pty Ltd v Mistmorn Pty Ltd (1994) 15 ACSR 139; 12 ACLC 936; Olifent v Australian Wine Industries Pty Ltd (1996) 19 ACSR 285; 14 ACLC 510. The rule was accepted in New Zealand in Blanchett v McEntee Hire Holdings Ltd, above n 38.

Telfer & Brown, at 15.

At 38.

McEntee issued a ‘Stop Credit Notice’ against the company. This meant that all the payments made after this date were preferences and approximately $21,384.35 was to be returned to liquidator. The court held, in the alternative, that if its finding was wrong and the relationship had continued up to the date of the liquidation, the liquidators were able to choose 9 January 2008 as the date from which the running account began. This would have resulted in a voidable amount of $18,124.12, being the net effect of the transactions between 9 January 2008 and the date the liquidation application was filed.

McEntee demonstrates the significant impact the peak indebtedness rule has on creditors. The ability of the liquidator to choose any starting date undermines the “ultimate effect” premise as it allows the liquidator to arbitrarily disregard the value of goods or services supplied after the commencement of the specified period but before the chosen start date of the continued business relationship.146 As part of the recommendations for reform, it is suggested that the running account principle be amended to prevent the operation of the peak indebtedness rule and to overcome the evidential difficulties associated with proving the predominant purpose of payment.

These difficulties aside, the running account principle is a significant improvement on the ordinary course of business exception and its introduction upheld the policy of creditor equality. However, the alteration of position defence represents the last signification erosion to the creditor equality objective. This defence was not only maintained in the 2006 reforms but was also amended to reflect the creditor deterrence rationale.

2. The alteration of position defence The avoidance regime as it currently stands promotes the creditor equality rationale through the effects-based test and the running account principle, but shifts to a culpability and deterrence focus in the alteration of position defence.147 H Bolitho, Continuing Business Relationships — Eight Questions in Search of an Answer (1998) 16 Company and Securities Law Journal 581 at 599.

Brown & Telfer, above n 69, at 7; Murray Tingey, Dean Elliott and Nick Moffatt in Heath and Whale, above n 30, at [24.1] The amended section 296(3), identical to section 588FG(2) of the Australian

Corporations Act, provides that:

–  –  –

The alteration of position defence in section 296(3) applies to all claims by a liquidator to recover property under the Act, in equity or common law or otherwise.148 The focus here is on the availability of the defence in relation to recipients of voidable preferences.

(a) Justifications for the defence

–  –  –

The creditor deterrence rationale is introduced through the new two-limbed test of suspicion in section 296(3)(b) which assesses the suspicions of the creditor on both objective and subjective grounds. Regardless of whether a creditor is able to establish alteration of position and good faith,149 a creditor who had suspicions of insolvency is denied the protection of the defence because that creditor has knowingly engaged in Note that recovery is also precluded where a person who is not a party to the transaction with the company acquires title or interest in property as a bona fide purchaser for value without notice of the circumstances under which the property was acquired from the company, or the circumstances relating to the giving of the charge. The availability of this defence is not questioned.

Alteration of position requires some detrimental conduct that, but for the payment or transaction, would not have occurred; see Re Bee Jay Builders Ltd [1991] 3 NZLR 560. Value requires new value be given at the time of the impugned transaction. This means that previous extension of credit will not be considered valuable consideration.

the dismemberment of the debtor and attempted to opt-out of the collective regime.

Presumably, a creditor with suspicions of insolvency should have known not to alter their position in reliance on the payment.

The fallacy of the deterrence rationale has been detailed earlier but the flawed reasoning is particularly evident in relation to the alteration of position defence.150 A creditor is only protected by the defence if it can establish it had no reasonable grounds for suspecting insolvency, thus the creditor is motivated not to monitor the financial position of the debtor in order to avoid to any accusation it had knowledge of insolvency. If there is no suspicion of insolvency because the debtor chooses not to monitor, there is no awareness on the part of the creditor that they are involved in the dismembering process and hence no deterrence.151 Thus the defence itself undermines the deterrent effect it aims to achieve.

Furthermore, the unstated premise of alteration of position defence is that culpability matters and that innocence should therefore be rewarded.152 The creditor’s knowledge of the debtor’s insolvency, or lack thereof, does little to comfort other creditors similarly situated who will receive that much less from the liquidation as a result of the preferential transfer.153 As was stated in the United States Cork Report “to argue that…creditors should not be required to disgorge what they took in supposed innocence is to ignore the strong bankruptcy policy of equality amongst creditors.”154 One may also question whether even a supposedly innocent creditor is really so innocent, or whether in most cases the liquidator is simply unable to prove that optout behaviour is nevertheless taking place.155 Even then, a suspicious creditor is often no more blameworthy than an unknowing one. If a creditor can be shown to have had actual suspicions of insolvency, it will not be protected by the defence even if it did not engage in a ‘scramble’ for the debtor’s assets but was merely paid fortuitously.156 See Chapter II C Andrew Keay Avoidance Provisions in Insolvency Law (Law Book Company, Sydney, 1997) at 53.

Tabb, above n 5, at 992.

A Keay ‘‘Liquidators Avoidance of Preferences: Issues of Concern and a Proposal for Radical Reform’’ (1996) 18 Adel L Rev 160 at 185.

H.R. Rep. No. 595 at 178 (1977).

Tabb, above n 5, at 992.

Keay, above n 155, at 187.

A creditor in these circumstances appears no more culpable than a creditor who had no suspicions of insolvency and could thus rely on the defence.

Furthermore, the reasonable suspicion test has resulted in litigation around similar facts to those raised under the “ordinary course of business” standard. The question is whether, in the circumstances of the trading relationship and the knowledge of the creditor at the time (rather than with hindsight), the cumulative factors present would have been grounds for suspicion of insolvency.157 Factors that have been relevant to the test include post-dated and dishonoured cheques, late payments, and demands for payment by the creditor.158 These indicators were also prominent under the “ordinary course of business” cases.

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