LEGALLY SPEAKING with Simpson Western Lawyers

INSOLVENT TRANSACTIONS and CLAWBACKS

Section 292 of the Companies Act 1993 carries a sting
in its tail that all businesses should be aware of.

It gives liquidators the power to recover payments made by a troubled business in the two years prior to its liquidation, and at a time when it was unable to pay its debts. The purpose of section 292 is to ensure all unsecured creditors are treated equally, by stopping one creditor receiving more from a troubled business than it would otherwise receive in a liquidation.

Sad Client
I once had a client who was owed $60,000 by one of their customers. The customer agreed to repay the debt by fortnightly instalments of $2,000, and these payments were made. Eighteen months later, however, the customer went into liquidation. The liquidator attempted to recover those instalments ($60,000 worth) from our client. This didn’t go down well. Nobody wants to ‘give back’ $60,000!

Defence
There is a defence available to creditors under the Companies Act, but it requires them to prove that when they received the payments, they had acted in good faith, they provided value for the payment, and that a reasonable person in their position, would not have suspected, and did not have reasonable grounds to suspect, the customer was or would become insolvent.
This defence is demanding due to the difficultly in satisfying the good faith and reasonable person elements. The good faith element requires the creditor to show it honestly believed the payments would not put them in a better position than other creditors. They will fail if they knew the customer was experiencing financial difficulties, and if there were signs they were paid before other creditors. The reasonable person element is difficult because it does not consider the creditor’s actual belief at the time payments were received. Rather, the focus is whether another person in the position of the creditor would, having regard to all the circumstances, have an actual fear that the customer was insolvent. Relevant factors include the age of the debt, whether cheques had been dishonoured or enforcement action taken, and whether a creditor had knowledge about the businesses’ poor cash flow.

Courses of Action
The better course of action is to try and avoid the sting of section 292 in the first place. This is difficult, as many businesses accept payment plans from time to time, and need to continue doing so to obtain payment. The following courses of action can help:
Always be aware that payments received for an outstanding debt could be vulnerable to attack;
Make sure you have a valid security interest over supplied goods. This will involve registering your security interest on the Personal Property Securities Register (www.ppsr.gtovt.nz);
If possible, obtain a personal guarantee from the directors/shareholders of the customer;
Try to get payments up front, or if that is not possible, implement a debt collection policy that encourages fast payments, and stick to it; and
Watch for signs indicating a business is in trouble and if concerns do arise, seek legal advice immediately as to how to manage the situation.