Voidable transactions are one of the most controversial areas of insolvency. A voidable transaction (or an insolvent transaction under the current terminology), is one where the liquidator can compel a creditor who has received a payment to pay it back to the company. Needless to say, the affected creditor is usually not impressed and a vigorous debate often ensues.
The New Rules
The rules have changed and so have some of the terms. Insolvent transaction has replaced Voidable Transaction, and a new concept of running account has been introduced.
An Insolvent Transaction is Defined as:
- The company was insolvent at the time the transaction was made
- The transaction enables one creditor to receive a greater reduction of debt than they would have received in the course of liquidation.
- If the transaction was in the last six months of the companies life the company was deemed to be insolvent
- If the transaction were between six and twenty four months prior to liquidation the burden of proof of insolvency lay with the liquidator
Voidable transactions referred to the granting of securities as well as the payment of money. This would also typically include any questionable entries that voided the current account of the directors.
The Ordinary Course of Business Defence
Rather than looking at a specific transaction, the new test looks at the commercial relationship between the creditor and the insolvent company, essentially the ‘running account’ between the two. The reduction in a creditor debt over a period caused by a series of transactions (payments and new debts raised) is essentially a single transaction for the purposes of the new rules.
Using Australian guidelines, a running account is one where new debts are being created, as opposed to one where debt is simply deduced. A wholesaler providing building equipment to a builder would have a running account. A finance company (who holds a personal guarantee from the director) who receives a large cash payment in the months leading to liquidation, would not be seen to be holding a running account.
Why is running account important?
If an insolvent company makes a payment to a creditor in the last six months of its life, the liquidator can recall the payment. If the creditor can show that it had a ‘running account’ with the insolvent company and that its level of exposure did not materially change over a longer period, this is a defence to the liquidator, (this defence essentially replaces the ‘ordinary course of business’ defence)
An Australian Example:
Compass Airlines was required to pay Air Services Limited for aviation services. They paid $10 million and were billed $18 million. The liquidators for Compass tried to recover the most recent payments from Compass Airlines to Air Services. The Australian courts took the following view:
“If at the end of a series of dealings, the creditor has supplied goods to a greater value than the payments made to it during that period, the general body of creditors are not disadvantaged by that transaction they may even be better off. The supplying creditor, therefore, has received no preference”.
In this case the Liquidators of Compass were unsuccessful in recalling the money.
If Air Services has ceased supplying services to Compass Airlines, all payments received by Air Services from the moment they ceased supply would have been called back by the liquidator.
When does the running account start?
This is going to be a much litigated area over the next few years. Australian law is unclear, and the New Zealand parliament did not codify when it should start.
Protecting yourself from an Insolvent Transaction
If supply has ceased, all payments received by an insolvent firm should be considered voidable and liable to be recalled by a liquidator.
If supply is continuing, but net indebtedness is reducing, the amount that the debt is reducing is liable to be recalled by a liquidator.
The simple answer is to not supply to an Insolvent company, and if you suspect that you are trading with an Insolvent company look at some form of security. Specifically:
- Personal Guarantees
- PPSR Security over specific assets.
The act, Section 296(3) gives one very specific defence:
The person from whom the recovery is sought received the property in good faith and has altered their position in the reasonably held belief that the transfer to that person was validly made and would not be set aside.
The old rules allowed for a creditor to claim the payment was in the ordinary course of business. The new rules do not allow for this.
The new legislation is based largely on the Australian Corporations Act (2001). It replaces the ‘ordinary course of business’ with the ‘ Running Account’ or ‘Continuing business relation’ test.