A payment doesn’t need to be a diminution in order to be an insolvent transaction

In its early stages, it was hard not to cheer Bob Jones on in his company’s litigation battle with the liquidators of a Blue Chip company.  But, against the backdrop of Sir Bob vowing to collect unpaid rent for Blue Chip’s lease of its offices in Queen Street, Auckland and labelling what Blue Chip did to many elderly investors as “appalling”, was a serious issue affecting the insolvent transactions regime in the Companies Act.

Ultimately, it may be some of those elderly investors who stand to gain from the outcome of the Supreme Court decision ordering Robt. Jones Holdings to repay the liquidators of Northern Crest (formerly Blue Chip) over $750k.  The moneys weren’t paid by Northern Crest – but by two other Blue Chip companies which were due to pay money to Blue Chip.

Importantly, the payments were received by Robt. Jones Holdings within 2 years of Northern Crest going into liquidation.  Consequently, the liquidator of Northern Crest applied to set the payments aside pursuant to section 292 of the Companies Act on the basis that they were an ‘insolvent transaction’.

Diminution not required

The liquidator had been successful in the earlier decisions.  In the Supreme Court, Robt. Jones Holdings argued that, despite the fact that the payments met the principal requirements for a voidable transaction under section 292 (having been entered into by Northern Crest when it was unable to pay its due debts, occurred within 2 years of liquidation, and enabled Robt. Jones Holdings to receive more than it would otherwise have received in the liquidation), that an insolvent transaction must also have the effect of diminishing the pool of assets available to unsecured creditors in the liquidation.

Robt. Jones Holdings argued that the need to show diminution is a common law principle which had survived the reforms introduced by the Companies Act – when it replaced its predecessor.  Therefore, it said because the payments effectively replaced the debt owed by Northern Crest to Robt. Jones Holdings with an equivalent debt owed to the Blue Chip companies that made the payments, there was no diminution to the pool of assets available in the liquidation.

The liquidators argued that section 292 was exhaustive, and all that was required to be shown was that the recipient of the insolvent transaction received more than it would otherwise have received in the liquidation.

Agreeing with the liquidators, the Supreme Court confirmed that section 292 does not require an element of diminution, because:

• the insolvent transactions regime focuses on the effect of the transaction, rather than the intention with which the transaction was entered into/payment was made (which was the emphasis in the decisions made under section 292’s predecessors);
• there is nothing in the text of section 292 to indicate that the definition of ‘insolvent transaction’ is other than a complete definition of that phrase – with the result that there isn’t room to imply an additional requirement of demonstrating that a diminution of assets had occurred;
• an additional requirement to demonstrate diminution would introduce an (unneeded) complexity into the insolvent transactions regime – when the purpose of the reforms to the insolvency regime in the Companies Act was that of simplification, to provide straightforward and cost effective procedures for realising and distributing assets to creditors;
• protection of the company’s asset pool is now only one objective of the insolvent transactions regime (and not the most important one) with the key policy objectives being those of creditor equality and creditor deterrence – to prevent a race between creditors to obtain payment when a company is on the brink of insolvency; and
• overseas case law did not provide compelling support for Robt. Jones Holdings’ argument.

It seems that the liquidators’ arguments about the complexities that would result from the need to prove diminution well most persuasive.

The liquidators also argued that a diminution requirement would create artificial distinctions.  For example, had the other Blue Chip companies advanced the funds to Northern Crest rather than paying Robt. Jones Holdings directly, despite the economic effect being little different, there would have been a diminution of Northern Crest’s assets.

Outcome

In unanimously dismissing Robt. Jones Holdings’ arguments and holding that there is no additional requirement for a liquidator to demonstrate that an insolvent transaction had diminished the assets of the company, the Supreme Court surveyed the history of the insolvent transactions regime. 

As a result, Sir Bob’s crusade has had the unintended benefit of adding certainty to the test for voidable transactions, and avoids adding unnecessary complexity into the corporate insolvency regime.

It is interesting to note that, had Robt. Jones Holdings’ argument prevailed and a diminution requirement been imputed by the Court, then liquidators would need to establish both the source of funds for an insolvent transaction, and that the transaction had a negative impact on other creditors.  In this case, the liquidators said in evidence that identifying the source of funds had resulted in arguments in discovery which, they said, delayed the case for years.  Arguably, such a finding would also have the impact of incentivising the structuring of transactions that preferred certain creditors prior to liquidation – such as the perennial arguments about whether directors are incentivised to “stream” certain payments in order to extinguish the claims of those creditors whose debts are personally guaranteed by the directors.

Concluding comments

The Supreme Court’s decision will be welcomed by insolvency practitioners because of the manner in which it gave effect to Parliament’s stated purpose in reforming the insolvency regime in the Companies Act by simplifying the regime, and providing straightforward and cost effective procedures for realising and distributing assets to creditors.

Whilst affected creditors and, arguably, directors of companies teetering on the brink may have welcomed the addition of a diminution requirement – the clarity of the outcome is also of benefit.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.