Voidable Preferences – a contractor’s view

A precis presentation from a contractor’s view made by Don Tilbrook to a voidable preferences seminar late last year.

When I first heard that the Contractors’ Federation (now Civil Contractors NZ) was supporting an action in the Supreme Court regarding voidable preferences, my first thought was some scepticism. Why was this a special case?

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Don Tilbrook

 

I knew that the voidable preference clawback ability for liquidators is not new, and is there to provide fairness to all creditors in the event of a company going into liquidation.

I also have personal experience in this process and have been a beneficiary of a clawback as an unsecured creditor (more about this later).

The case that the association was supporting was for about $15,000, which is worth complaining about but not a huge amount in the overall scheme of things. I since understand Hiway Stabilizers’ reasoning behind the action wasn’t so much financial, but challenging the whole voidable preferences process as wrong.

I still kept thinking; what had changed in the law that makes it worth fighting? The best answer I got was that the law changed here in 2007 and liquidators could more easily clawback payments made up to two years before liquidation.

In addition, Hiway Stabilizers is an association member and it’s good to support members, especially if the support has knock-on benefits to other members.

So the following is my understanding of the insolvency law behind the case, why the construction industry in particular felt so aggrieved and why the Contractors’ Federation supported the Supreme Court action.

The basics for contractors

Before looking at voidable preference recovery, the liquidator has to satisfy a few criteria but (without going into detail) this is not hard to do. The most important evidence is that the company is ‘insolvent’ at the time the payment was made to a contractor.

When getting a clawback demand from a liquidator, the creditor has three defences. First, they were acting in good faith (that is without an intention to gain a preference). Second, they did not have reasonable grounds for believing the company was insolvent when the payment was made. Note that being short-paid and late-paid are long-standing features of the construction industry and not necessarily reasons for thinking the company is insolvent.

The third defence has been a problem for contractors and others in the construction industry and relates to the giving of ‘value’ in exchange for payment and (importantly) the time at which that value was given. In this respect, from what I’ve gathered, the Australian law (on which ours is based) is written around the wording that the creditor has to have “given value before receiving payment”. This seems entirely reasonable. However, our law, as applied since late 2007 (apparently to bring us into line with Australia), is “give value when receiving payment” and this subtle difference has been seized upon by liquidators in the past. It is not the norm in the construction industry to receive payment at the exact time value is given. Indeed, in the case of retentions release, this can occur a long time after the value is given.

The clawback regime is very rarely of benefit to unsecured creditors at the bottom of the priority list, so who gets the money that the liquidators claw back? Is it altruistically spread among all the deserving cases of creditors who in any event are going to lose money? Well no. Here’s the order of priority.

Liquidators are in fact top of the pecking order in the payments and this should come as no surprise. The very people who decide whether to enforce the clawback provisions are the first recipients of any money.

Next comes the ‘petitioning creditor’ costs of winding up the company – relatively minor; and any wages for the last four months – a worthy recipient of any money clawed back, but if you worked as an hourly paid contractor, then you move further down the queue.

Then there’s the government – perhaps not worthy of sympathy, but then it makes the rules. Next are unsecured creditors who might be way down the list but are the source of most of the clawback. Shareholders are last in line, while secured creditors look after themselves.

The law as written since November 2007 was open to unfair interpretation and was taken advantage of by liquidators.

The Supreme Court, with the intention to bring it more in line with Australian law and practice, has clarified the position on the giving of value in respect of the three defences against a liquidator’s clawback. This should make it much harder for liquidators to claw back money from creditors. If there are any complaints from insolvency practitioners, then perhaps they can look at the Australian practice.

To a certain extent some liquidators have brought this situation upon themselves by pursuing easy targets and relying on an interpretation of the law that is clearly unreasonable in many cases. Now they have to work harder to clawback money. However, a more intelligent response to avoid the pendulum swinging too far towards the unscrupulous company owner, would be that a balance needs to be struck – again, more about this later.

Unsecured creditors need to be given some measure of protection against companies paying out some creditors in preference to, for example, avoid personal guarantee problems later, or to pay out friends.

The construction industry is a special case for the “Giving Value” defence as it involves large amounts of money coming in and large amounts going out. This gives rise to a potentially large liability – this is not unique to the construction industry but a feature nonetheless. So the effects can be large. Not only does this make a significant loss for the contractor but also makes the contractor a tempting target for the liquidator.

Separate Box?

  • Payment is usually on account and the contractors, as creditors, are often unsecured and again this is common to many parts of the commercial world.
  • There can be large swings in claimed amounts because of, for example, quantity remeasure and variations, to name two common examples. This can result in payment being made well after the work was carried out.
  • In the case of building companies, margins can be very small, three or four percent, say, so cash flow effects can be very significant.
  • Many subcontractors are involved especially in the case of a building company failure.
  • Specialist Trades Federation president Graham Burke is reported as saying there are more insolvencies in the construction sector than others – this may or may not be true but the above notes could explain this.
  • It is very common, in fact usual, to have payments withheld, called retentions. These can be released well after the work has been carried out. In the case of a foundations subcontractor working on a multi-storey building the giving of value could be five years before the liquidation of a failed main contractor.
  • You could argue that slow payment or part payment of accounts was a clear indication of the insolvency of the company so the liquidator could say that you knew that the company was insolvent. However both these actions are very common in the construction industry for reasons other than insolvency, such as financing cash flow.

Example of a clawback

A personal example of a clawback in action occurred about 15 years ago and was related to work as a main contractor for a developer of a large residential subdivision.

This was before the Construction Contracts Act made it permissible to stop work if payment was not being made by the principal.

In this case, we completed our contract, but then refused to carry out work outside of the contract as we had not been paid by the developer. This additional work, necessary for the developer to obtain title for the sections, was carried out by another contractor. This enhanced the position of the primary secured lender.

We spent a considerable sum in winding up the developer’s company and several years later received a clawback of money from the second contractor via the Official Assignee. This second contractor should have known better in our opinion.

We paid all our suppliers and subcontractors in full, but the money clawed back barely covered the costs of winding up the company.

Why the Supreme Court got it right (contractor view)

In our industry, how can we ever be expected to give value at the ‘time’ of payment? Get real. The 2007 law was open to unfair exploitation.

Is every payment received from any organisation other than government, a contingent liability for two years? Where is the logic in that?

So where to from here?

As I alluded to above, there needs to be a balance between the rights of the liquidator to claw back funds and the rights of the organisation subject to that clawback.

Surely it is correct that the third defence should reflect whether value had been given in exchange for the payment, rather than “at the time”.

This article was first published in February 2016’s Contractor.

 

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