The Companies Act carries a sting in its tail
Section 292 of the Companies Act 1993 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 s292 is to ensure all unsecured creditors are treated equally and prevents one creditor receiving more from a troubled business than it would otherwise receive in a liquidation.
There is a true story of a business that was owed $60,000 by its customer. The customer agreed to repay the debt by regular instalments, and these were made. Eighteen months later, however, the customer went into liquidation. The liquidator attempted to recover every instalment. This didn’t go down well; nobody wants to ‘give back’ $60,000!
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 doesn’t 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 s292 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 in order to maintain acceptable cash flow. The following courses of action can help if your business finds itself in this situation:
»» Always be aware that payments received for an outstanding debt could be vulnerable to attack
»»Make sure you have registered your security interest on the Personal Property Securities Register (www.ppsr.govt.nz)
»» If possible, obtain a personal guarantee from the directors/shareholders of the customer, and
»» Try to get payments up front, or implement a debt collection policy that encourages fast payments, and stick to it.
Finally, always keep watch for signs indicating a business is in trouble and if concerns do arise, talk with us immediately for guidance on how to manage the situation.