Building contracts and “running accounts” - voidable transactions
Friday, 4 November, 2011
Author: Karen Shaw
The High Court has said that generally building contracts are not running accounts under the voidable transaction provisions in the Companies Act 1993. As a result, the High Court found that payments which had been made to an electrical sub-contractor were insolvent transactions and that subcontractor was ordered to repay a significant portion of what had been paid to it back to the company’s liquidators.
Voidable transactions
Once a company goes into liquidation, its liquidators will consider whether the company engaged in any voidable transactions prior to its liquidation. A voidable transaction is one which was:
- entered into within a specified period (which is 2 years before the commencement of the liquidation);
- is an “insolvent transaction”, or a transaction which was entered into at a time when a company is unable to pay its due debts and which enables one person to receive more towards the satisfaction of a debt than what they would have received, or would have been likely to receive, in the company’s liquidation.
The purpose of the voidable transactions provisions is to prevent companies from favouring certain creditors when that company is aware that it is in financial difficulty. The voidable transactions regime is designed to ensure that unsecured creditors of an insolvent company are all treated equally.
Running Account exception
The Companies Act used to include a defence that transactions made in the ordinary course of business were not voidable. The Companies Amendment Act 2006 abolished this defence because it had been assessed as creating too much uncertainty. However, the 2006 reforms also introduced a running account exception which closely follows Australian law. This exception provides that where there is a continuing business relationship between a company and a creditor and, where the level of indebtedness to the creditor is increased or decreased over time, then all the transactions undertaken as part of that relationship are treated as a single transaction.
In Jollands v Mitchell Communications Ltd, the High Court considered a situation where an electrical sub-contractor, Mitchell, sought to rely on the running account exception. Mitchell had carried out work supplying and installing cabling at a Christchurch mall for the electrical contractor, Aden Electrical Ltd (in liquidation). It carried out services to the value of $84,215.98. Aden was placed into liquidation on 5 March 2010 and its liquidators applied to set aside the payments that Aden had made to Mitchell and which totalled $59,454.02. There was no issue that Aden made the payments to Mitchell in the specified period. The Court found that there was clear evidence of Aden’s insolvency dating back to April/May 2008 and that was insolvent at the time that it made all of the payments to Mitchell.
Mitchell sought to rely on the running account exception. Here, the High Court considered Australian authority which had found construction contracts do not give rise to running accounts or continuing business relationships. An essential feature of running accounts is that they contemplate a continuing relationship of debtor and creditor and an expectation that further debits and credits will be recorded. Australian authorities said this description did not fit the concept of a building contract where progress claims are made separately and in isolation from each other.
The High Court found that there was no running account in this case as:
- The sub-contract was a one-off dealing between the parties;
- Mitchell had never done any work for Aden before and it had no expectation of continuing work;
- Mitchell had issued payment claims for the work and the payments made by Aden generally matched the invoiced amounts. The payments were then for past services and on the basis that future work under the contract would be the subject of fresh invoices and fresh payment schedules.
Mitchell was, however, able to retain a portion of the payments it had received from Aden because it was able to rely, in part, on the good faith defence under section 296 of the Companies Act. Under the good faith defence, a creditor may resist recovery if it can establish that it had acted in good faith, that a reasonable person would not have suspected and it did not suspect that the company was or would become insolvent, and that it gave value for the property or altered its position on the reasonably held belief that the transaction was valid. Each of the elements of section 296 have to be established before a Court will grant relief. In Mitchell’s case, the Court accepted it had acted in good faith and, despite slow payments, it did not suspect Aden’s insolvency. It was only able to establish, however, that that it gave value following the payments to it in the sum of $16,910.72 (this was in the form of further services). The net result was then that it was required to repay the sum of $41,338.42 plus interest and costs to the liquidators.
Summary
It is important for creditors dealing with companies to be aware of the voidable transactions provisions. As the ordinary course of business defence no longer exists, creditors should be proactive before entering into transactions with companies. If there is no history with the company it may be wise to seek personal guarantees or security. If payment issues do become evident during the provision of work or services, it is important to seek advice on the best strategy for managing the situation. In some instances the only prudent option is to cease performing the work or offering services to that company.
For further information please contact:
Karen Shaw
Phone: 07 834 4665
Email: karen.shaw@harkness.co.nz
