What happens if a company pays off an old debt but goes into liquidation shortly after, even though they assured you everything was fine and you had no idea they were in trouble?
Often such payments are a target for liquidators under the voidable transaction scheme in sections 292 – 296 of the Companies Act 1993, and can be clawed back, despite you genuinely being owed the money.
If this happens, there are two main defences to a voidable transaction claim:
- The running account defence (see What is a running account’s relevance to voidable transactions?)
- The section 296(3) defence
This article will specifically address the section 296(3) defence, and the three limbs you must make out in order to succeed in avoiding having to repay the liquidator.
Section 296(3) of the Companies Act 1993 states that the Court must not order the transaction to be set aside if the person receiving the money can prove, that when they received the money they:
- Acted in good faith; and
- A reasonable person in their position would not have suspected, and they did not have reasonable grounds for suspecting, that the company was or would become, insolvent; and
- They gave value for the property, or altered their position in the reasonably held belief that the transfer of property (money) was valid and would not be set aside.
Usually the only limb of contention is Limb B – whether the recipient of the funds had suspicion of the company’s insolvency and reasonable grounds to suspect insolvency.
Suspicion of insolvency – a subjective and objective test
For a payment not to be set aside, the person receiving the money must show that they did not suspect that the paying company was insolvent, and a reasonable person in their shoes would have also not had a suspicion that the company was insolvent at the time the payment was made.
This limb of section 296(3) was recently litigated in the High Court in the case Grant v Magnum Hire Ltd (insert link to case).
In this case, the company Landwork Civil Ltd owed Magnum Hire Ltd $77,297.07 for invoices owing since September 2023. Landwork failed to make payment, and Magnum sent a statutory demand demanding repayment of this amount, on 15 January 2024. The statutory demand was to expire on 7 February 2024.
“Landwork Civil Limited has been entered into a transfer ownership procedure, starting from 15 December 2023, and It’s expected to have the transfer process completed in February. Due to this reason, we are experiencing cash flow problems currently, however there is $500,000 of January claims to be received about the middle of February 2024, would you please kindly consider extending a month for the due amount $77,497.07 to 24th of Feb?”
Later that day, Magnum responded stating:
“Our lawyer’s advice is to continue with the court action and we will be proceeding with this.”
On 2 February 2024, Landwork’s accountant responded, stating:
“have confirmed by our director that we will make payment next week.”
On 7 February 2024, the following week, Magnum responded again:
“Legal proceedings will begin tomorrow as it is 16 days since the statutory demand was delivered. Once the legal proceedings start additional costs of $4800.00 will be added.”
On 15 February 2024, following the expiry of the statutory demand, Landwork made two payments to Magnum totalling $77,297.07. A text message was sent on this day from one of Landwork’s employees to another saying:
“Hey bro we have a situation that me and [the accountant] are dealing with. Magnum Hire have issued us final warning before putting notice in the gazette and herald. We got paid 30k from 323 yesterday which we used to pay Magnum Hire instead of anything else. I have a loan approved which we were going to use to get the balance of 52k sorted this afternoon.”
The voidable transaction and the defence
The liquidators of Landwork applied to the High Court to set aside the two payments on the basis that they were paid within 6 months of the liquidation (the “restricted period”), and that a reasonable person in Magnum’s position must have had suspicion of Landwork’s insolvency based on the above communications and the fact that its statutory demand had expired.
Since the payments met the requirements of section 292 of the Companies Act 1993, the Court was entitled to set aside the payments, unless all three limbs of section 296(3) were met.
Magnum advanced their defence under Limb B of section 296(3) on the following representations made by Landwork to Magnum:
- the accountant’s email on 1 February 2024 where Landwork said they were expecting approximately $500,000 for January claims in February 2024;
- that additional capital would be available from the sale of a property; and
- that there would be an injection of capital from “shareholders and/or another investor”.
The Court was not persuaded that these “representations” would have caused a reasonable person in Magnum’s position not to have known or suspected that Landwork was insolvent or would become insolvent when the transactions were made. The following reasons were given:
- the invoices that the payments related to a three-month period and only one had been partially paid prior to the statutory demand being issued. Some of these invoices were over 4 months overdue, showing that Landwork was not paying Magnum’s invoices when they fell due.
- The statutory demand was not paid prior to its expiry, meaning that a statutory presumption of insolvency had arisen. Magnum appears to have been aware of this, given its response to Landwork on 7 February 2024.
- The email sent by Landwork to Magnum on 1 February 2024, while stating that $500,000 worth of January claims were expected to be received in mid-February, this was the only “representation” provided in evidence that Magnum was relying on. This email also explicitly stated that Landwork was experiencing cashflow issues, and requested an extension to pay until 24 February 2024.
- The explanation provided for its cashflow issues on 1 February 2024 was unconvincing, as it does not automatically follow that a change in shareholding (if that was being referenced) would result in cashflow issues. A reasonable person in Magnum’s position should have viewed this statement with cynicism, as this was not a reassurance of solvency, but an indication to a lack of capital and need for external support for Landwork to meet its creditor obligations.
- Magnum’s response did not suggest that it was convinced either – it insisted on court action rather than agreeing to a delay for payment.
- It was inferred that the reason that two payments were made to Magnum totalling $77,297.07 was because after receipt of the first payment (of $25,000), Magnum continued to put pressure on Landwork by giving it a “final warning” (per the text message between the Landwork employees) and then the remaining amounts were paid.
On this basis, the Court held that Magnum had more than a “mere idle wondering” as to Landwork’s insolvency, and instead had a “positive feeling of actual apprehension or mistrust”, and ordered that the two payments be set aside.
What does this teach us?
This case helpfully illustrates that when the Court is required to determine whether a creditor receiving payment had suspicion of the paying company’s insolvency, the evidence of communications is heavily taken into account. How the creditor responds to requests for payment extensions gives rise to an inference on whether they were concerned about whether payment would be received, especially if the invoices are already overdue.
Despite the accountant explaining that a “transfer process” was underway and this being the reason for cashflow issues, the Court was not convinced that a reasonable person in Magnum’s shoes would not have had doubts about the truth of this statement.
This means that even if a director, or employee tries to explain a late payment, but the reason is not convincing, the Court might imply that a suspicion of insolvency arose, and order the payments you received be set aside. It is worthwhile being aware of this risk when a company you have previously dealt with has entered into liquidation and considering the costs of litigation if a liquidator makes demand against you to repay the amounts received.
