How are recoveries allocated in a Liquidation?

When administering the liquidation of a company, it is common for the Liquidator to make a variety of recoveries including sale of fixed assets, collection of Company accounts receivable, and legal claims pursued by the Liquidator.

When allocating the net proceeds of recoveries, the Liquidator must assess the nature of the Recovery and determine whether any secured creditors have a security interest in the collateral, and whether any other provisions apply which direct the Liquidator to distribute funds to a specific class of creditor, despite a security interest.

The two primary statutes of reference are as follows:

1. Schedule 7 of The Companies Act 1993, which sets out the priority of creditors in liquidations, along with the allocation of specific classes of recoveries.
2. The Personal Property Securities Act 1999 (“the PPSA”), specifically the provisions relating to the attachment of and priority of security interests, including provisions relating to purchase money security interests.

Schedule 7 – Preferential Claims

Schedule 7 of the Companies Act 1993 (“the Act”) sets out the priority in which liquidators distribute funds to creditors. Specific classes of creditors, notably former Employees of the Company and Inland Revenue are granted a preference under the act, entitling them to be paid before unsecured creditor claims are paid.

Schedule 7 is broken into several key parts; the notable sections include:

• Section 1, which deals with the priority of specific claims (including employee claims, and specific claims relating to Inland Revenue)
• Section 2, which deals with the conditions to priority of payments to Preferential Creditors and sets out how inventory and debtors are to be allocated.
• Section 3, provisions relating to employee claims.

Schedule 7 – Section 1 – Priority of payments to preferential creditors

Section 1 of Schedule 7 sets out the priority of payments to preferential creditors; the section is broken into several sub-sections:

Section 1 prescribes that the subsections are to be paid in order (i.e., subsection 1 is to be paid in full, before subsection 2.)

Schedule 7 – Section 1(1)

Sub-clause 1 is summarized below; in contrast to the other classes of preferential creditors, Schedule 7 prescribes that they are to be paid in the order in which they are listed.

Section	Description
Section 1(1)(a)	Fees, expenses, and remuneration incurred by the Liquidator in carrying out duties and exercising powers
Section 1(1)(b)	Fees, expenses, and remuneration incurred by the Administrator in carrying out duties and exercising powers.
Section 1(1)(c)	Reasonable costs incurred applying for a court order to place the Company into liquidation.
Section 1(1)(d)	Actual out of pocket expenses incurred by a liquidation committee
Section 1(1)(e)	Any Creditor who preserves the value of or recovers assets for the general benefit of Creditors.

As shown above, Liquidator’s fees and expenses are afforded the first priority.

Other notable sub-sections include Section 1(1(c), relating to the reasonable costs incurred applying for an order to place the Company into liquidation. While this specific section is typically associated with liquidations commenced by order of the High Court, it  appears that if a creditor had filed an application to place the Company into liquidation, and the company was subsequently placed into liquidation by special resolution of the shareholders prior to the liquidation order being made, the Court costs can still be claimed.

The other notable sub-section is section 1(1)(e), relating to creditors who preserve the value of, or recover assets of the Company for the general benefit of creditors by the payment or money, or giving an indemnity. Notably, the section has the effect of making the unsecured creditor’s claim preferential for specific recoveries (for which they preserved value, or recovered assets), for both:

• their unsecured debt; and
• the costs incurred protecting or preserving value.

Schedule 7(1) – Sub-sections 2 – 5 – Priority of payments to preferential creditors

Section	Description – Key Entitlements
Sub-section 2	Employee entitlements including unpaid wages, holiday pay, Specific elements of ERA Judgements, child support deductions, Kiwisaver and student loan
Sub-Section 3	Specific provisions relating to the Fair-Trading Act
Sub-Section 4	Costs relating to the arranging of a creditor’s compromise.
Sub-Section 5	Obligations owed to Inland Revenue and the Comptroller of Customs including Unpaid GST, PAYE and Duties payable.

In contrast to subsection 1, every individual sub-clause in each class of creditor ranks equally; another interesting point to note is that individual employee preferential claims are limited to $23,960.00.

Treatment of Accounts Receivable, Inventory and Secured Creditors

Section 2 of Schedule 7 prescribes that the claims listed in sub-clauses 1(2) – 1(5) of schedule 7 are to be paid ahead of a secured creditor who has a security interest in the accounts receivable, or inventory of the company (including a General Security Agreement (GSA) holder), provided the secured creditors security interest is not a purchase money security interest, and is not a security interest that arises from the transfer of an accounts receivable for which new value was provided by the transferee for the acquisition of that account receivable.

The criteria of a Purchase Money Security Interest is set out in section 14 of the PPSA defines a purchase money security interest as the following

(i) a security interest taken in collateral by a seller to the extent that it secures the obligation to pay all or part of the collateral’s purchase price; or

(ii) a security interest taken in a collateral by a person who gives value for the purpose of enabling the debtor to acquire rights in the collateral, to the extent that the value is applied to acquire those rights; or

(iii) the interest of a lessor or goods under a lease for a term of more than 1 year; or

(iv) the interest of a consignor who delivers goods to a consignee under a commercial consignment; but does not include a transaction of sale and lease back to the seller.

In essence, if a secured creditor who financed the purchase of an asset of the company, for example a motor vehicle, who has a valid attached security interest (the secured creditor provided value for the purchase of the motor vehicle, and has a valid security agreement which creates a security interest), and registered their financing statement within the appropriate timeframe (within 10 working days for collateral other than inventory or intangibles) will have a valid purchase money security interest, and therefore rank ahead of other secured creditors in that specific collateral, (section 73(1) of the PPSA).

Another example of a Purchase Money Security Interest is a trade supplier with a retention of title clause who supplies inventory on credit. Notably, the financing statement must be registered at the time the debtor company obtains possession of the inventory.

In summary, the above sections of Schedule 7 and the PPSA have the effect of making inventory and accounts receivable available to the preferential creditors of the Company ahead of secured creditors, provided certain criteria is not met, notably that a secured creditor does not have purchase money security interest in the specific collateral.

Case Study – Shareholder Liquidation, Secured Creditors

Placeholder Building Limited was placed into liquidation by special resolution of the Company’s shareholders on 1 June 2021.

The realisable assets of placeholder consisted of the following:

1. An outstanding payment claim issued by the Company for work completed
2. A heavy excavator owned by the Company, subject to finance.

Upon commencement of the liquidation, the liquidator took immediate action to secure the excavator, and collect the outstanding payment claim

The Liquidator received the following unsecured creditor claims and allocated them as follows:

Class of Creditor	Amount	Status (Schedule 7)
Employee Claims – Unpaid Wages and Holiday pay	20,000.00	Preferential – (1)2(a) & (b) of Schedule 7
Inland Revenue – Unpaid GST and PAYE	10,000.00	Preferential – Section (1)(5)(a) & 5(b)
Unsecured Creditors	50,000.00	Unsecured.

Furthermore, the company has three secured creditors:

1. The General Security Agreement Holder (“GSA Holder”) – owed $20,000.00, in relation to funds advanced on 1 January 2021.
2. A creditor with a specific security interest in the excavator owned by the Company, who financed the purchase of the excavator on 1 February 2021 – owed $10,000.00.
3. A trade supplier who supplied building materials used on company projects, who had a specific security interest in goods supplied; owed $20,000.00

Please note the implications of GST are ignored in this particular example.

Throughout the Liquidation, the Liquidator made the following totalling $80,000.00.

Asset	Recovery	Total
Outstanding payment Claim	60,000.00
Heavy Excavator	20,000.00
Total Recoveries		80,000.00

The two recoveries were allocated as follows:

Excavator

The Liquidator formed the view that the secured creditor had a valid purchase money security interest in the excavator, as:

• The specific secured creditor provided value to purchase the excavator
• The specified secured creditor had a valid security agreement; and
• The secured creditor had lodged their financing statement within the appropriate timeframe (10 working days).

While, the GSA holder’s security predated the specific secured creditors charge, in accordance with section 73(1) of the PPSA, the specific secured creditors charge will ahead of the GSA holders charge.

The allocation of the Proceeds is as follows:

	Amount	Amount
Recovery – Sale of Excavator		20,000.00
Distribution to Specific Secured Creditor	-10,000.00
Sub-Total		10,000.00
Distribution to GSA Holder	-10,000.00
Residual proceeds		0.00

After receiving the distribution, the General Security Agreement holder is still owed $10,000.00.

Outstanding Payment Claim

The Liquidator formed the view that the outstanding payment claim constituted a monetary obligation owed to the Company (per section 14 “Accounts Receivable” of the PPSA).

It was determined that of the outstanding payment claim, $10,000.00 of the proceeds from the payment claim could be traced to product supplied to the trade supplier.

The Liquidator reviewed documentation from the trade supplier and reviewed the payment claim. The Liquidator formed the view that the supplier had a valid Purchase Money security interest in inventory they had supplied to the Company as:

• The supplier had a security interest in the form of a retention of title clause contained in their signed terms of trade
• The supplier registered a financing statement prior to supplying inventory (therefore, perfecting their security interest)

Therefore, $10,000.00 was paid to the Supplier, as the supplier had a valid purchase money security interest in the inventory supplied, and the proceeds from the sale of this collateral, which was determined to be $10,000.00.

In accordance with section 2 of Schedule 7, the residual proceeds were to be paid in the following order:

1. To the staff for their outstanding holiday pay and wages
2. To Inland Revenue in relation to unpaid GST and PAYE.
3. To the General Security Agreement Holder (as there were no further preferential creditors afforded a preference in the proceeds of accounts receivable.

Furthermore, the Liquidator’s remuneration and expenses associated with the recovery totalled $10,000.00.

The funds would be distributed as follows:

	Amount	Amount
Recovery – Collection of Payment Claim		60,000.00
Distribution – Building Supplier	-10,000.00
Sub-Total		50,000.00
Liquidator’s Remuneration and Expenses	-10,000.00
Sub-Total		40,000.00
Distribution – Employee Claims	-20,000.00
Distribution – Inland Revenue	-10,000.00
Total Preferential Distributions		-30,000.00
Sub-Total		10,000.00
Distribution – GSA Holder	-10,000.00
Residual Proceeds		0.00

If you have any Insolvency related questions. Please get in touch with us at 0800CLOSED or enquiries@waterstone.co.nz