Voidable transactions and contingent liabilities: the latest from the Supreme Court

The Supreme Court’s decision of David Browne Contractors Ltd v Petterson [2017] NZSC 116 was released this earlier week.

Summary

In summary, the Supreme Court has held that “due debts” in the voidable transactions regime (s292 of the Companies Act 1993) includes both present and contingent debts. In this case, the directors of a company had failed to take into account a quantified damages claim (but prior to any award being made) when making repayments to related companies, and when restructuring that company’s affairs.

Facts

Mr Browne operated a group of 20 companies. Polyethylene, Contractors, and Mechanical were part of that group. In 2007, Polyethylene entered into a subcontract agreement with McConnell Dowell (the Subcontract) to weld the polyethylene pipes that were to be laid in Lyttleton Harbour as part of a major sewer outfall project for the Christchurch City Council.

Unfortunately, some of the welding was defective.

In May 2008, McConnell Dowell wrote to Polyethylene giving notice of its intention to seek recovery of its costs as a consequence of the welding failure in accordance with the provisions of the Subcontract. On 26 August 2008, McConnell Dowell quantified its losses at just over $3 million.

However, on 30 June 2008, Polyethylene’s directors decided to restructure. Their accountant advised that the company had sufficient funds to repay unsecured advances from Contractors, Mechanical, and Mr Browne, together totally $1,253,537. The directors agreed to repay these advances, and then resolved to enter into a GSA with Mr Browne to secure a further advance of $450,000 to fund Polyethylene’s ongoing operations. The directors also signed a solvency certificate dated 1 July 2008. The claim by McConnell Dowell was discussed at the meeting, but the directors addressed it by stating that the claim was disputed, would be offset by counterclaims for extras and, in any event, would be covered by McConnell Dowell’s insurers.

On 28 July 2008, Polyethylene and Mr Browne executed the GSA. On 2 September 2008, despite receiving notice from McConnell Dowell quantifying its losses, Polyethylene repaid its debts to Contractors, Mechanical, and Mr Browne. This repayment occurred despite Polyethylene having been advised twice that McConnell Dowell had suffered significant losses and was expecting these to be met under the Subcontract’s indemnity.

In January 2009, in an adjudication under the Construction Contracts Act, the Adjudicator, Mr Derek Firth, assessed the losses payable by Polyethylene to McConnell Dowell as $2,965,334 (ex GST) plus $31,590 in costs.

In July 2009, Mr Browne responded by placing Polyethylene into receivership under the GSA. On 5 October 2009, Polyethylene was placed into liquidation upon McConnell Dowell’s application. Mr Petterson was appointed as liquidator.

On 4 April 2013, Mr Petterson served notices on Contractors, Mechanical, and Mr Browne pursuant to s294 of the Companies Act to set aside the payments made to them by Polyethylene in September 2008 on the basis that the transactions were voidable as insolvent transactions. Mr Browne objected to this notice on 2 May 2014. Contractors and Mechanical did not respond, as the accountants who received the notices did not pass them on to Mr Browne. Consequently, the transactions involving Contractors and Mechanical were automatically set aside 20 working days after the notice were served (Companies Act, section 294(3)).

The High Court

Mr Petterson issued High Court proceedings against Contractors, Mechanical, and Mr Brown requiring repayment, and sought to set aside the GSA. Associate Judge Matthews held that:

• At the time the transactions were entered into, the sum claimed by McConnell Dowell was not a due debt, and that Polyethylene met the solvency test.
• That the transactions were not a one-off transaction, but were part of a general restructuring by Mr Browne undertaken for good commercial reasons.
• That, when the charge was given, Mr Browne and Polyethylene had sound reasons to believe that Polyethylene was not liable for the faulty welding, and that McConnell Dowell’s insurance policy would cover the claim.

As a result, the High Court refused to set aside the transactions.

The Court of Appeal

Mr Petterson was successful in the Court of Appeal. The Court of Appeal held that:

• Polyethylene’s directors and advisors knew that, at the time of entering into the GSA, Polyethylene would face a substantial claim from McConnell Dowell exceeding Polyethylene’s net worth, that there was a real risk that Polyethylene would be found liable, and that insurance cover would not be available.
• At the time the September 2008 repayments were made, McConnell Dowell had quantified its losses, which were subsequently confirmed in adjudication. Under the Subcontract, Polyethylene was liable for the losses under the indemnity provision. The Court concluded that, at the time the payments were made, Polyethylene was unable to meet all of its objections, including the indemnity in favour of McConnell Dowell.

The Court of Appeal set aside the GSA on the basis that it was just and equitable to do so. Mr Browne was ordered to repay $210,316. The Court attributed Mr Browne’s knowledge to Contractors and Mechanical, and refused to entertain the Companies’ defences under s296(3).

The Supreme Court

Leave to appeal to the Supreme Court was granted to Contractors and Mechanical. The leave application by Mr Browne regarding the setting aside of the GSA and the repayments by him was dismissed.

The main issue for the Supreme Court was whether the repayment of the debts to Contractors and Mechanical occurred at a time when Polyethylene was unable to pay its due debts pursuant to s292(2)(a) of the Companies Act. Should Polyethylene have taken into account the amount owed to McConnell Dowell?

What is meant by “due debts” in s292 of the Companies Act?

The Supreme Court referred to similar legislation in Australia and the United Kingdom, and held that “debt” encompasses present and contingent debts.

In terms of the meaning of the word “due”, the Supreme Court again referred to Australian authority, and held that:

“[91] Solvency in a cash flow sense must be assessed objectively, taking a practical business approach. What is reasonably temporally proximate will…fall to be considered in light of the facts of the particular case. If a reasonable and prudent business person would be satisfied that there is sufficient certainty that a contingent debt will, within the relevant period, become legally due then it must be taken into account.

[92] We accept that there is a different between debts and damages but, once liability and quantum have been established in any claim for damages, the resulting judgment sum will be a debt owing. This means that the question is the same – if there is sufficient certainty that a claim will crystallize in the relevant period, then it must be taken into account.”

Should the McConnell Dowell claim have been taken into account?

The solvency certificate signed by Polyethylene’s directors listed three reasons to support the contention that the company was solvent. These were:

• That the debt was disputed. The Court rejected this reason, as the materials and reports available to the directors showed that Polyethylene was responsible for the welding failures.
• That McConnell Dowell owed money for extras and variations. The Court did not have any evidence of these sums, and these amounts were not claimed in adjudication.
• That McConnell Dowell’s insurance would cover the claim. Mr Browne’s view was based on the advice of Polyethylene’s loss adjuster (who was not a lawyer), who advised Mr Browne after McConnell Dowell’s claim was notified, that insurance would cover the claim. The Court said that a prudent business person would have sought advice promptly on the insurance position, either from McConnell Dowell’s insurer or its own solicitor.

The Court held that none of these reasons were valid:

“[108] Assessed from the perspective of a reasonable and prudent business person at the time the transactions were entered into, the McConnell Dowell claim was therefore sufficiently certain to crystallise into a legally due debt in the relevant time frame that it should have been taken into account in the cash flow solvency assessment…”

The Court said that the existence of the indemnity strengthened its conclusion.

The Court held that there were no defences available under s296(3), as there were no reasonable grounds for the directors of Polyethylene to consider that it was solvent. As a director of Contractors and Mechanical, Mr Browne’s knowledge and motives were attributable to those companies. The Supreme Court’s decision also touches upon whether there is a general discretion not to order repayment under s295 when no defences under s296(3) are made out, but the Court held that it was not required to address that point in the appeal.