Law Change Affects Debtors and Creditors

16th September 2008 | Shane Kilian

One of the risks that all businesses face is the threat of not getting funds owing to them, or being able to maintain sufficient leverage to keep the business running.

Although a liquidator has the power to overturn transactions between an insolvent company and a creditor, the fact that the transaction took place "within the ordinary course of business" has always provided the creditor with a good defence. It would require costly litigation to resolve on the part of the liquidator.

In an effort to reduce the costs to liquidators of pursuing voidable transactions, the Government introduced amendments to the Companies Act late last year.

The new legislation has replaced the "ordinary course of business" test with a new principle of "continuing business relationship (running account)". Instead of attempting to determine whether a transaction occurred in the ordinary course of business, the liquidator now has to consider the transactions between the creditor and the company.

They must decide whether the transactions were integral to the continuing business relationship and if the company's indebtedness fluctuated because of each transaction. If the liquidator finds that this is the case, then the legislation allows for a series of transactions to be seen as a single transaction.

If these transactions took place within two years before the company went into liquidation, the liquidator has the ability to regard these transactions as a voidable transaction. This two year period now applies to any charge placed on the assets of the company as well, an increase from the previous six month period.

Payments to creditors, which are necessary to enable the company to continue trading, are usually seen as being part of a continuing business relationship and should be an accepted defence to claims made by a liquidator.

The onus for commencing any legal proceedings has also been shifted from the creditor to the liquidator. Previously the creditor, against which a voidable transaction claim had been made, had to file an opposition with the Court but is now only required to notify the liquidator of their opposition, in writing, within 20 days of receiving the claim from the liquidator.

The amendments also provide a statutory defence against voiding a transaction, if the transaction was entered into in good faith and the creditor did not know, or could not have reasonably known that the company was insolvent, or the creditor altered his position as a result of the transaction.

To obtain this defence the legislation now places some form of responsibility on the shoulders of the creditor. Any misrepresentation by a director could, however, lead to personal action being taken against that director.

So to prevent being caught by the new provisions; if you are a creditor pay attention to any signs which may indicate that the company you are entering into a transaction with is experiencing financial difficulty. If you are a company, ensure that any transactions you enter into, during a period where you might find yourself cash strapped, are transactions that are necessary for the continuing day to day running of the business.