On 15 September 2014, insolvency and business recovery specialists McDonald Vague advised 288 former employees and unsecured creditors totalling $13.112 million that a total dividend pay-out of 100 cents in the dollar had been made to most of them.

Given that this was a large corporate failure with initial unsecured claims in excess of $25 million this is a significant pay-out.

Early on in the liquidation it looked like creditors would face a nil dividend.  The steps taken to achieve this result include:

1. Engaging in, and winning, a significant arbitration award relating to DML's mining operations at Waihi.
2. Establishing the unsecured creditors' position by disputing and settling several significant unsecured claims for amounts primarily owed by other companies related to DML.
3. Settling all voidable preference claims by agreement where some unsecured creditors were preferred over others when receiving payments prior to liquidation, which led to the establishment of a Preference Trust.
4. Taking High Court proceedings against the directors of DML.  This case settled just before a lengthy trial was to begin.

A novel element to the liquidation which had a positive result on the outcome is the solution to a number of voidable preference claims.  These challenges can be costly and take time to resolve.  The liquidators' advisers had proposed a cost-effective solution to resolve the preference issues, as some parties had been paid (preferred) ahead of the others.  The proposal was accepted by both the liquidators and the preferred parties.  McDonald Vague as a result established and oversaw a Preference Trust.  The operation of the settlement agreements meant that the payments to remaining unsecured creditors have been significantly topped up by funds paid into the Preference Trust from the preferred creditors.  The purpose of that trust has now been met.

The funds received into the liquidation in future will, after meeting liquidation costs and expenses, see dividends paid to the creditors that contributed to the Preference Trust to bring their dividends up.  The expecation is that they will not in the end reach 100 cents in the dollar but they may be close.

"Whilst the liquidation has been a long process the outcome is one McDonald Vague is very satisfied to have reached", says Peri Finnigan, director at McDonald Vague.  "Special thanks go to the liquidators' barrister, Kerry Fulton, who has worked tirelessly on this liquidation".

McDonald Vague would like creditors who have not received a distribution cheque to contact them at This email address is being protected from spambots. You need JavaScript enabled to view it. or 09 303 0506.

It is an unfortunate fact that many companies experience financial difficulties at times.  Often the directors/shareholders do not realise that there are a number of options available to them.  This article provides an overview of the various options for distressed companies.  

A compromise is an agreement between a company and its creditors.  The purpose is to enable a company to trade out of its financial difficulties and thus avoid administration, receivership or liquidation.  In this way the company can survive into the future and provide continuing business to creditors.  

There are two basic features of most compromises:  

• Creditors will be repaid in full or in part over a period.  If creditors are paid in part they write off the balance of their debt;
• During the term of the compromise the company's debts are frozen and no creditor may take any action against the company.

Usually, the directors of a company decide to allow the company to enter into a compromise, subject to creditor approval. Creditors will only approve if they believe that they will receive more money than in an administration, receivership or liquidation.  

Compromises are governed by Part 14 of the Companies Act 1993.  Each class of creditors affected must vote as a class.  Classes can include trade creditors, landlords, employees for preferential wages and holiday pay, Inland Revenue for preferential GST and PAYE, hire purchase creditors and other secured creditors.  

For a compromise to be approved, a majority in number representing 75% in value of each class of creditors must vote in favour of the proposal.  

A creditor's compromise can be a good option for businesses that are fundamentally sound, but are experiencing financial difficulty.  

Voluntary administration   

Voluntary administration is a relatively new rehabilitation mechanism that was introduced into the Companies Act 1993 about seven years ago.  An administrator may be appointed by a distressed company's directors, a secured creditor holding a charge over all or substantially all of the company's property, a liquidator or the Court.  

The aim of voluntary administration is to maximise the chances of the company (or its business) continuing in existence, or if this is not possible, for creditors to receive a better return than in a liquidation.  It is an interim measure during which creditors' rights to enforce charges, repossess assets or enforce guarantees are restricted.  A General Security Agreement ("GSA") holder may, however, appoint a receiver within 10 working days of the administration commencing.  It is therefore critical for the administrator to have the support of any GSA holders.  

Once a company enters into voluntary administration the directors can only act with the written permission of the administrator.  The administrator takes control of the company's business and has 25 working days to complete an investigation and provide an opinion on the most beneficial course of action for creditors.  This will be one of three options:  

• Have the company enter into a Deed of Company Arrangement ("DOCA") with creditors;
• Put the company into liquidation; or
• Return the company to its directors (this is very rare).

A DOCA is an agreement between the company and its creditors.  It is the responsibility of the deed administrator to ensure that the company adheres to the DOCA's terms and conditions.  

Receivership   

A receivership appointment is made by a secured creditor who has been granted a General Security Agreement ("GSA") over the company's assets.  The GSA holder is usually a financial institution or a private lender.  

The conduct of receivers is governed by the Receiverships Act 1993.  A receiver has control over the company's assets subject to the GSA under which they have been appointed.  The receiver's primary purpose is to recover funds for the secured creditor, however, the receiver also has a duty to protect the rights of other creditors.  The receiver provides reports on the conduct of the receivership to the secured creditor and files this report with the Companies Office. 

The receiver ceases to act when the secured creditor has been repaid and at this time control of the company reverts to the directors.  However, a liquidator can be appointed if there are further assets to be realised, funds still owed to unsecured creditors or matters requiring investigation.  

Liquidation   

When the directors/shareholders of an insolvent company become aware that there is no realistic ability to trade out of their financial difficulties they can resolve to appoint a Licensed Insolvency Practitioner of their choice as liquidator.  This is known as a voluntary liquidation. 

In instances where the directors/shareholders do not take any action, a creditor of the insolvent company may apply to the Court for an order requiring the company be put into liquidation.  This is known as a Court appointed liquidation and it is the Court's decision as to who will be appointed as liquidator.  If a company is served with a winding up application by a creditor, the directors/shareholders cannot appoint voluntarily unless with the consent of the applicant creditor. 

The conduct of liquidators is governed by Part 16 of the Companies Act 1993.  Once a company liquidation commences the director's powers are restricted and they must provide the company's records to the liquidator.  They must also co-operate with and support the liquidator. 

The liquidator's main duty is to realise assets belonging to the company and distribute the proceeds to creditors.  The liquidator may also investigate the reasons for the company's failure, set aside insolvent transactions and take legal action where necessary.  The liquidator must report to the company's creditors every six months and file these reports with the Companies Office. 

Upon completion of the business liquidation the company is struck off the Companies Register. 

Every situation is unique and a number of factors should be taken into consideration to determine the best course of action in the event of company insolvency.  If you wish to discuss your situation please contact one of the team at McDonald Vague.

Alternatively, download our Free Guide to Insolvency Services

Question:

Liquidators have different views regarding proxies and representatives of company creditors at creditors meetings. What is the correct procedure?

Legislation:

The legislation which applies is:

• The Companies Act 1993, Section 314
• The Fifth Schedule to the Companies Act 1993, Clause 6 and Clause 9
• The Companies Act 1993 Liquidation Regulations 1994, Regulations 23 and 27.

Answer:

An examination of the legislation shows that a company may be represented at a meeting of creditors in two separate ways (refer the legislation for full details): -

Formally by proxy (in writing):

1. • The company may appoint a proxy.
   • The proxy may be any person including the liquidator or if there is no liquidator, the chairperson of a meeting.
   • Where the person appointed as a proxy is proposed as liquidator, then the person holding the proxy may use the proxy to vote in favour of himself or herself as liquidator, if it is not inconsistent with the terms of the proxy to do so.
     
     

By representation:

1. • A body corporate [company] which is a creditor may appoint a representative to attend a meeting of creditors on its behalf.
   • The chairman of the meeting (in most cases the liquidator) is entitled to ask and receive proof that the company has appointed the representative.
   • If satisfactory proof is not forthcoming then if the person present could show that they were connected with the company most chairpersons would allow that person to remain at the meeting but would not let them exercise a vote.

Summary:

A Company is entitled to attend a meeting of creditors: -

• By appointing a proxy
• By appointing a representative

We enclose a suitable letter which could be used by a representative who attends several meetings. It is to be noted that Clause 19 of the Companies Act 1955 Liquidation Regulations 1994 provides as follows: -

A person shall not be entitled to vote as a creditor unless, by the time the vote has been taken the creditor has filed a liquidation claim form.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

Question:

How can a liquidator be removed from office?

Legislation:

The legislation which applies is the Companies Act 1993.

Introduction

Apart from the normal procedures, the office of liquidator also becomes vacant if the person holding office dies or becomes disqualified under Section 280 of the Companies Act 1993. This is the section which deals with qualifications of liquidators. For example, the office would become vacant if the liquidator were to be made bankrupt or were to become subject to a compulsory treatment order under the Mental Health Act. In normal circumstances however, a liquidator is removed from office in one of the four ways: -

1.Removed by Resignation

A person may resign from the office of liquidator by appointing another such person as his or her successor in sending or delivering notice in writing of the appointment of his or her successor to the Registrar for resignation.
Reference: Companies Act 1993, Section 283(2)

2.Removal by a Liquidation Committee

The Act provides that the liquidator must have regard to the views of any Liquidation Committee given in writing to the liquidator.
Reference: Companies Act 1993, Section 258(1)(d)

3.Removal by the Creditors

Creditors meeting convened by liquidator at request of creditors

The liquidator has a duty to summon a meeting of creditors forthwith when required to do so by notice in writing given by creditors to whom is owed not less than 10% of the total amount owed to all creditors of the company.

Creditors meeting convened by Liquidation Committee

The Liquidation Committee can also call a meeting of creditors.

General

The meeting must be called in accordance with the 5th Schedule of the Act, the 5th Schedule of the Act provides for postal votes. It therefore follows that the notice of meeting must stage the purpose for which the meeting is being called. Namely, to replace the liquidator by the appointment of some other person as liquidator. The creditors must also have the opportunity to vote on this matter by postal voting.

Reference: Companies Act 1993, Section 315(2)(c)

4.Removal of the Liquidator by the Court

A liquidator has an obligation to comply with his duties. The Act provides that a creditor may make application to a Court in relation to a failure to comply. Notice of the failure to comply must be served on the liquidator not less than five working days before the date of application. At the date of application there must be a continuing failure to comply.

The Court has power to remove a liquidator from office only if the Court has made a compliance order and the person against whom it is made has failed to comply with that order, however, if it is shown to the satisfaction of a Court that a person is unfit to act as liquidator by reason of persistent failures to comply, the Court must make in relation to that person, a prohibition order for a period not exceeding five years. The person to whom a prohibition order applies must not act as a liquidator in a current or other liquidation or act as a receiver in a current or other receivership.

Reference: Companies Act 1993, Section 286

The meaning of failure to comply is defined in Section 285. Failure to comply means a failure of a liquidator to comply with a relevant duty arising under the Companies Act or rule of Law or rules of Court, etc.

Reference: Companies Act 1993, Section 285

OVERVIEW

In practice where creditors wish to replace a liquidator they should discuss the matter with the liquidator. In theory, a liquidator should derive little satisfaction in remaining in office when he/she is not wanted. Hopefully, the liquidator will appreciate the position of a new liquidator. If the liquidator will not resign then one of the other options will have to be used. An application to the Court is difficult and should only be used as a last resort.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

McDonald Vague provides a specialist service conducting solvent liquidations. Companies are often put into liquidation this way when a business has been either sold, closed down or reorganised for tax and/or management purposes.

Capital gains on company sales

Under current New Zealand law, companies that have sold their business at a capital profit can then, on liquidation, distribute that profit to their shareholders tax free (arm's length transactions only) under Section CD26 of the Income Tax Act 2007.

There is often debate as to whether a formal liquidation process is necessary to distribute tax free capital profits, or whether it is sufficient to simply have the company struck off the Companies Register. When large sums of money are involved, we believe it is prudent to carry out a formal liquidation that cannot subsequently be challenged by potential creditors. Even though the company may have been removed from the register in a strike off, this will not prevent acrimonious third parties from having the company reinstated at a later date. A formal liquidation ensures peace of mind.

Reorganisation of company affairs

McDonald Vague is particularly experienced in reorganisation of companies, especially those with a foreign parent. Amalgamations are commonplace and old entities no longer required are absorbed.

Company "deaths"

For a variety of reasons, a company will often reach the end of its useful life. Whilst shareholders may do nothing (annual returns not filed) and wait for the Registrar of Companies to remove the company from the register, shareholders in some circumstances will want some finality to the process. Although the company may have paid all known debts, the shareholders can rest assured that once the formal liquidation process has been completed they are highly unlikely to be called upon for anything that may arise in the future.

Processes involved

The directors of a company must first make and file resolutions as to solvency before the liquidation can commence. The shareholders then pass a resolution to appoint a liquidator. The liquidator deals with any liabilities of the company and distributes surplus assets to the shareholders in accordance with their rights.

With an insolvent company the liquidator realises the assets and distributes the cash in accordance with the various priorities. With a solvent company it is possible to make an "in specie" distribution. That is, the assets themselves can be distributed to the shareholders in proportion to their shareholding.

Solvent liquidations we have undertaken

McDonald Vague has performed numerous solvent liquidations. Some of the many assignments we have undertaken have included:-

• a group of property management companies (no longer trading) with a parent company domiciled in Hong Kong
• a pharmaceutical supplies company where the business was sold for capital profit
• the reorganisation of a group of insurance and financial asset management companies
• a forestry development winding up
• a New Zealand advertising agency sold to a major international group but requiring a lengthy liquidation to allow for transfer of intellectual property
• an investment company (no longer trading) with a US parent company
• an in-store promotions company where the business was sold for capital gain
• a Canadian owned manufacturer and distributor of beverages
• a technology investment company
• a retailer and distributor of industrial and other chemicals
• a company specialising in the development of a prominent software package for accountants where the intellectual property was sold for capital gain

Please contact Peri Finnigan on 09 303 9519 for confidential, no obligation advice on this area.

DISCLAIMER

This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

McDonald Vague are solution providers for businesses at risk, and specialists in business recovery. We often deal with liquidations where the director has continued to trade an insolvent company. In many of those cases, prior to liquidation the director/shareholder has increased the mortgage on their house and advanced further capital for a short term cash flow fix without taking out any security for that advance. If funds are advanced to the company, the director/shareholder should seek legal advice on obtaining security and registering that security on the Personal Property Securities Register prior to the advance.

CONCERNED ABOUT YOUR PERSONAL LIABILITY?
TALK TO US IN CONFIDENCE

• If you are concerned your business maybe be trading while insolvent;
• or are worried about you personal liabilities as a director if your company goes into liquidation,
• Contact us now for free, confidential, expert advice.
• The sooner you contact us the more options are open to you.

This email address is being protected from spambots. You need JavaScript enabled to view it.

Iain McLennan

Director

Phone: (09) 303 9512

Mobile: 021 664 556

Email: This email address is being protected from spambots. You need JavaScript enabled to view it.

A director must not allow the company to enter into any transaction which could create substantial risk of serious loss to creditors. The penalties for doing so are severe and include making the director personally liable for the debts of the company without any limitation of personal liability. Directors can avoid that personal liability by acting promptly and not increasing the exposure to creditors. Directors may also face prosecution by the Inland Revenue Department ("IRD") for failing to pay over PAYE deductions or GST. The IRD is taking an increasingly tough stance in this area, and bringing numerous prosecutions. Examples of such prosecutions can be found in media releases on the IRD website.

A company director has a responsibility to seek specialist advice if the company fails to meet either of the two limbs of the solvency test. To satisfy the balance sheet test, the value of the company's assets must be greater than the value of its liabilities, including contingent liabilities. The primary focus of the liquidity test is that the company is able to pay its debts as they become due. It is essential to recognise that the company must meet both limbs of the test, not just one.

Often a business facing insolvency can be restructured. In some cases a Creditor Compromise can be entered into, pursuant to Part 14 of the Companies Act 1993. Please see our article Company creditor compromises - worthwhile or not? on this subject.

If a company can not pay debts when they fall due this should trigger action by the directors. A director should not wait for a statutory demand, a winding-up application or for a secured creditor to appoint a receiver.

We deal regularly with companies that not only struggle to pay debts but also have negative net asset positions. Those companies may have suffered from a bad debtor, a downturn in the economy, competition, or lack of capital. Often liquidation is the only option for such companies. Placing a company in liquidation is as simple as liquidators consenting to act and the shareholders signing a resolution. For more information on the liquidation process, please visit our Liquidations page.

We find that businesses subject to risk have common warning signs such as the loss of a key account, unrealistic assets on the balance sheet, increase in staff turnover, slow stock turn, rising debts and slowing growth, price cutting, extended credit terms and large bad debts.

These symptoms do not necessarily mean that a business is on its last legs. If any of these signs are caught early enough, they can be turned around so that the business can end up stronger in the long run.

The director should be wary that he or she will be held accountable if proper action is not taken at the date they knew or should have known that the company was insolvent. It is our recommendation that advice is sought earlier rather than later to reduce the financial culpability of the director for trading recklessly and the risk of financial loss to creditors.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

The following are some issues which tend to crop up on many of our liquidations.

Vehicles claimed by directors

A minor, but often emotive issue, is the car "owned" by the director. The director states it is their car, and it is registered in their name. Registration, however, does not prove ownership and if the car is in the company's accounts and shown on the depreciation schedule, the liquidator will fulfill one of their principal duties by taking possession of the car and selling it.

Share capital not paid up

Under modern company law, shares have no nominal value. Too many times we hear that if a company has 1,000 shares then there is an obligation on the shareholders to pay $1,000. This is not the case. The consideration for shares is determined by the board of directors pursuant to Section 47 of the Companies Act 1993. If a 100 share company goes into liquidation and the directors have not determined the consideration for the shares, there is a risk that the liquidator will take a stance that the consideration for the shares should have been $1,000 each and will instigate legal proceedings accordingly.

Tools of trade - machinery etc

These are a little like the car. The director/shareholder regards them as theirs. They have built them up over the years and owned them in the period when they were a sole trader. Unfortunately, these too may be in the company's accounts, usually for one or more of three reasons:-

• So that the accountant can claim depreciation on them
• To help pay up the share capital
• To wipe out an overdrawn shareholder's/director's current account

Again, the liquidator will insist on taking control of these items and selling them.

Personal guarantees

Unfortunately for directors (but not for creditors), limited liability is often negated by personal guarantees. Few directors are conscious of the guarantees they have signed. Such personal guarantees can lead to a director becoming bankrupt. Some common situations where personal guarantees are required are as follows:-

• The bank
• Hire purchase and leasing agreements - a personal guarantee is usually required
• The landlord - lease documents invariably include a personal guarantee
• Trade creditors - the catch here is in the application for credit. This often has a personal guarantee incorporated into it and the director scarcely realises what they have signed

The big bluff

A creditor states they are holding a personal guarantee. A guarantee to be effective must be in writing. Ask for a copy of it. It may not even exist.

Construction companies

Did the director build themselves a house and charge the kitchen and laundry and roofing material to other jobs? The liquidator tends to find out about such matters.

The accountant's or solicitor's lien

Where an accountant or lawyer is owed money and the liquidator requires their files, that professional can claim a lien over them. The Companies Act 1993 provides that in such circumstances the liquidator must agree to accept a preferential claim of 10% of the total value of the debt, up to a maximum amount of $2,000. The important thing here is to claim a lien before handing over the books. If the books and records are simply handed over on request it is too late afterwards to claim preferential status.

Conclusion

Liquidation is a tricky business, and the issues involved are often more complex than they may appear at first sight. We are always available to discuss with accountants, lawyers and their clients any issues they have in this area.

Note: This article was written by Jonathan Barrett who has subsequently left the firm.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

Introduction

A Chartered Accountant providing business services arrives at results through double entry bookkeeping. That is, for every debit there must be a credit. That same accountant, although they are excellent at their job, may be confused if they are asked to draw conclusions from inadequate records.

On the other hand, the forensic accountant thrives on inadequate records and is used to coming to conclusions by drawing information from different places and bringing it together to a meaningful conclusion.

One of the duties of a liquidator is to realise the assets of a company. Often those assets take the form of a claim against someone who has defrauded a company. For a liquidator to do their job properly they must recognise that fraud has occurred and that everything may not be what it appears at face value.

Common types of fraud include the following:-

• Business assets such as cars and equipment somehow being regarded as directors' personal property
• Sale of assets to the director or an entity controlled by them at an undervalue
• Sale by director to company of assets at overvalue
• False invoices from companies controlled by director or perhaps in-house accountant
• Valid invoices to customers, but showing the director's own bank account details
• Non-existent people on the payroll
• Suppression of creditors at the time of preparation of annual accounts
• Showing stock that does not exist in the annual accounts
• Giving personal trading trusts the good profitable contracts and leaving the failing company with unprofitable contracts
• Taking money and showing it as having been invested in an overseas investment

The skills of a forensic accountant

For a forensic accountant to succeed they need more than ordinary accounting skills. They need legal skills, an enquiring mind, and to be a student of human behaviour. A degree of cynicism also would not go astray.

Psychological skills

These become very important. What is the best way to approach someone to get information out of them:-

• Do you flatter them?
• Do you make them believe you already have the answers?
• Do you suggest they might be more lightly treated if they come clean?
• Do you give them the impression that you know more than you actually do?

Following this:-

• What does the person's body language tell you?
• Is the person hiding something?
• Is the person telling the truth?

Accounting skills

The accounting skills required are unlike those of the usual accountant. For a start, in the usual accountant's office the detailed work such as posting individual items to the ledger is done by clerks. On the other hand the forensic accountant must themselves be prepared to trawl through a mass of detail.

The forensic accountant must be aware of creative accounting practices and have an instinct as to where something unusual might have happened. In particular, they must be able to differentiate between the ordinary and extraordinary.

They will notice things which would not be normally noticed in a Chartered Accountant's office; such things as abnormal behaviour and the timing and sequence of events. They will be on the look out at all time for possible manipulation. They will understand information flows and be in a position to compare ratios and results with those of similar businesses.

Legal skills

The duties of directors are set out in the Companies Act 1993. The forensic accountant will have those duties in mind at all times.

For example:-

• Have the directors exercised their powers for a proper purpose?
• Have they acted in the best interests of the company?

An example of the enquiring mind

An actual case which comes to mind came about when the director of a company had a new boat. The forensic accountant, with his enquiring mind, wondered how the director could afford such a luxury while the company was making losses?

An examination of the books and records solved both the problem of the losses and the acquisition of the vessel. The company was in the business of importing machinery to order for its customers. An invoice to one customer simply stated as follows:-

Needless to say, the motor yacht never appeared in the books of the company. The director of the importing company simply treated the vessel as a personal asset.

Computer forensics

Because they understand the flow of information, the forensic accountant will recognise when information is missing from a computer. They will then use forensic software such as 'Encase' to examine the computer. The forensic accountant connects to the target computer and selects the media (disc, hard drive, USB device etc) for investigation. A duplicate of the original media is created. This protects the integrity of the base data. Investigation is performed on the data image using the tools in Encase. These tools include keyword searches, hash analysis, file signature analysis, filters and compound queries and data encryption. Evidence and investigation results are documented using the Encase reporting function. Any hard drive of any size can be compressed and stored on removable media, allowing the forensic accountant to take evidence with them. Even files that have been deleted, hidden or renamed can be located quickly and easily.

Conclusion

For a liquidator to properly do their job they must take control of the assets and realise them. Without good forensic skills it is not possible for liquidators to recognise all those assets which are capable of being realised.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

Introduction

In August 2011, the High Court issued an important decision in Burns v Commissioner of Inland Revenue on the widely argued question of "what is an account receivable?". This followed an earlier decision (re Northshore Taverns, 2008) in which the High Court decided that "accounts receivable" amounted to "book debts" only. This may sound like an academic point, but it is very important in determining which creditors receive distributions from the various sources of funds realised in a receivership or liquidation. The decision has positive implications for employees and the IRD as preferential creditors, and negative implications for General Security Agreement ("GSA") holders and guarantors.

The legal issue

The Seventh Schedule to the Companies Act 1993 sets out the order in which receivers and liquidators must pay preferential claims. This relies on definitions in the Personal Property Securities Act 1999 ("the PPSA"). The current wording took effect from 2002 but the meaning of some of the definitions is still being debated in insolvency circles.

The Seventh Schedule provides that, where a creditor holds a GSA over a company's assets, they rank ahead of most other creditors in the distribution of funds from the insolvent estate, except where the assets comprise "accounts receivable" or "inventory", in which case the proceeds must first be used to pay preferential claims, ahead of the GSA holder.

These preferential claims mainly comprise employee debts for wages, holiday pay and redundancy pay, and amounts owing to IRD for GST and PAYE.

While inventory is relatively easy to assess, there are many assets that could potentially be considered accounts receivable. Whether these assets are categorised as accounts receivable or not can have a major impact on the returns to secured and preferential creditors. In many cases, these items are the only assets and therefore the interests of preferential and secured creditors are directly in competition, with one or other of these groups potentially standing to recover nothing.

The PPSA defines an account receivable as "a monetary obligation...whether or not that obligation has been earned by performance". In most cases it is easy to determine whether an asset is an "account receivable" within that definition.  There is no question that routine trade debtors, properly invoiced and appearing in the company's accounts as a trade debt, fit the definition. This had already been confirmed in the earlier High Court decision. Where problems arise is in situations where money is due to a company for some other reason.

The Burns v IRD decision considered this definition in the context of such items as:-

• Council bond refunds
• Amounts refundable following overpayments
• Amounts held for the company in a lawyer's trust account

These, and similar items, have in the past proved difficult to categorise for distribution purposes and therefore entitlement to the proceeds of these assets has been potentially contestable.

The decision in Burns v CIR

The Burns decision stated that a broad interpretation should be applied to the phrase "account receivable". It held that bond refunds, refunds of overpayments and amounts held for the company in a lawyer's trust account all fitted the definition of accounts receivable and were therefore available to preferential creditors. The decision thus clarifies the position regarding a range of assets which were previously seen by practitioners and their lawyers as a "grey area". The decision also resolved the question of at what point a debt is classed as an "account receivable". Is it at the date of liquidation, or could it also refer to amounts which only become due after liquidation or receivership? The Court confirmed that the wording only refers to amounts due at the date of liquidation, and therefore only these amounts will be payable to preferential creditors. This is unsurprising, as otherwise many anomalies would arise.

For instance, if a liquidator trades on for a short period and sells inventory purchased after liquidation on credit, or sells a company's plant and gives the buyer 30 days to pay, should the amounts due suddenly become payable to the preferential creditors? The High Court has said no; the asset type is tested and determined as it exists at the date of appointment.

Implications for preferential and secured creditors

This decision will clearly not be welcomed by banks, finance companies and other parties who have lent against GSA securities (for instance, private individuals including investors, directors, and their spouses, friends and family members). It will, however, be welcomed by employees and the IRD, who will see themselves pushed to the front of the queue in cases where they might otherwise have ranked behind a GSA holder. For our part, there remains the question of which other assets the definition could capture. We are concerned that the two decisions have not provided total clarity as to what assets may constitute an account receivable. Instead, there is the potential for the definition to capture even more assets.

We understand that the case may be subject to an appeal in mid 2012, but for now it is the precedent and we must follow it. There may well be other cases on this issue, as there unfortunately remain some unanswered questions.

This decision should be brought to the attention of GSA holders, and also to guarantors under those GSAs. It means that there are likely to be less proceeds available to secured creditors and consequently there is a greater likelihood that secured creditors will be pursuing other repayment rights and remedies. The decision, and consequent expectations of loan collectability, will also impact on the holding values of loans in the financial accounts of secured lenders.

Update - December 2012

The Burns v IRD case is the subject of an appeal to the Court of Appeal. We understand that this is likely to be heard in mid 2013.

Note: This article was written by Jonathan Barrett who has subsequently left the firm.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

Introduction

It is now almost ten years since the Personal Property Securities Act 1999 ("PPSA") was enacted. Despite this, in our insolvency work we still regularly come across suppliers who have not performed the necessary registrations, and as a result lose priority to other creditors. This is highly unfortunate, given that a PPSR registration is simple to do and costs only $3.07. A PPSR registration is a little like income protection insurance - not terribly exciting to think about now, but it can make all the difference if the unexpected happens. We encourage all our clients to check that they, and their own clients, are fully conversant with this vital area. In this short article we attempt to explain the main points of the PPSA and its implications for suppliers.

The PPSA - a brief summary

The PPSA came into force on 1 May 2002. It constituted a major reform of the law relating to security interests in "personal property". The new law was closely modelled on a similar act in the Canadian province of Saskatchewan.

Prior to the PPSA, such interests were registered at a variety of locations including the Companies Office. The previous law was regarded as inadequate and cumbersome. The PPSA set out to provide a single online location where suppliers could find out at minimal cost what existing security interests there were against their customers' assets.

The PPSA affects lending, leasing and other types of credit-providing activities. Personal property is given a wide definition. With few exceptions it covers any property someone can own, notable exceptions being land (interests over which are still registered at the Land Registry), and ships over 24 metres in length.

The Personal Property Securities Register ("PPSR")

The PPSA introduced a registration system for what are termed "security interests" in personal property. This is run through an online registry called the PPSR, which anyone can search for just $1.02. Registration is not compulsory. However, failure to register means a creditor may lose priority to another creditor who does register, and is therefore inadvisable. A supplier generally only has to register once in respect of each customer (not every time goods are supplied), and then renew the registration every five years. There are strict time limits for registration - generally on or before delivery in the case of inventory, and within 10 working days for other assets.

"Security interest" is a broad term. Some of the most important examples of a security interest are:-

• A General Security Agreement - previously known as a debenture
• A retention of title clause
• A lease of goods/equipment of more than one year
• A lease of goods/equipment for an indefinite term
• An agreement to provide goods on consignment

Where things tend to go wrong

Where problems arise for many suppliers is when a bank or other lender has been granted a General Security Agreement ("GSA"). This is because most GSAs refer to "all present and after acquired personal property" and therefore potentially cover all company assets.

Because a supplier of stock or equipment has provided new value for its security, it normally ranks ahead of the GSA holder's general security in respect of those goods (this is known as 'super-priority'). However, this is only true if the supplier registers its interest on the PPSR. If not, it is likely to lose priority in those goods to the GSA holder (and also potentially the preferential creditors) in the event of its customer's insolvency. In most cases this means a supplier with a retention of title clause or a lessor of goods who has not registered walks away with nothing.

This is despite the fact that the retention of title clause may be perfectly valid in itself. This is because the PPSA only concerns itself with priority between security interests, not legal ownership. This subtle distinction is not often understood and tends to result in some understandably very disgruntled creditors.

Even where there is no GSA, a supplier of stock with no PPSR registration is still at risk of losing priority to the preferential creditors.

What are the key areas of risk for suppliers and lessors?

For most normal trading businesses, the main risk areas tend to be:-

Retention of title/"Romalpa" clauses

These should be agreed in writing rather than just stated on the back of invoices. However, even with a full set of signed terms and conditions, a retention of title ("ROT") clause is likely to be worthless in an insolvency if a PPSR registration has not been made. We have been involved in numerous cases where we have had to tell suppliers that their unregistered ROT clauses had no practical use and they could not recover any stock.

Consignment stock

The same principle applies to stock supplied on a consignment or "sale or return" basis. Even though legal title may not have passed to the customer, the consignment is a security interest and therefore has to be registered to rank ahead of a GSA holder or preferential creditors. Again, an unregistered supplier is likely to be unable to recover stock supplied in the event of its customer's insolvency.

Leased goods

Where a lease is for a term greater than one year (or for an indefinite term), the lessor must register its interest in the goods on the PPSR. If it fails to do so, the lessor may lose priority over those goods to a GSA holder. A lease agreement may be held to be of an indefinite term if it does not contain a clearly stated term, or end date. This is where many lessors run into problems.

General Security Agreements

GSA holders need to be aware that the old priority rules no longer apply. Previously, the first GSA to be executed ranked first, unless specific accommodation had been given to a subsequent GSA holder. The date of a GSA's execution is now irrelevant when assessing priorities. What matters now is the date of registration on the PPSR. The first GSA to be registered ranks first.

Conclusion

This is only a brief summary of this complex legal area. However, two very important points are clear. Suppliers/lessors of goods must ensure that their terms and conditions are properly worded to reflect the current law. They must also ensure that they have a valid PPSR registration to protect those legal rights. We recommend that all businesses selling goods on credit (or leasing goods) carefully review both their terms of trade and their PPSR registration procedures. We are happy to answer further questions, and can also recommend appropriate commercial lawyers with expertise in this field.

Note 1 -PPSR fees increased on 1 August 2012 to $3 for a search and $20 to register or renew a financing statement.

Note 2: This article was written by Jonathan Barrett who has subsequently left the firm.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.