Avoiding clawback of insolvent payments
How to avoid clawback of payments
Imagine a company owes you $10,000, and owes $10,000 each to four other unsecured creditors. In all cases, the money is well overdue. However, because you are an effective credit manager, you put some pressure on and get paid. The company goes into liquidation a few months later and the other creditors miss out completely.
But then the liquidator contacts you and demands the money back. A basic concept in insolvency law throughout the world is that everyone in a class of creditors is supposed to suffer equally. The law says you have to pay it back.
You pay the money back and it's distributed pro rata amongst all the creditors. If there were only the five of you and there were no other priority debts, you would each get $2000 each out of your $10,000.
Late last year there were significant changes to New Zealand individual and company insolvency law. These included changes to the rules for clawback of insolvent transactions. I'll refer only to companies in my examples, but essentially the same rules now apply to companies which go into liquidation and to individuals who go bankrupt.
This concept punishes effective credit managers. Any large payments of overdue accounts within two years of the debtor company going into liquidation may to be clawed back. Generally, difficulties of proof mean liquidators will only worry about debt within the last six months. If you had old debt paid within six months of the liquidation, the onus is on you to prove you don't have to give it back. Beyond six months, the burden of proof is on the liquidator.
Under the new rules, which largely copy the relevant Australian law, the creditor can defend the liquidators claim if (s296 Companies Act 1993, s208 Insolvency Act 2006):
- The creditor acted in good faith; and
- A reasonable person in the creditor's position would not have suspected, and the creditor did not have reasonable grounds for suspecting, that the company was, or would become, unable to pay its debts; and
- The creditor gave value or altered its position in the reasonably held belief that the transaction was valid and would not be cancelled.
So ignorance is bliss. If you can say, "I didn't know the debtor company was in trouble, and no reasonable person in my position would have known," and you've changed your position (which usually means you've supplied more goods on credit) you may convince the court to let you keep the money. But it's hard to say you didn't know they were in trouble when you only got paid as a result of stopping credit, sending the debt to debt collectors, and suing them.
One particularly unjust situation under the old rules has now been fixed. Imagine that every month Doomed Company Ltd buys $20,000 worth of stock from Slack Creditor Ltd. Doomed always owes about $60,000. Each month it pays the oldest month's invoices and gets another $20,000 of stock. Then Doomed goes into liquidation. Over the previous six months it had paid $120,000 which, under the law as it stood prior to 1 November 2006, might well have been clawed back by the liquidator, even though Slack provided $120,000 of new credit over that period and was still owed the same amount - $60,000 - as at the start of the period.
This injustice has been addressed by the concept of running accounts, also imported from Australian law. In our example the $120,000 of payments would be negated by the $120,000 worth of stock provided.
The problem for creditors is how to avoid clawback when you know that your customer is in trouble. You want to put them on a payment plan, but you suspect that they may go bust. If they do, how do you keep the money? Here are some thoughts from an experienced Australian credit manager.
1. For a start no repayment arrangements are ever confirmed in writing.
2. All part-payments must avoid rounded amounts (e.g. rounded up to the nearest $1000). Instead, they must always pay specific overdue invoices.
3. If the customer is on COD terms, then they make a payment for the agreed weekly/fortnightly/monthly repayment amount PLUS enough to cover the value of the new COD invoices.
4. BUT allocating the payments to the COD invoices plus some of the overdue, would show that it is clearly a repayment program. Instead, the payment is worked out to clear specific overdue invoices to that value and applied against those invoices. It's not applied to the COD invoices. That way, if the debtor company goes into liquidation, you will be able to argue that they were not on stop and you have a running account. This will allow you to keep some of the payments.
5. Obviously, the arrangement will have achieved a reduction in the overall debt but we would argue to the liquidator that we opted to reduce their credit limit to bring them into line with agreed terms. Also, in our business we sell a seasonal product so we also argue the drop in the outstanding balance is due to a natural drop in sales during that period.
6. All else fails always ALWAYS make an offer before going to court.
As you can expect of Aussies, his approach is hard-nosed and pragmatic. A word of caution - it's one thing to stretch the truth when haggling with a liquidator; it's another thing to stand up in court and lie... even if the law is an ass.
Lastly, in New Zealand, payment to a registered secured creditor (where registration is required) is not a transaction that has a preferential effect. If you register a security on the Personal Property Securities Register, you don't generally have to worry about clawback of insolvent payments. We recommend to all our clients that they word their contracts to give them a registerable security over any goods they provide... even businesses like accounting firms and power companies that don't actually provide goods.
Peter Hattaway - www.hattaways.com - is a director of Hattaways, specialists in credit management training and consulting.