What happens when the Construction Contracts Act collides with the Liquidation regime?

By Ross Dillon | Civil Litigation

The Liquidation Regime

When a company can’t pay its debts, the shareholders and directors can appoint a Liquidator, to wind up the company. If they do not do so, a creditor can apply to the Court to place the company into Liquidation (and has the opportunity to nominate the Liquidator).

Once a company is in Liquidation, the Liquidator has legal authority over all the company assets and must realise them, then apply the proceeds of sale to the creditors of the company in accordance with a schedule of priorities that appears in Schedule 7 of the Companies Act. This schedule ranks the priorities of certain types of creditors. However, the overall premise is that once a company is in liquidation, everyone (within the same class of creditor) is treated equally. This is known as the “pari passu” principle (meaning “side by side” and signifying payment at the same rate or on an equal footing).

In order to achieve that equality of treatment, it is important to ensure that the liquidator can compare “apples with apples” – that claims being advanced by creditors in the liquidation are all proper claims of equal soundness and merit. In other words, that they are proper claims.

The assessment of the claims is a major part of the Liquidators role. To that end, on appointment the Liquidator invites any party that thinks it has a claim against the company to file a “proof of debt” claim. This is a very formal document that sets out the claim, attaches any documentary evidence needed to support the claim. The form itself is prescribed by the Liquidation Regulations and must contain a note that it is an offence to file a false claim.

Where there is some uncertainty regarding a claim, under s. 307 of the Companies Act the Liquidator has the power to make an estimate of the amount of the claim (which a creditor can then challenge by application to the Court), or the Liquidator can make an application to the Court to have the Court determine the amount of the claim.

One area of uncertainty is where there have been mutual dealings between a creditor and the company in liquidation. Pursuant to section 310 of the Companies Act, any claim made in the liquidation must set off the value of any claims against the company, to any money or claims due to the company. If the company owes $5,000.00, but the claimant owes the company $2,000.00, then the proof of debt claimed can only be the balance of $3,000.00.

That works well enough when those figures are all known and accepted, but what when they are not?

The Construction Contracts Act (CCA) regime

There is a lot of variability in a construction contract. There is a lot of room for differences of opinion, a variety of differing types of contract, and thus fertile ground for disputes. Disputes can take years to resolve, Which can be fatal to cash flow. The CCA addresses such practical problems in the construction industry by proving a particular process that allows for fast but provisional resolution of disputes, so any unaccepted positions can be subsequently litigated. This is known as the “pay now, argue later” regime.

The first step is that a contractor issues a payment claim, which is often simply the invoice. But to be a payment claim, it must comply with the CCA, section 20. In essence, this requires that the claim must clearly state it is a payments claim and set out the basis on which it is being made by reference to the requirements of the relevant contract and contain a brief description of how it may be responded to.

The options for response are either to pay the claim, or issue a payments schedule. A payments schedule must meet the requirements of the CCA, section 21. The payments schedule must set out how the difference from the claim is calculated, the reasons for the difference, and if any sum is being withheld, the reasons for doing so. In practice, these requirements are quite onerous.

Where a payment claim has not been paid, or paid in full, there is a dispute. Disputes can be referred to adjudication under the CCA. Adjudication is designed to be a fast dispute resolution process, but is expressly without prejudice to any party taking other formal and finally binding processes, such as arbitration or application to a Court. Adjudication is designed to be “provisional”, so that a payment can be made, to preserve cash flow. Hence, “pay now, argue later”.

"Where a payment claim has not been paid, or paid in full, there is a dispute."

However, an adjudication can be limited in scope. It can determine whether a payments claim has been correctly made and/or whether a payments claim has been correctly responded to. If a payments claim has been correctly made but not correctly responded to, the payments claim is immediately payable – even if the amount claimed in the payments claim is incorrect. The substantive question of what is actually due and owing under the terms of the contract does not have to be determined in an adjudication.

This means an adjudication can result in a determination that a payment claim was properly made, and is immediately payable, where there may be no substantive right to any payment.

Collision

So, what happens when just such an adjudication is used to support a proof of debt against a company in liquidation?

This is the question the Court was asked in the case of Mason-Thomas and Anor v Three Dukes Homes Limited (and Ors) [2022] NZHC 1868.

The claimant had filed a proof of debt based on an adjudication that determined the claimant had made a payment claim using the correct method. The adjudication on its face said that it did not determine whether any money was due to the claimant. In effect, that issue was to be determined later. But the amount of the payment claim was immediately payable.

The company in liquidation maintained that the payment claim was substantively erroneous and that the money claimed was not due and owing. The company maintained that as it was now in liquidation, it was the substantive rights only that fall to be considered, just as every other creditor of the company had to establish substantive rights to prove their debt.

Prior to liquidation, the company had commenced separate proceedings in the High Court, to determine the substantive rights as between the parties. That proceeding had been stayed prior to the liquidation, on terms that required the company to place the amount of the adjudication into the hands of a third party stakeholder. That had not been done.

Once the company was in liquidation, a case may only proceed with the consent of the liquidator, or an order of the Court.

The company viewed the separate proceedings as a claim in the nature of a set-off. The amount the claimant could establish in the liquidation was not simply the adjudication, but only the substantive amount due under the contract (if anything was substantively due). However, that amount had not been determined by the Court.

A factor that the Court did regard as important was that this particular case involved a “solvent liquidation”. Once all claims against the company had been met, there was a significant sum left over for the shareholders. The liquidators indicated that once this particular issue had been determined, the company could be returned to the shareholders. Unlike most liquidations, it was likely that the company would exit the liquidation process and be restored to normal operations.

Because of that fact, the Court found that the liquidation process was not the end of the road for the company. In terms of “pay now, argue later”, there was indeed likely to be a “later” when the substantive merits could be determined – namely, when the company was restored to normal operations.

The Court also noted that while a liquidator can assess the value of a claim made against a company to assess a value (under s.307 noted above), it was not clear that a liquidator could assess the value of the companies own claim against a creditor. The UK had solved the same problem by a specific amendment to their Act, but this had not occurred in New Zealand.

Accordingly, it was not clear that the set-off provision could apply, as the amount of the set-off was unknown.

Thus, on the particular facts of the case, the claimant was entitled to the adjudication sum in the liquidation.

What if?

Similar facts are likely to recur in future. Had the company not been solvent, then there would be no “later” in which to determine the substantive claim.

It is hard to see how an adjudication that only deals with a payment claim being in correct form could be accepted by a liquidator as proof of the debt, where the company is insolvent and all other creditors must substantively prove their debt. That would breach the pari passu principle.

It would seem that a liquidator could properly assess a claim under s.307, when faced with an adjudication that does not determine the substantive merits, by making exactly such a substantive assessment. However, as that assessment is likely to be challenged, an application to Court could be made for that purpose.

Or possibly, as an “outside the box” solution, the liquidator could seek adjudication under the CCA, to determine the substantive merits of the claim, and then seek directions from the Court where a substantive determination has been made. There is existing authority that supports a liquidator using the CCA process.

Disclaimer:
We have taken care to ensure that the information given is accurate, however it is intended for general guidance only and it should not be relied upon in individual cases. Professional advice should always be sought before any decision or action is taken.