Last week, the Court of Appeal clarified the rights of purchasers of partially completed tiny homes following the builder's insolvency. [1] The High Court ruled last year [2] that these purchasers had an equitable lien over the tiny homes and priority ahead of secured creditors in the liquidation of Podular Housing Systems Ltd (Podular). If unchallenged, this decision would have had the effect of altering the priorities of creditors established under the Personal Property Securities Act (PPSA) and Companies Act in this context.
The Court of Appeal has overturned the High Court's decision, holding the purchasers did not have an equitable lien, providing greater certainty as to the priority of creditors in respect of tiny homes and other bespoke goods.
Background
Podular built and installed architecturally designed tiny homes, known as "pods". These pods were partially constructed at Podular's facilities before being transported to purchasers' properties where further earthwork and construction took place.
Podular was placed into liquidation on 12 December 2021. At the time, Podular had partially completed 18 pods. The purchasers of these pods had paid deposits and instalments of the purchase price.
Podular's liquidators applied to the High Court for urgent directions as to the nature and priority of competing claims, including those of preferential and secured creditors, unsecured creditors (including purchasers who had paid deposits but whose pods had not yet been constructed), and finally, the purchasers of partially completed pods who argued they had an equitable lien over their respective pods.
Justice Jagose found that Podular retained legal title to the partially completed pods, but that the purchasers had an equitable lien over the pods to the value of the purchase price paid by them. That equitable lien entitled the purchasers to sell the pods and use the proceeds to discharge the debt owed to them. In a subsequent minute, Jagose J also determined that the liquidators' costs could only be deducted from the proceeds from selling the pods after the purchasers had been paid. The liquidators appealed both findings.
Court of Appeal decision
Equitable liens
Most significantly, the Court of Appeal concluded that New Zealand law should not recognise the existence of a purchaser's equitable lien over partly completed tiny homes. The Court provided five reasons for its conclusion. They boil down to respecting the carefully crafted regulation regarding the priority of creditors on insolvency.
- The Court considered the unconscionability to the purchasers did not justify a proprietary remedy in the form of an equitable lien. The Court reasoned it is common commercial practice for insolvent suppliers such as Podular to only partially perform their obligations to unsecured creditors. Unsecured creditors will almost always be denied full performance of suppliers' contractual obligations, so any injustice to these purchasers is no greater than that of all other unsecured creditors on insolvency. The Court declined to follow an Australian High Court decision to the contrary. [3]
- Flowing from this finding, the Court ruled that there is no principled reason to justify imposing an equitable lien and giving purchasers of partially completed pods priority over other unsecured creditors when these purchasers had other protective mechanisms available to them. If these purchasers wished to protect their interests, they could have contracted for a purchase money security interest (or "PMSI"), as the purchasers of one pods had done in their contract with Podular.
- The Court of Appeal considered that recognising an equitable lien in this context would involve significantly widening the scope of this remedy for no good reason. Equitable liens have been recognised in a range of circumstances in property law, including to protect purchasers who have paid part of the purchase price for land where, for reasons beyond their control, the contract is repudiated and the land has not yet been transferred to them. However, if an equitable lien was recognised in the tiny homes context, a strong argument could be made that it should also be recognised in the context of other partially-completed goods for which a portion of the price has been paid, such as modular components of buildings, specialised vehicles, machinery and joinery. Again, this would upset settled priority rules on the suppliers' insolvency and effectively provide these customers with priority when they did not contract for it.
- Recognising an equitable lien in this context would arguably be inconsistent with Parliamentary intent. Under the Layby Sales Act 1971 (and now subpart 1 of part 4A of the Fair Trading Act 1986), purchasers of goods that have entered into a layby sale agreement, such that they will not take possession of the goods until a specified portion of the purchase price has been paid, are provided with priority on the insolvency of the seller. However, this statutory regime only provides priority to purchasers where the purchase price is less than $30,000. Purchasers of Podular pods are in an analogous situation, however, the price of these pods is significantly greater than $30,000. The Court of Appeal considered that imposing an equitable lien, and granting priority on these purchasers, would undermine Parliament's decision to carefully confine such priority to contracts of less than $30,000.
- Recognising an equitable lien in this context would also be inconsistent with Parliament's intention in enacting the PPSA, a carefully prescribed regime which establishes the priority of creditors on insolvency. This is undesirable and would result in uncertainty. It would cause common law and equity to develop in a manner incompatible with relevant statutory frameworks.
Relative priority of an equitable lien considered
To illustrate the consequences of recognising an equitable lien, the Court considered what priority it would have given purchasers of partially completed pods had it granted them equitable liens. The Court's reasoning underscores why such a lien would cut across relevant statutory frameworks.
The Court determined that any such equitable liens would have to rank behind security interests under the PPSA. PPSA security interests are legal interests and must therefore have priority over equitable interests. If an equitable lien existed over a pod, it would not have priority over a secured creditor's PPSA legal interest, provided the security interest was acquired in good faith and without notice of the circumstances giving rise to the equitable lien.
That in turn would have created a mismatch with the position of preferential creditors. Preferential creditors under the Companies Act rank ahead of certain claims by secured creditors under the PPSA. This priority is determined by s 312 and Sch 7 of the Companies Act, which provides that preferential creditor claims, such as certain employee and Inland Revenue claims, have priority over most GSA security interests in accounts receivable and inventory (which, in the Podular case, would include the pods).
However, if equitable liens were to be recognised, preferential creditors would rank behind purchasers with an equitable lien. Preferential creditors would only have priority over those creditors with "security interests" as defined by s 17 of the PPSA. An equitable lien is not a "security interest" because it arises by operation of law and is not expressly provided for in a transaction.
This would have created an unworkable outcome. Logically, if preferential creditors were intended to have priority over secured creditors, and if secured creditors should have priority over purchasers with equitable liens, then purchasers who have equitable liens should not rank ahead of preferential creditors. These difficulties supported the Court of Appeal's conclusion that purchasers should not have an equitable lien as it would undermine settled, legislative priority rules.
Liquidator costs
Finally, the Court's finding that there was no equitable lien meant it did not need to determine the priority dispute between an equitable lien and the liquidators' right to recover their costs. However, the Court addressed the issue anyway, commenting for the avoidance of doubt that because an equitable lien only entitles the party with the lien to the net proceeds of sale, the liquidators would have been entitled to recover their costs from the proceeds of the sale of the pods before paying the balance to the purchasers. The Court of Appeal therefore overturned Jagose J's finding on this matter as well.
Key takeaways
The Court of Appeal's decision has removed the uncertainty created by equitable liens of this type in New Zealand and has also removed their priority on insolvency. The Court's finding that security interests under the PPSA take priority over this type of equitable lien is particularly welcome. It provides liquidators and creditors alike with much needed certainty and confirms that secured creditors will retain priority in the case of insolvency in accordance with established principles. Purchasers can in theory protect themselves by negotiating for security interests over goods allocated to the pod being constructed for them.
One element not resolved is whether the outcome would be different were the contract for the sale of goods. The Court held that the relevant contracts were for work and materials, and not for the sale of goods.