Payments under direct payment agreements may not be vulnerable in the liquidation of a developer
The New Zealand Court of Appeal has held that payments by a financier to a contractor under a direct payment agreement may not be clawed back by liquidators of the developer. The Court of Appeal reversed a High Court decision that had attracted considerable attention.
Contractors will welcome this decision. However, the same result may not necessarily apply to all direct payment agreements, as the Court noted that the agreement had some features seen as unusual in the market. Financiers and contractors may wish to review the form of any direct payment agreements to ensure they contain the same key features as the agreement in this case.
Direct payment agreements
A direct payment agreement is a three-way agreement between the developer, contractor and financier. The financier obtains the ability to step in and complete the project if the developer defaults. Also during the project, the financier is permitted (or required) to make payments directly to the contractor. Although popular in the 2000s, in our experience it is now less common for financiers to accept direct payment obligations to contractors.
The key question – was there a payment 'by' the insolvent company?
The key question for the Court of Appeal concerned how those direct payments are treated if the developer is put into liquidation: are payments made by the financier voidable preferences recoverable by the liquidator under section 292 of the Companies Act 1993?
The case turned on whether the payments could be said to have been made 'by' the insolvent developer.
Other similar situations of payments by third parties
The Court set out four analogous examples of payments by a third party in respect of a company's debts that would not be set aside as voidable transactions in the liquidation of the company:
- A payment by a guarantor to a creditor of the company.
- A payment by a parent company or shareholder who has agreed to indemnify a creditor against a failure by the company to perform an obligation.
- A payment by a third party who is jointly liable with the company to a creditor.
- A payment by a bank under a letter of credit facility.
The Court noted that the particular feature of these kinds of transactions is that the third party makes payment to discharge a direct liability of its own. The third party does not make payment as agent for the indebted company.
The Court concludes that there was no payment 'by' the insolvent company
The Court of Appeal found that the financier was directly liable to the contractor under the direct payment agreement. At the time of the challenged payments, the developer was in breach of its facility agreement with the financier, and the financier was not obliged to honour any drawdown request by the developer. The financier's obligation to make payment under the direct agreement was owed to the contractor, and not the developer.
The Court observed that it is of essence in the avoidance of a preferential payment 'by the company' that the funds (or asset conveyed) are from resources available to the company to pay its general creditors. The developer could not have used its facility to pay other creditors.
A somewhat unusual feature of the particular payment agreement assisted the Court of Appeal's conclusion: the pre-conditions on the financier making direct payment to the contractor did not include a condition that the developer was not in default under the facility agreement.
Payments were not 'insolvent payments'
The Court of Appeal also held that the payments under the direct agreement were not 'insolvent payments'. That is, they would not have enabled the contractor to receive more than it would have received in the liquidation of the developer. The contractor had rights against the financier under the direct agreement, so it was always entitled to seek to recover directly against the financier whether before or after liquidation, rather than making a claim in the liquidation of the developer. The direct agreement was not entered into in the specified period, so was not voidable.
Ebert Construction Limited v Sanson & Anor  NZCA 239
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