Legal Comment

Direct agreements – back from the dead?

By JAMES McMILLAN AND SAM McCUTCHEON, KENSINGTON SWAN

IN JUNE THIS year the Court of Appeal held that payments made to a contractor by a financier under a direct agreement were not subject to the voidable transactions regime (Ebert Construction Ltd v Sanson [2017] NZCA 239).

In doing so, the Court confirmed that a suitably structured direct agreement will provide contractors with protection from clawback of payments by a developer’s liquidator.

Following the Court of Appeal’s decision, Ebert and the developer’s liquidators reached a confidential settlement, which saw the liquidators withdraw their appeal to the Supreme Court.

What is a ‘direct agreement’?

A direct agreement is a three-way arrangement between a developer, contractor and a financier. Under the agreement, the financier can ‘step in’ and complete the project if the developer defaults. The financier can also make direct payment to the contractor.

The benefit to the financier of having a direct agreement is certainty that the project can be completed. The developer will be able to earn a return on its investment (eg, from the sale of the building).

The benefit to the contractor is that payments for the contract works are received directly from the financier and are not subject to the solvency of the developer.

Background

Takapuna Procurement Limited (TPL) developed the Shoalhaven Apartments. TPL engaged Ebert Construction to build the apartments. BOSI and Strategic Nominees agreed to finance the development and entered into a direct agreement with TPL and Ebert.

The apartments were completed in April 2008 and BOSI made the final payments to Ebert in mid-November 2008. On the day that the final payment was made to Ebert, liquidators were appointed to the developer.

The liquidators subsequently applied to set aside the payments that BOSI had made to Ebert on the basis that these payments were insolvent transactions made by TPL which enabled Ebert to receive more than it otherwise would have in TPL’s liquidation.

The High Court agreed with the liquidators and set aside the payments. The High Court took the view that the payments to Ebert were made ‘by’ TPL and were insolvent transactions for the purposes of section 292 of the Companies Act.

The debt that TPL owed to Ebert had been reduced by BOSI making the payment. In a subsequent judgment, the High Court also awarded the liquidators interest on the judgment sum from the date of 2008 liquidation (this amounted to a significant sum), even though the liquidators had not taken steps to set aside the payments until 2014.

Court of Appeal

The Court of Appeal had to decide whether payments made by BOSI to Ebert were subject to the voidable transactions regime. The Court of Appeal found that the payments by BOSI were made in order to satisfy a direct obligation that BOSI owed to Ebert and, as a result, were not subject to the voidable transactions regime.

In reaching this finding the Court examined two key questions:

  1. Whether the payments were transactions ‘by’ TPL; and
  2. whether the payments enabled Ebert to receive more than it otherwise would have in the liquidation.

Were the payments transactions ‘by’ TPL?

For a transaction to be subject to the insolvent transactions regime, it must be a transaction made by the company that subsequently is placed into liquidation. The Court acknowledged that a payment by a third party can, in certain circumstances, be regarded as a transaction by the company that subsequently goes into liquidation.

However, whether it is or not will depend on the relevant contractual arrangements and in making the required assessment, the substance and reality of the transaction will be more important than its form.

The Court held that BOSI’s payments to Ebert were made in order to satisfy BOSI’s own direct obligation to Ebert. The Court found that these payments by BOSI were akin to payments made under a performance bond or guarantee and were not made as an agent for TPL.

The Court examined a number of factors in reaching this conclusion including:

  1. The history of direct agreements in the New Zealand;
  2. Expert evidence by those involved in the New Zealand construction industry; and
  3. Ehe specific terms of the development agreement, which provided that the payments by BOSI were not conditional on TPL meeting its finance covenants and that Ebert had a right to pursue BOSI directly for payment.

Did Ebert receive more than it would have under the liquidation?

Due to the above finding (that the payments by BOSI were not payments by TPL) the Court was not required to determine this point. Nevertheless, it went on to find that, even if the transactions had been transactions by TPL, they did not have the effect of enabling Ebert to receive more than it otherwise would have in the liquidation.

The fact that Ebert had a contractual right under the direct agreement to pursue BOSI directly for payment after TPL entered liquidation meant Ebert received the same amount as it would have following liquidation. Ebert would not have bothered with joining the general pool of TPL’s creditors. The liquidators’ argument would therefore also have failed on this ground.

Our comments

This decision will come as a relief to many involved in the construction sector. Contractors can take confidence that payments made under a suitably drafted direct agreement will not be clawed back from them by liquidators.

The case is a timely reminder that contractors need to consider the insolvency risk of the instructing party, and, where solvency might be an issue, take appropriate steps to ensure payment can be retained for any work performed.

Direct agreements are one of the tools that contractors might adopt to provide additional security.

If you are considering entering into a direct agreement it is important to ensure that the direct agreement is drafted to ensure it will withstand subsequent scrutiny from a liquidator.

  • Kensington Swan regularly provides comment on the construction industry on its blog Site Visit.

Check out www.nzconstructionblog.com to stay up to date.

This article first appeared in Contractor November 2017.

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