The Court of Appeal allowed an appeal by Ebert Construction Limited (Ebert) which challenged the ability of the liquidators of a developer company to claw back payments made by a financier under a direct payment agreement. The Court held that the payments made by the financier were under a direct obligation to a builder, and were therefore not payments by the insolvent company, and were therefore not subject to the insolvent transactions regime. The form of direct payment agreements or tripartite agreements will be important, particularly in voidable transaction cases.
In October 2005 Takapuna Procurement Limited (TPL) entered into a construction contract with Ebert to construct the 134-unit Shoalhaven Apartments complex at Takapuna for approximately $32,500,000. TPL arranged finance with BOS International (Australia) Limited (BOSI) through a Senior Facility Agreement and Strategic Nominees Limited (Strategic) through a Junior Facility Agreement.
The direct agreement
Ebert, BOSI and Strategic entered into a “direct agreement” in relation to the project.
Direct agreements generally provide for a contractor’s progress payments to be paid directly by the financier. They typically provide a financier with “step in rights” if a developer defaults on their obligations. The direct agreement in this case included the following relevant features:
- BOSI was required to pay Ebert progress payments due under the construction contract provided a) BOSI had received an approval payment certificate for the amount to be paid and b) Ebert was not in default of its obligations under the construction contract.
- TPL gave an irrevocable authority for these payments to be made by BOSI direct to Ebert.
- BOSI and Strategic could only terminate TPL’s finance facilities if they first paid duly approved progress payments to Ebert.
- Neither BOSI nor Strategic had any liability or obligation to Ebert other than as provided in the direct agreement. TPL remained “primarily liable” for all obligations under the construction contract. However, BOSI had the right to step in and complete the project if TPL defaulted on its obligations under the construction contract.
- A default by TPL under its loan facility agreement did not discharge BOSI from its obligations to Ebert under the direct agreement. This provision was described as unusual in direct agreements.
Completion of the project and insolvency
The apartments were completed in April 2008. TPL defaulted on the loan facility with BOSI in July 2008. In November 2008, TPL and Ebert agreed that the final amount owed to Ebert was $1,603.891.90, which would be paid by way of two cash payments and settlement of the apartment. TPL issued drawdown notices, and BOSI made payments in accordance with those notices. An arrangement for the sale of one of the apartments with Ebert as nominated purchaser was also entered into.
TPL was put into liquidation within a few days of these transactions on the application of the Inland Revenue Department.
In the High Court, Associate Judge Doogue held that the two cash payments and the transfer of the apartment were voidable transactions and ordered repayment of $1,603,891.90 plus interest. Ebert appealed.
A direct liability to pay
The Court of Appeal allowed the appeal. The key reason was its finding that BOSI had an obligation, as a principal debtor under the direct agreement, to pay Ebert if certain conditions were met. As a result, the payments were not transactions “by” TPL (as required under s 292 Companies Act 1993), nor did they allow Ebert to receive more than it would otherwise have received in the litigation (as Ebert always had a right to sue BOSI directly).
The Court noted also that the funds paid by BOSI to Ebert would not have been available to any other creditor, and accordingly did not form part of the general resources of the company. While that is true, it should be noted that the payments made by BOSI to Ebert had the effect of increasing the level of secured debt, and thus reducing the general resources of the company that were available to unsecured creditors.
It is also important to note that the features of the direct agreement which led the Court to its conclusion are not common to all direct agreements. The Court observed that it is unusual for the financier to have an obligation to pay a contractor in circumstances where the principal has defaulted on the loan agreement. If a direct agreement provides that direct payments are at the discretion of the financier, the payments may still be vulnerable to claw back in the event of insolvency.
Contractors presented with a direct agreement need to bear in mind the risk that payments made by a financier could be clawed back by a liquidator in the event of the principal’s insolvency. To prevent this, the financier must have an obligation (not a discretion) under the direct agreement to pay the contractor that is independent of the direction and will of the principal.