Can payment into a solicitor’s trust account be grounds for setting aside a statutory demand?

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Having a legal right to be paid, or even getting a court or adjudication decision in your favour, is sometimes only half the battle. In this article we look at one approach that some companies are taking to avoid making payment, and why the courts don’t seem to be buying it.

Making payment without making payment

A common way to enforce a debt owed by a company is to serve a statutory demand. Once the demand is served, the debtor company has ten working days to apply to set it aside, failing which the company has fifteen working days to pay. If the debtor company does neither, the creditor can apply for the appointment of liquidators on the basis that it is presumed to be unable to pay its debts. Statutory demands therefore create a strong incentive to pay.

The standard ground on which a debtor company can apply to set aside a demand is that the debt is disputed. However, what if the debtor company accepts that the debt is currently due, but has begun proceedings to have it overturned? This situation is most common in a construction context as a result of the ‘pay now, argue later’ principle, but may also arise in other contexts. For example, a civil judgment is generally enforceable even if an appeal has been filed.

In this situation, some debtor companies have been refusing to pay the creditor and instead paying money into a solicitor’s trust account. Their thinking is that, by doing so, they are proving their solvency so the statutory demand procedure should not apply. If, down the line, they are successful in challenging the debt, it will then be easier for them to recover their funds.

This approach might seem attractive to debtors, but will it work? As set out below, the answer seems to be that it won’t.

Testing the waters

The most recent decision touching on this approach is Melbourne Limited v Bartlett Concrete Placing Limited [2022] NZHC 1786.

Melbourne, a construction company, engaged Bartlett to carry out works. Bartlett made monthly progress payment claims to Melbourne under the Construction Contracts Act 2002 (‘CCA’). Melbourne did not pay Bartlett, because of concerns about the quality of Bartlett’s work, but failed to issue a payment schedule as required by the CCA.

Bartlett issued a notice of intention to recover the outstanding debt and to suspend any future work. In response, Melbourne asserted the payment claims had not been validly served. Two days later, Bartlett issued a statutory demand for NZ$100,011.60, being the combined outstanding amount of the payment claims.

Melbourne’s sole shareholder made payment into Melbourne’s solicitors trust account of the NZ$110,011.60. Melbourne then applied to the court to set aside the statutory demand and commenced adjudication proceedings disputing the original debt.

Melbourne’s argument and why it failed

Pursuant to section 290(4) of the Companies Act, the court may set aside a statutory demand if satisfied that;

  • there is substantial dispute whether or not the debt is owing; or
  • the company appears to have a counterclaim, set-off, or cross-demand; or
  • the demand ought to be set aside on other grounds.

In this case, Melbourne argued that the statutory demand should be set aside on other grounds because it was solvent, and was in the process of resolving the dispute expeditiously through adjudication. Melbourne attempted to rely on the payment into its solicitor’s trust account as evidence of its solvency.

Melbourne’s arguments failed for two main reasons (which are consistent with previous cases):

  • The judge was not satisfied that the payment proved Melbourne was solvent, as it was made by a third party rather than by Melbourne.
  • Even if the payment had proven solvency, it would not have been a basis to set aside the statutory demand. A company should not be able to avoid paying a debt simply by proving that it could pay the debt if it wanted to. This principle applies particularly in the construction context as the CCA imposes a ‘pay now, argue later’ system to enable cashflow while disputes are being resolved. If a party could avoid a statutory demand by proving solvency, this would undermine the system.

The judge gave Melbourne three working days from the date of judgment to make payment.

Takeaways for parties looking to get paid

It has long been established that issuing a statutory demand is a valid debt recovery option. This option would lose its force if a debtor company could avoid the consequences of not complying with the demand simply by proving its solvency.

This decision and the ones that proceeded it are therefore welcome. If a company owes a debt, it should pay its creditor, not into its own lawyer’s trust account.

Having said that, there are two important caveats. First, the courts may come to a different conclusion if the debtor can show that the creditor would not be able to repay the sum in question should the debtor be proved right by the further dispute resolution procedure (i.e. that the creditor itself is in financial difficulty – the ‘black hole’ argument). Second, even where the courts have refused to set aside a statutory demand, they may not ultimately agree to put a company into liquidation.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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