Restructuring & Insolvency

Unfair preferences payments

A liquidator has the powers to recover funds from certain voidable transactions, including unfair preference payments.

An unfair preference refers to a transaction where a creditor receives payment or other assets in the following circumstances:

  1. whilst the company was insolvent;
  2. the creditor suspected or ought to have suspected the company was insolvent;
  3. the creditor’s claim is unsecured; and
  4. the payment results in the creditor receiving a higher payment against her claim compared to the dividend they would have received if the payment had been retained and added to the company’s assets.

The Corporations Act 2001 (the Act) allows liquidators to unwind and recover such payments.

Unfair preferences commonly arise where a creditor is able to exert significant pressure, compared to other creditors, in retrieving amounts owed to them. They are the loud squeaky wheel. If the creditor is an unrelated party, the payment or payments will be recoverable if they occurred within the 6 month period leading up to the relevant date, which is usually the commencement of the liquidation. If the creditor is a related party, the 6-month timeframe increases to 4 years.

Recovering an unfair preference
Recovering an unfair preference generally begins with the liquidator writing to the creditor in question. In the letter, the liquidator outlines the reasons why he believes the creditor received an unfair preference, details the amount of the preference, and requests repayment. A liquidator may commence Court proceedings to recover an unfair preference should a request for payment be ignored or negotiations to settle are unproductive.

Proving an unfair preference
The following elements, explained in further detail below, are to be proven in an unfair preference claim:

  • a transaction was entered into (usually a payment of monies);
  • the transaction was between the company (or a party on behalf of the company) and a creditor of the company;
  • it happened when the company was insolvent;
  • it happened within the statutory period (usually 6 months, 4 years if the creditor is a related party) before the liquidation started;
  • the transaction gave the creditor an advantage over other creditors;
  • the creditor suspected, or ought to have suspected, that the company was insolvent;
  • the debt is an unsecured debt; and
  • in a continuing business relationship, the payment results in a reduction in the amount owed.

A transaction was entered into
There must be a transaction involving the company and the creditor. Commonly, a transaction is a payment from a company’s bank account, although any asset passing from a company to a creditor is enough to establish a transaction.

For example, the return of stock that is not subject to the Personal Property Securities Act 2009 (PPSA), or assignment of debt could qualify as an unfair preference.

The transaction was between the company and a creditor
The transfer of property or cash payment must have been done at the company’s direction and that transaction must satisfy a debt that was due and payable at the time.

Where a supplier supplies goods on COD (cash on delivery) or cash before delivery plus a payment towards an existing debt, the paying down of the existing debt is deemed preferential and is therefore recoverable by a liquidator. However, the COD or cash before the delivery portion is not preferential.

An advance payment for future works, or the future supply of goods, is not preferential because there is no debtor/creditor relationship. The advance payment, however, would need to be repaid if the services/products have not been used by the company.

It happened within the statutory period before the liquidation started
The transaction must have occurred during a specific period before the ‘relation back-day’, being:

  • 6 months for non-related parties; and
  • 4 years for related parties.

The relation-back day is the date that the liquidation is deemed to have started or otherwise:

  • for a liquidation that follows a voluntary administration or Deed of Company Arrangement (DOCA), it is the day that the administrator was appointed;
  • for other voluntary liquidations, it is the date of the members meeting that the liquidator was appointed; and
  • for a Court appointment, it is the day that the winding up application was filed in the Court.

It follows that the further the relation back date is, the greater the period of time the liquidator can examine in terms of identifying possible unfair preferences.

The transaction gave the creditor an advantage over other creditors
The creditor must have received more than they would have received if they refunded the monies and proved for that amount in the liquidation process. If the creditor did not receive more by way of the payment than they would have received from a dividend, there is no advantage or preferential treatment.

It happened when the company was insolvent
For a creditor to be party to a preference payment the company must have already been insolvent.

It is up to the liquidator to prove that the company was insolvent at the time that the creditor purportedly received a preference payment.

The creditor suspected, or ought to have suspected, that the company was insolvent
The liquidator reviews whether the creditor received, or may have known of, any information or circumstance that would lead them (or a reasonable person in their position) to suspect that the company was insolvent. It is not necessary to prove the creditor knew, believed, or suspected that the company was insolvent.

If the liquidator is unable to do so, but can instead show that a reasonable person would have suspected, that will be enough to prove the claim. Events typically giving rise to a creditor suspecting a customer was insolvent include:

  • dishonoured cheques;
  • requesting payment agreements;
  • knowing of other creditors that are unpaid;
  • pressing for payment; and
  • issuing legal demands.

Debt must be unsecured
A preference has not occurred if the creditor holds a valid and existing security interest over company assets pursuant to the PPSA, and the value of the assets secured is greater than the payment amount. However, if the security interest is not properly created or registered, the liquidator may decide the security interest is invalid and the corresponding claim is unsecured.

In that case, the payment would be an unfair preference. Similarly, if the value of the security is less than the payment amount, the excess would be an unfair preference. A debt associated with a security interest over circulating assets (cash, debtors and stock) created during the six month period before the beginning of the liquidation is also treated as unsecured.

Defending an unfair preference claim
Section 588FG of the Act provides defences that may be available to creditors who received preferential payments. To rely on a defence, a creditor must satisfy all three conditions of the defence. The onus of proving the defence is on the creditor; it is not for the liquidator to initially disprove them.

The three conditions of the statutory defence are:

  1. the creditor gave valuable consideration for the payment i.e. they have given something of value in consideration for receiving the payment;
  2. the creditor received the payment in good faith – i.e the creditor acted under normal trading conditions. Examples that may indicate no good faith include: commencing legal proceedings or issuing statutory notices; ceasing supply; changing to cash on delivery terms, or forcing payment by any form of threat or action; and
  3. the creditor had no reason to suspect the insolvency of the company – commented on above at “The creditor suspected, or ought to have suspected, that the company was insolvent.”

Running balance defence
The ‘running balance defence’ refers to a continuing business relationship between a company and a creditor and usually applies when there is a number of transactions between the two parties in the ordinary course of business – i.e. the balance of the account fluctuates with invoices received and payments made.

The liquidator should take into account all transactions that occurred between relevant dates and whether the owed debt increased or decreased to the creditor during that period.

If the balance owing decreased, this amount is the potential preference amount, with all other factors being considered. If the balance owing increased, there is no preference as the creditor is actually disadvantaged by the transactions, in total. The liquidator determines the start date of the review and concludes on the date the winding-up commenced.

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