In every liquidation, Liquidators seek to identify and recover monies paid to creditors where it can be shown the recipient knew or suspected a Company was insolvent at the time payment was made.

The primary purpose of the law of Unfair Preference Claims is to ensure that no one creditor should receive more than others in terms of a cents in the dollar return from a winding up.

While the intent of the law is to ensure everyone receives their fair share of whatever remains of an insolvent company, the consequence can be a creditor may be punished for their diligent, efficient and persistent approach to business in favour of other creditors who may not have been as industrious.

However, just because your client receives a demand to repay an unfair preference does not mean all is lost. There are effective ways to respond and retain the benefit of the funds collected.

The Law

Section 588FA of the Corporations Act 2001 says a transaction is an unfair preference, given by a company to a creditor, if the Liquidator (who bears the onus of proof) can show:

1. The company and the creditor were parties to the transaction;
2. The transaction results in the creditor receiving, in respect of an unsecured debt, more from the company than it would have received from the company if the transaction were set aside and the creditor were to prove for its debt in the liquidation process;
3. The company was insolvent at the time of the transaction or became insolvent as a result of the transaction; and
4. The transaction was entered into during the 6 month relation back period preceding the winding up (If Liquidation followed Voluntary Administration, the relation back date is the date upon which the administrators were first appointed to the company).

What the Liquidator needs to prove.

To succeed, a Liquidator must be able to demonstrate:

1. The Company was insolvent at the time of the transaction(s); and
2. The creditor knew or ought to have had some knowledge or suspicion the company may have been insolvent and that it could not pay its debts as and when they were due and payable. This is based on an objective or “reasonable person” test.

What the Liquidator looks for.

The Liquidator looks for evidence to prove a creditor knew or ought to have known the company was insolvent at the time of obtaining payment. In this regard, the Liquidator will focus on evidence such as:

• Poor payment history.
• Late payments made well outside of normal trading terms (date of payment -v- the date on the invoice
• Payment arrangements entered into or unilaterally imposed by the creditor.
• Failed payment agreements.
• Dishonoured payments or cheques.
• Threats to cease work or supply.
• Accounts placed on stop credit.
• Other changes to credit terms such as placing the Company on COD plus requiring additional payments to discharging the old debt.
• Seeking a Deed of Acknowledgment or Personal Guarantees before continuing to supply.
• Actual refusal to supply until debt paid.
• Rounded payments not referable to any specific invoice.
• Demands made by the creditor, debt collectors and solicitors.
• Threats to issue a Statutory Demand.
• Issuing a Winding up application.

The Liquidator tries to obtain this evidence from the books of the Company and also a review of all emails and other correspondence from the Company’s IT systems. Often, this information is volunteered to a Liquidator by comments made by the creditor.

Defending an Unfair Preference claim

Firstly, a creditor who receives such a demand should immediately engage a lawyer and avoid any discussion or correspondence with a Liquidator that will (and often does) weaken their position.

A competent lawyer will be aware of the defences available and will draft a response that may result in the creditor retaining all or part of the benefit of the payment obtained by addressing the:

1. Running account defence.
2. Good Faith defence.
3. Set-Off defence.

*Secured creditors (including creditors who hold PPSR) are generally not subject to unfair preference claims.

Running Account Defence

Section 588FA(3) of the Act states that where:

1. A transaction is an integral part of a continuing business relationship (for example, a running account) between a company and creditor, and
2. In the course of the relationship the level of the company’s net indebtedness to the creditor increased and reduced from time to time as a result of a series of transactions;

• Then all the transactions are taken to be a single transaction for the purposes of establishing whether there was an unfair preference.
• In such a ‘continuing business relationship’ while a creditor may have recovered payments totalling say, $50,000 in the 6 month relation back period immediately before liquidation, and at the same time they continued to supply $60,000 in the same period.
• There would be no net reduction from the peak indebtedness, and therefore, no preference would exist.

Good Faith, No Knowledge and Valuable Consideration

Section 588FG(2) of the Act states that a Court shall not make an order for a preference or voidable transaction if the creditor can prove that:

1. The person received no benefit because of the transaction.
2. The person acted in good faith,
3. At the time, when the benefit was received:
4. 1. the person had no reasonable grounds for suspecting that the company was insolvent or would become insolvent, and

(b) A reasonable person in the creditors position would have had no such grounds for suspecting insolvency, and

4. The person provided valuable consideration for the payment.

While a liquidator may assert a preference has been paid, it is up to the creditor who received the payment to prove their defence if a preference is to be avoided.

Set Off – Section 553C

In a recent Federal Court matter, Stone v Melrose Cranes & Rigging Pty Ltd, in the matter of Cardinal Project Services Pty Ltd (in liq) (CPS)(No 2) [2018] FCA 530, where a creditor has no actual notice of facts that would have indicated to a reasonable person in its position that the debtor company was insolvent, they may be able to offset payments received, that may otherwise be preferential, against their outstanding debt remaining unpaid upon liquidation.

For example, where a creditor was owed $100,000 and was paid $40,000 by preference payments, and the creditor has no actual notice of facts that would disclose the company lacked the ability to pay its debts when they fall due, within the meaning of section 95 of the Act, the creditor could set-off its outstanding debt of $60,000 against the $40,000 preference and not have to disgorge any amount to the liquidator.

Certain Industry Standard Practices

It is possible to defend claims for preferential payments on the basis of standard practice in certain industries. For example, in the building industry it is commonplace for payments to be made well outside of the creditors’ normal credit terms.

It is also possible to argue that the debtor and creditor relationship was such that there was a history and an agreement, although unwritten, that payments were often made very late.