Unfair Preference Claims in Liquidation – A Basic Guide for Creditors

JHK Legal is quite often approached to provide advice on unfair preference claims in liquidation.

An unfair preference is precisely as the name describes – payments or transfers of assets that give a creditor an advantage over other creditors. Liquidators appointed to companies can recover such unfair preferences to distribute equally among the creditors.

While usually money, unfair preferences can include a variety of transactions. This article will focus on money.

This article is a guide to the basic elements of an unfair preference and defences that can be relied upon. It is not a substitute for legal advice. If you have any questions or concerns we suggest that you contact JHK Legal for further information.

Elements of an unfair preference payment claim

The elements of an unfair preference claim are as follows:

1. The transaction was entered into between creditor and company;

2. The transaction entered into within the statutory period before the relation back day:

(a) 6 months for non-related parties; or

(b) 4 years for related parties; or

(c) 10 years for any evidence of “attempt to defeat, delay or interfere” with the rights of creditors.

3. The debt the subject of the transaction must be unsecured.

4. The company was insolvent at the time of the transaction of became insolvent as a result of entering into the transaction;

5. The creditor received a better return than it would otherwise.

Legislative basis

The legislative basis for unfair preference payments in the liquidation of a company is the Corporations Act 2001 (Cth) (“the Act”). There is no independent common law basis and no state legislation directly on point.

The relevant sections of the Act are as follows:

Also describing in more detail a number of elements referred to above:

Defences

Section 588FG of the Act provides defences that may be relied upon by creditors when faced with an unfair preference claim from a liquidator. On the assumption that the creditor was a party to the transactions (see section 588FG(1) of the Act if it was not), the three elements that must be satisfied are:

1. the creditor became a party to the transaction in good faith; and

2. at the time when the creditor became such a party

(a) the creditor had no reasonable grounds for suspecting that he company was insolvent at that time or would become insolvent; and

(b) a reasonable creditor in the creditor’s circumstances would have had no such grounds for so suspecting; and

3. the creditor provided valuable consideration under the transaction or has changed his, her or its position in reliance on the transaction.

The so called “running account” defence should also be remembered as found in section 588FA(3) of the Act. Note that this does not provide a complete defence to a claim. In essence, where parties have an ongoing business relationship rather than considering each transaction to determine whether a creditor has received a preference the Court looks at the net position of all of the transactions which formed part of the relationship as if they were one transaction. The Court will consider the difference between the “peak” (maximum) amount of the debt during the relevant statutory period, and the amount owed on the Relation-Back Date.

Case law – third party payments

It is important to note that even if a payment is made by a third party on behalf of the company that is in liquidation, this does not necessarily mean that there has been no preference payment made.

As was found in Re Emanuel (No 14) Pty Ltd: Macks v Blacklaw & Shadfroth Pty Ltd (1997) 147 ALR 281 (“Emanuel”), a liquidator has a right to recover payments made to creditors on behalf of the company by a third party where the net effect of the transaction is either crease or extinguish debt between the third party and the company.

This was expanded in Kassem and Secatore v Commissioner of Taxation [2012] FCAFC 124 where there was no evidence that the third party payer owed a debt to company that was satisfied or reduced by the third party’s payer’s payment to the company’s creditor (akin to that in Emanuel). Instead, the third payer’s payment simply resulted in the creation of a new debt, from the third party payer to the company.

The Full Court of the Federal Court of Australia determined that company’s direction to the third party payer to pay the company’s debt was no different than if company had directed its bank to pay the creditor using funds available from the company’s overdraft account. The Court stated:

“this was a clear example of a lender paying moneys advanced to a creditor of the borrower in accordance with the borrower’s directions…

…Moreover, even if it is not correct to describe the transaction between Mortlake and Antqip as a loan, what is important is the finding that the payment by Antqip to the Commissioner was a payment that was made by or on behalf of Mortlake. So much is plain from the evidence to which we were taken..”

In effect, the challenged payments were made directly from the company to the creditor (using funds borrowed from the third party payer).

It can be drawn from the above two cases that unsecured creditors will not gain any protection from future unfair preference claims by demanding payment from third parties unless the third party pays by way of a gift or other “white knight” arrangement under which any rights created in favour of the third party are subordinated to the company’s other unsecured creditors.

What to watch out for

Unfair preference claims can seem quite technical. With that in mind, creditors should consider the following indicators that liquidators look out for when determining whether unfair preference payments have been made by a company:

1. payment arrangement and/or instalment plans made outside normal trading terms;

2. lump sum or round numbered payments not connected to a particular supply invoice;

3. payments made after legal proceedings have commenced by a creditor; and

4. payment that are only made after a threat to stop supply or supply has stopped;

amongst other items.

If a company you deal with has gone into liquidation, you have received a demand from a liquidator for the repayment of money, and any of the above items ring true, JHK Legal are happy to assist you through the process.

Author: Alicia Auden, Senior Associate

Published: November 2015