When a company enters liquidation, a liquidator’s role (among other things) is to conduct investigations, realise company assets and distribute the proceeds to the company’s creditors. A liquidator’s investigations will ordinarily include determining whether any payments made by the company immediately prior to winding up constitute ‘unfair preferences’ and can be ‘clawed back’. In this article, we explore briefly the nature of an unfair preference claim as well as how to defend an unfair preference claim.
What is an Unfair Preference Claim?
An unfair preference is a payment made by an insolvent company to a recipient creditor (the creditor), in the 6 months before the company was wound up, [1] where the creditor knew or had reason to suspect that at the time it received the payment, the company was insolvent or would become insolvent.
A claim by a liquidator to recover an unfair preference payment can seem doubly harsh, in that it might be perceived as penalising a creditor who:
- has not received payment in full from a company (now in liquidation); and
- is now required to disgorge what payment it has received, with little to no prospect of recovering payment in part or in full from the company which is now in liquidation.
However, the purpose of the legislation, and the liquidator’s role, is to prevent an insolvent company from preferring one creditor over others, and to ensure that any preferential payments made by the company prior to liquidation are recovered and distributed equally amongst all creditors.
Importantly, not all payments made by an insolvent company prior to liquidation are an unfair preference; there are a number of requirements a liquidator must satisfy to successfully make a claim, and there a number of defences available to companies who receive a demand or claim from aliquidator.
How Can You Defend an Unfair Preference Claim?
For a liquidator to succeed in recovering an unfair preference payment, the following elements must be satisfied:
- there must be a ‘transaction’; [2]
- the company and the creditor must be ‘parties’ to the transaction; [3]
- the transaction must be entered into during the ‘relation back period’; [4] 6 months ending on the ‘relation back day’ (usually the date of the winding up of the company); [5]
- the transaction must confer on the creditor a preference with respect to an ‘unsecured debt’ of the company; [6] and
- it must be an ‘insolvent transaction’; [7] ie. the company was insolvent at the time the transaction was entered into, or the company became insolvent as a consequence of having entered into the transaction. [8]
In addition to having to satisfy the above elements, the Corporations Act 2001 (Cth) provides two statutory ‘defences’ which creditors can rely upon to defend an unfair preference claim:
- good faith defence; and
- running account.
Good faith defence
The most common defence to an unfair preference claim is the ‘good faith defence’. This requires a creditor to establish that:
- it received the payment in good faith; [9]
- it had no reasonable grounds for suspecting the company was insolvent (the first limb) [10] and a reasonable person in the creditor’s circumstances would not have had grounds to suspect that the company was insolvent (the second limb); [11] and
- the creditor provided valuable ‘consideration’ for the payment, or changed their position in reliance on the transaction. [12]
The first part of the test is one of wholly subjective honesty and propriety. [13]
The Courts have at times interpreted the second part of the test in different ways, however most of the cases [14] interpret the test as:
- first limb: a subjective test with an objective element; and
- second limb: an objective test.
The subjective test requires consideration of whether the creditor had ‘reasonable grounds’ for suspecting insolvency, including suspicion and belief, or the existence of facts which are sufficient to induce that state of mind in a reasonable person. [15] This part of the test takes into account creditors’ specific circumstances.
The objective test requires consideration of the facts and matters appreciated by a hypothetical, reasonable person in the creditor’s circumstances. [16] This means the Court will assess what conclusion a reasonable person (the ‘average business person’ [17]) would have reached with the same facts as the creditor, but does not take into account the creditor’s specific skills, training and experience. [18]
Running Account
It is a ‘defence’ to an unfair preference claim if the payment forms part of a series of transactions which are an integral part of a continuing business relationship which does not result in conferring a preference on a creditor. [19] The principle recognises that a creditor who supplies a company on a running account, in circumstances of suspected insolvency, enables the company to continue to trade for the benefit of all creditors. [20]
For example, at the beginning of January, Company A (the debtor) owed Company B (the creditor) the sum of $100,000 for goods supplied. During the next six (6) months (ending on the day Company A was wound up) Company A paid Company B the sum of $50,000 to induce ongoing supply, and purchased goods valued at $100,000 on credit. Company B can rely upon the “running account” defence to defend an unfair preference claim to recover the $50,000 payment. The test as to whether the payment was received as an integral part of an ongoing business relationship is an objective one, determined by reference to the parties’ actual business relationship, although the parties’ intentions can be relevant to that inquiry. [21] The Courts have also identified the following matters to be relevant in determining the existence of a continuing business relationship: [22]
- whether there was a mutual assumption between the company and the creditor as to a continuing business relationship;
- whether the payment was connected with the subsequent provision of goods or services;
- whether the purpose of the payment was to induce the creditor to provide further goods or services, as well as to discharge an existing indebtedness; and
- whether there was an express agreement that one of the purposes of the payment was to permanently reduce the level of the prior debt.
Defending an Unfair Preference Claim: Key Takeaways
If you have received a demand by a liquidator for an unfair preference claim, there are a range of defences which might be available to you. However, the law in this area has undergone significant changes in recent years so we recommend that you seek legal advice from experienced lawyers in this field specific to your circumstances.
If you are owed a sum of money by a debtor company who is experiencing cashflow problems, there are various steps you can take to ensure payment is not the subject of a later claim by a liquidator.
Contact Gear & Co Lawyers
Gear & Co Lawyers has extensive experience assisting liquidators and companies in liquidation to recover unfair preference payments, as well as advising directors of creditor companies in relation to how to defend a claim for an unfair preference.
If you or someone you know receives a demand or claim in respect of an unfair preference payment, contact Chad Gear or Aman Singh on (07) 3209 2547, or at info@gearandco.com.
Copyright © 2024 Gear & Co Lawyers
While attempts have been made to ensure the currency of information contained in this publication, it is not guaranteed. This publication is intended to provide only general information on matters of interest. It is not intended to be comprehensive and does not constitute and must not be relied upon as legal advice. You should seek legal or other professional advice which is specific to your circumstances.
[1] The time from which the 6 months is calculated is referred to as the ‘relation back day’. Although this is usually the day on which the winding up commences, section 91 of the Corporations Act 2001 (Cth) provides 23 separate categories of cases for determining the ‘relation back day’.
[2] Corporations Act 2001 (Cth) s 588FA and s 9.
[3] Corporations Act 2001 (Cth) s 588FA(1)(A).
[4] Corporations Act 2001 (Cth) s 588FE(2)(b).
[5] Corporations Act 2001 (Cth) s 588FEA(4)(c).
[6] Corporations Act 2001 (Cth) s 588FA(1)(b).
[7] Corporations Act 2001 (Cth) s 588FE(2)(a).
[8] Corporations Act 2001 (Cth) s 588FC.
[9] Corporations Act 2001 (Cth) s 588FG(2)(a).
[10] Corporations Act 2001 (Cth) s 588FG(2)(b)(i).
[11] Corporations Act 2001 (Cth) s 588FG(2)(b)(ii).
[12] Corporations Act 2001 (Cth) s 588FG(2)(c).
[13] Re Ermayne Pty Ltd; Sims v Tech Holdings Pty Ltd (t/as Westline Furniture) (1999) 30 ACSR 330.
[14] Sutherland v Eurolinx Pty Ltd (2001) 37 ACSR 477; [2001] NSWSC 230; Whitton v Konemann Australia Pty Ltd (2002) 43 ACSR 436; [2002] NSWSC 1137; Dean-Willcocks v Commonwealth Bank of Australia (2003) 45 ACSR 564; [2003] NSWSC 466; Cussen as liquidator of Akai Pty Ltd (in liq) v FCT (2004) 51 ACSR 530; 22 ACLC 1528; [2004] NSWCA 383; D’Aloia v FCT (2003) 203 ALR 609; 48 ACSR 204; [2003] FCA 1336; Wily v Eastern Elevators Pty Ltd (2003) 45 ACSR 261; [2003] NSWSC 377; Cook’s Construction Pty Ltd v Brown (2004) 49 ACSR 62; [2004] NSWCA 105; Dean-Willcocks (as liquidator of SJP Formwork (NSW) Pty Ltd (in liq)) v Cmr of Taxation (2004) 51 ACSR 353; [2004] NSWSC 1058.
[15] George v Rockett (1990) 170 CLR 104 at 112; 93 ALR 483 at 488.
[16] White & Templeton v ACN 153 152 731 Pty Ltd (in liq) & Anor [2018] WASCA 119.
[17] Cussen as liquidator of Akai Pty Ltd (in liq) v FCT (2004) 51 ACSR 530; 22 ACLC 1528; [2004] NSWCA 383.
[18] Cussen as liquidator of Akai Pty Ltd (in liq) v FCT (2004) 51 ACSR 530; 22 ACLC 1528; [2004] NSWCA 383; White & Templeton v ACN 153 152 731 Pty Ltd (in liq) & Anor [2018] WASCA 119.
[19] Corporations Act 2001 (Cth) s 588FA(3).
[20] Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2 at [70].
[21] Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2.
[22] Badenoch Integrated Logging Pty Ltd v Bryant, Gunns Ltd (in liq) (recs and mgrs apptd) (2021) 284 FCR 590.