What do you do when a Liquidator Claims you have Received an Unfair Preference

  1. What do you (or your company) do when a liquidator comes knocking and demands to claw back money you’ve received from the company in liquidation?
  2. One of the most common issues our clients face are claims for Unfair Preferences and other types of Voidable Transactions, that is, transactions that liquidators have the power to claw back, pursuant to the Corporations Act 2001.

What is an Unfair Preference Payment?

  1. Unfair preferences are governed by section 588FA of the Act.
  2. In short, an unfair preference is a transaction that is entered into by an insolvent company (or a company that is about to become insolvent, i.e. by entering into the transaction) which allows the creditor of the company to receive a benefit from the transaction as a priority over other creditors.
  3. These are transactions that liquidators will try to recover because the benefit of those transactions should become part of the assets to be distributed to the company’s unsecured creditors in the winding up of the company.
  4. The first element the liquidator needs to establish to prove an unfair preference, is that a “transaction” existed, within the definition of that term in section 9 of the Act.
  5. The most common forms of unfair preference transactions are payments of money or transfers of assets where the company and the creditor are both parties, however, occasionally they also involve other parties to the transaction.
  6. For a transaction or payment to be an unfair preference it must:
    • Be an insolvent transaction, pursuant to section 588FC of the Act, in that the company must be insolvent at the time of the transaction; and
    • Be made by the company to a creditor during the relation back period, that is the 6 month period prior to the relation back day (or 4 years prior to the relation back day if the creditor is a related entity); and
    • Result in the creditor receiving more than would have received in winding up of the company, i.e. if the creditor proved for its debt in the company’s liquidation;
  7. This applies even if the transactions are entered into because of a Court order, i.e. the payment of a judgment debt owed by the company in liquidation.
  8. It is in those circumstances that liquidators will often seek to set aside the transaction and require the creditor to prove for its debt in the company’s winding up.

Relation Back Day

  1. Incorrectly determining the relation back day is a pitfall to which many of our clients fall victim when attempting to oppose an unfair preference claim without first seeking professional advice. This is particularly so after the amendments to section 91 of the Insolvency Law Reform Act 2016.
  2. The relation back day is, in the case of a:
    • Creditors voluntary liquidation (CVL), the date the liquidator is appointed;
    • Court-appointed liquidation, the date the winding up application was filed with the Court; and
    • Company in administration prior to liquidation, the date its administrator was appointed.

Defending an Unfair Preference Claim

  1. The liquidator has the burden of proof in proving the elements of the unfair preference claim, including proving the company was insolvent at the time of the transaction.
  2. As a creditor, there are a number of potential defences available to you if you or your company are on the receiving end of an unfair preference claim, in defending the claim and otherwise trying to negotiate a commercial outcome.

Secured Debt

  1. The first thing you should do is check if the unfair preference transaction being alleged by the liquidator was for a secured debt (such as debts secured by mortgage or security interest over the company’s property). In that case, a transaction will not be an unfair preference.

Good Faith Defence

  1. As mentioned above, a liquidator needs to prove that the company was insolvent at the time the transaction. That being said, if you are able to show that you had no reasonable grounds to suspect that the company was insolvent at the time of the transaction, and that you entered into the transaction in good faith, you may be entitled to retain the benefit of the transaction.
  2. In deciding whether you knew that the company was insolvent at the time of the transaction (or would become insolvent because of the transaction), a Court will consider whether a reasonable person in your circumstances would have suspected that the company was insolvent.
  3. This means that a Court will likely examine your commercial history with the company, including whether the company had a prior tendency to make payments later than credit terms allowed, or making sporadic payments in lump sums, which cannot be attributed to specific invoices.

Running Account Balance

  1. If payments you received by the company in liquidation were recorded on a running account statement and monies owed by the company were paid on account without differentiating between past and future goods supplied, the Running Account Principle may apply.
  2. The Running Account Principle only applies where you and the company in liquidation had a continuous business relationship which would allow individual transactions to be considered as a whole when determining the unfair preference.
  3. The Running Account Principle is less a defence and more an alternative cause of action open to a liquidator when calculating the preference amount, meaning the preference amount would be calculated on the “peak indebtedness” of the company to you during the relevant period compared with the final amount, if any, owing.
  4. You can potentially use the Running Account Principle to reduce the calculation of the preference amount, thus reducing your exposure to the liquidator’s claim.
  5. Invoking the Running Account Principle requires a careful analysis of the historical payment circumstances and your business relationship with the company in liquidation, preferably with professional assistance.

Set-Off – No Longer

  1. Prior to 2021 you might have been able to set off mutual credits, debts and transactions between you and the insolvent company, pursuant section 553C of the Act, if you could demonstrate that payments were received in good faith. This would have had the effect of reducing the amount of the unfair preference.
  2. However, as a result of the High Court’s decision in Gavin Morton As Liquidator Of MJ Woodman Electrical Contractors Pty Ltd (In Liquidation) & Anor v Metal Manufacturers Pty Limited (MJ Woodman) [2021] FCAFC 228, creditors who receive an unfair preference can no longer rely on the set off defence to reduce the amount it must pay to the liquidator in respect of the preference.
  3. If you or your company are a creditor, and find yourself facing a claim for unfair preferences by a liquidator, feel free to contact PGC Legal and we would be happy to provide you with some advice about the options that are open to you in either defending an unfair preference claim, or trying to negotiate a more favourable outcome with the liquidator.
  4. PGC Legal has a number of insolvency experts, with experience in dealing with unfair preferences and we are always happy to help in any way that benefits our clients.
  5. Whether you need some initial advice on how to tackle your situation, or if you need experienced legal representatives to act for you in Court proceedings against a liquidator, our solicitors have decades of combined experience and proven favourable outcomes for our clients.

Please contact Peter Charatsis, Brenton Priestley or Jonathan Khoury for more information.