Insolvency Lawyers NSW

Unfair Preferences

A Liquidator may seek to recover (claw back) payments made or to void a transaction entered into by a company with a creditor as an unfair preference under the provisions of the Corporations Act 2001. Similar legislation exists for trustees in bankruptcy.

To establish that a creditor has received an unfair preference, the Liquidator must show:

  1. A transaction was entered into between the company and one of its creditors;
  2. The transaction resulted in the creditor receiving more from the company than it would have received if it proved for the debt in the liquidation;
  3. The company was insolvent at the time of the or as a result of the transaction; and
  4. The transaction was entered into during the period of six (6) months ending on the relation-back day.

Did the creditor receive a preference?

The creditor must receive more from the company than it would have received if it proved for the debt in the liquidation. This is commonly proved by comparing the return to creditors with and without the subject payment being recovered.

Was the company insolvent at the time?

The company must have either been insolvent at the time of the transaction, or became insolvent because of entering into the transaction.

Transaction must involve a creditor

The transaction must involve one of the company’s creditors. Transfers to parties that are not creditors may be voided under other provisions of the Act.

The timing of the transaction

The transaction involving a non-related creditor must have been entered into during the period of six (6) months ending on the relation back day. If the recipient is related to the company the period is extended to four (4) years before the relation-back day and if there is any attempt to delay or defraud creditors the period is extended to 10 years before the relation-back day.

The relation back day is the day on which the liquidation is recognised to have commenced. Essentially, there are three possibilities.

  1. If the Liquidation followed a voluntary administration, then it is the day that on which the administrators were first appointed to the company,
  2. If the Liquidation was by order of a Court, then it is the day on which the application was filed with the Court, and
  3. If the Liquidation is a creditors’ voluntary winding up, then it is the date of the resolution to wind up the company.

An Unsecured debt

The creditor must be an unsecured creditor. An unfair preference cannot be given to a secured creditor so long as the value of the security held is greater than the amount of the debt.

DEFENCES

Continuing Business Relationship

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

  1. A transaction is an integral part of a continuing business relationship between a company and creditor, and
  2. In the course of the relationship the level of the company’s net indebtedness is increased and reduced from time to time, then all the transactions are taken to be a single transaction for the purposes of establishing whether there was an unfair preference.

In plain terms this states that where there is a ‘continuing business relationship’ the amount of the unfair preference will be determined by considering all of the transactions (payments and further supplies) between the company and the creditor between the relevant dates and calculating the net effect of these transactions to determine whether a preference has been received.

The Courts have allowed Liquidators to choose the starting date of the period as the date which best suits them, so long as it falls within the relation back period. The end date is the commencement of the winding up. Therefore, the amount of the preference will usually be the difference between the highest amount owed during the period and the amount owing at the time of the appointment.

Statutory Defence

Section 588FG(2) of the Act states that a Court is not to make an order regarding a voidable transaction if a creditor can prove that:

  1. It became a party to the transaction in good faith,
  2. At the time when it became a party: (a) It had no reasonable grounds for suspecting that the company was insolvent or would become insolvent, and (b) A reasonable person in its circumstances would have had no such grounds for suspecting insolvency, and
  3. It provided valuable consideration under the transaction.

The onus of proving the above defence lies with the creditor and the creditor must establish all three elements to be successful.

The hardest points to prove are that the creditor became a party in good faith and had no suspicion of insolvency.

Good faith and suspicion of insolvency

It is not even necessary that the creditor knew or expected that the company was insolvent to lose the benefit of the defence. It is sufficient if a reasonable person in the circumstances would have had reasonable grounds to suspect insolvency.

It has been held by the Courts that some factual basis for a suspicion must be proven and that this consideration is to be made without applying hindsight.

It is important to note that the fact that a debtor company pays late does not necessarily mean that the creditor should or does suspect insolvency. This was considered by the Court in the often quoted case of Seller & Anor v Offset Alpine Printing Pty Ltd wherein:

  1. The Liquidator relied on the following signs of insolvency:
    (a) poor payment history;
    (b) the age of the debts;
    (c) earlier assurances that they could pay;
    (d) statements that they were in fact having difficulty in making the payments; and
    (e) forceful demands made by the creditor’s solicitors for a guarantee and provision of a statement of solvency.
  2. The creditor relied on the Statutory Defence and stated that even though the creditor’s terms were 30 days, it was not unusual for the company’s accounts to be outstanding for long periods of time, and the company had a habit of not paying until it had itself received payment.
  3. In upholding the Defence, the Court noted that although the matters raised by the Liquidator were relevant, the test to be applied in defending a voidable preference action was one based on the actual circumstances known to those who benefit from the insolvent transactions, which must be examined to see whether a person in those circumstances and with that particular knowledge could have had no reasonable belief as to the insolvency of the company.

If you have any questions about unfair preferences please do not hesitate to contact our Commercial Litigation team.


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