Australia: Insolvency - avoiding the long reach of an unfair preference payment claim

When the liquidator of a company comes knocking on a creditor's door, it is to echoes of "Queue jumper!" reverberating in the background.

Essentially, one of a liquidator's first tasks when appointed is to identify whether any creditors have been given 'preferential treatment' - that is, whether they have been paid some or all of their debt just prior to the company's liquidation and at the expense of other creditors.

Naturally, as a creditor you would like to keep any payments you have received. However the liquidator has the right to claim back that money if it is deemed to be an 'unfair preference claim' and you are unable raise a defence to such a claim.

So where do you stand as a creditor and how can you avoid a dispute over payments you may have received?

What is an Unfair Preference Claim?

Under the unfair preference payment provisions of the Corporations Act 2001 (Act), a liquidator will look at all of the transactions made by the company in the "relation back period" (six months before the start of the liquidation).

A payment to a creditor may be deemed a 'voidable transaction' (i.e. liable to be set aside) if it was made within that six month period. If that is the case, the creditor may receive a preference payment demand from the liquidator.

The liquidator bears the onus of proving a number of elements in establishing an unfair preference claim. Section 588FA of the Act states that a transaction is an unfair preference if:

  1. the company and the creditor are parties to the transactions (even if someone else is also a party); and
  2. the transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor, more than the creditor would have received from the company in respect of the debt if the transaction was set aside, and the creditor were to prove for the debt in the winding up of the company.

Who is a party to the transaction?

One of the primary criteria when determining unfair preference claims is proving that the company and the creditor were parties to the "transaction". On its face this may appear simple especially where it can be shown, for example, that the company made a direct payment to a creditor in the relation back period. However, life is never simple and all sorts of scenarios can arise.

Section 9 of the Act sets out a wide range of examples of actions that can constitute a 'transaction' by a body corporate (body).

These are:

  1. a conveyance, transfer or other disposition by the body of property of the body and
  2. a security interest granted by the body in its property (including a security interest in the body's PPSA retention of title property); and
  3. a guarantee given by the body; and
  4. a payment made by the body; and
  5. an obligation incurred by the body; and
  6. a release or waiver by the body; and
  7. a loan to the body;
and includes such a transaction that has been completed or given effect to or that has been terminated.

The examples are wide reaching but they are not limited to these. A variety of dealings can give rise to a transaction for the purposes of the unfair preference payment claim provisions.

Further, a company can be a party to the transaction where it instigates, authorises or ratifies the transaction and this has the effect of extinguishing the debt. The totality of the dealings initiated by the company to achieve the ultimate end will mean it may be deemed to be a transaction to which the creditor and company are parties.

Avoiding the octopus reach of the unfair preference claim

A creditor may be able to defend itself against an unfair preference claim that the liquidator has been able to prove if the creditor did not suspect the company was insolvent, and any other reasonable person in its shoes would not have held a suspicion.

However, before getting into this defensive position, consideration should be given to how to avoid falling within the grasp of the unfair preference claim regime in the first instance.

Key actions may include:

  1. requesting money up front for goods or services before supply (to avoid being in a debtor/creditor position at the time of payment);
  2. taking security from the company where the security is equivalent to the amount of payment received (remember the Personal Property Securities Act 1999 (Cth) has opened up opportunities for creditors in this regard);
  3. operating on strictly COD terms;
  4. running accounts for major clients that involve regular payment plans, which may help to mitigate potential losses.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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