Australia: Unfair preference claims and the importance of preliminary investigations

In the matter of Pacific Steelfixing Pty Ltd [2021] NSWSC 655

Liquidators pursue "unfair preference claims" routinely in a liquidation and some of those claims are stronger than others. Many liquidators perceive unfair preference claims against the Deputy Commissioner of Taxation (Commissioner) as relatively easy pickings, given the "running balance account" maintained. However, liquidators should be cautious about litigating without first conducting adequate investigations into the affairs of the company and should always consider the utilisation of insolvency specialists when it comes to the pursuit of claims in a liquidation scenario. What may appear to be a straightforward claim for a liquidator could have a disastrous outcome for the creditors of the company (and the liquidator) if not pursued through the lens of insolvency expertise.

In In the matter of Pacific Steelfixing Pty Ltd, the liquidator of Pacific Steelfixing Pty Ltd (In Liq) (Company) sought to recover 19 payments totalling $740,000 (Payments) made to the Commissioner on the basis that the payments were unfair preference payments (section 588FA of the Corporations Act 2001 (Cth) (Act), insolvent transactions (section 588FC of the Act) and therefore voidable transactions (section 588FE of the Act).

There was no dispute about whether the Payments were transactions¹ between the Company and the Commissioner during the relation-back period.² The primary issues for determination by the Court in this case (and which the Liquidator was required to prove) were:

• Did the Commissioner receive a preference over other unsecured creditors – that is, did the payments result in the Commissioner receiving more than they would have if the payments were set aside and the Commissioner were required to prove for the amount as an unsecured debt in the liquidation of the Company?
• Was the Company insolvent at the time that each of the Payments were made?

Background

The Company was in the business of providing labour hire services in the construction and steel fixing industry. MJCR Group Pty Ltd (MJCR) was the sole customer of the Company. The Company was wound up by order of the Federal Court of Australia a mere 16 months after its incorporation.

The liquidator's investigations into the financial affairs of the Company revealed that:

• the only assets were cash at bank of around $8,178 and receivables owed to the Company by MJCR under a Deed of Settlement and Release (Deed) in an amount which was "to be confirmed";
• it had 5 unsecured creditors totalling over $2.6 million and no secured creditors; and
• the Commissioner was the largest creditor of the Company, having lodged a proof of debt for over $2.2 million.

The liquidator issued several requests for books and records to various entities, including the Company's accountant, seeking production of the financial records of the Company and to MJCR seeking a copy of the Deed.

The liquidator received limited financial records from the accountant in answer to the request, which included invoices raised by the Company to MJCR for approximately $11.75 million (incl GST) in respect of labour hire services between 28 September 2017 and 26 November 2018. However, the Deed was not provided or produced to the liquidator.

As the liquidator was unfunded, he elected to instigate proceedings to recover alleged unfair preference payments from the Commissioner, without first conducting any public examinations into the Company's examinable affairs to consider any other potential claims for relief on behalf of the Company including in respect of any prospective claims against MJCR. The liquidator had made a commercial decision that the public examinations were not required, observed he did not have any funding to conduct them but also did not have any evidence of meetings consulting creditors of the Company in respect of prospective funding or requests to litigation funders in evidence before the Court.³

At the time of commencing the proceedings against the Commissioner, the Liquidator tried to rely upon a presumption of insolvency pursuant to sections 286 and section 588FE(4) of the Act based on the Company's "failure to maintain books and records". However, importantly, such a presumption is not available when prosecuting an unfair preference claim unless the recipient is a related party of the Company.⁴

The liquidator was not apprised of the terms of the Deed involving MJCR until just weeks before the final hearing when a copy of the Deed was produced to the Liquidator in answer to subpoenas issued to MJCR and Mr Gallagher (the controlling mind of the Company).The Liquidator then learnt that the Deed was entered into on the same date as the winding-up order, that the Company had agreed to release its rights in respect of receivables of $4.635 million from MJCR in exchange for payment of $95,000 in circumstances where there was a known relationship between the Company director and the MJCR director

Decision

The liquidator ultimately failed to prove that the Commissioner received a preference as a result of the Payments and the Liquidator's application was dismissed.

Primarily, this was because, at the time of final hearing, the Liquidator had not completed his investigations concerning the Deed, had not obtained any advice or otherwise taken any steps to determine whether (or not) to commence proceedings to have the Deed set aside as an uncommercial transaction to recover the $4.635 million receivables from MJCR being a course of action which he had otherwise reported to creditors that he intended to take. The liquidator conceded in cross-examination that there was nothing stopping him from seeking to recover the $4.635 million.

The Court was not prepared to find that the Commissioner had received a preference as a result of the Payments in circumstances where the extent of the Company's assets and funds available for distribution to creditors in the winding up was uncertain. The Court observed the tension between the conduct of a three day hearing of an unfair preference claim seeking to recover the Payments from the Commission in order to repay 80% of that sum to the Commissioner as the Company's largest unsecured creditor.⁵

The Court also emphasised the "significant potential upside for creditors in gathering information" seeking orders for the Deed under section 68 of the Civil Procedure Act 2005 (NSW) or through public examinations and orders for production in relation to the outstanding amounts owing from MJCR to the Company, which the Liquidator was in a position to estimate based on the Company invoices provided by accountant and the statements for the Company's only bank account. The Court also (unfortunately) observed that there was no evidence that explained the liquidator's decision to apply available funding to the prosecution of the proceedings against the Commissioner rather than a public examination.⁶

Implications

This decision suggests that liquidators should:

• ensure that detailed front-end investigations are undertaken in their appointments, including, a careful analysis of the necessary documents to assess any available claims for the company;
• always assess and document the availability of funding from creditors and litigation funders to pursue investigations and prospective claims;
• undertake appointment work through the lens that their decision-making can be justified and explained to both creditors, stakeholders and the Court (should the need arise);
• ensure that the company's financial position, including prospective recoveries arising from the pursuit of available claims, is readily known and assessed to determine the likely dividend payable to unsecured creditors in a winding up scenario and then interrogate whether the particular creditor (the subject of the alleged unfair preference claim) received more than they would otherwise receive in the winding up of the company; and
• always consider the potential "upside" for creditors in undertaking further investigations particularly through the public examination process.

Footnotes

¹"Transaction" is defined in section 9 of the Act.
² The "Relation-Back Day" and the "Relation-Back Period" is determined with reference to sections 9 and 91 of the Act.
³ In the matter of Pacific Steelfixing Pty Ltd [2021] NSWSC 655 at [77] per Williams J
⁴ Ibid at [56].
⁵ Ibid at [78].
⁶ Ibid at [79].

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.