Six months ago, your business supplied top quality goods and services to one of your better corporate clients. Five months ago, you respectfully sought payment. This resulted in a couple of months during which your client explained that “the cheque was in the mail”, followed by “cash-flow difficulties” and similar excuses. Throughout this period you obliged this client because it had always paid on time before and was a good client. You received payment in dribs and drabs over the next month but, the fact remains, the client has finally paid and you are still on good terms. When it goes into liquidation you receive a letter from a liquidator demanding payment to him of that hard-earned, hardfought cash. Is he kidding...? Unfortunately not.
The Corporations Act 2001 provides that, in the event of a company being wound up, the liquidator is able to claw-back payments made by the insolvent company to creditors within certain time frames and in certain circumstances.
The Queensland Court of Appeal recently reiterated some of the applicable principles in Sheldrake and Anor v Paltoglou  QCA 52 (3 March 2006). Briefly, a company, Going Bananas Restaurant (Qld) Pty Ltd, operated a restaurant business at Port Douglas. The individual shareholders of the company were the lessees of the premises from which the business was operated. One of those shareholders was the sole director of the company.
Prior to 1 March 2002, the company sometimes paid rent and other expenses which were actually owed by the individual shareholders. After 1 March 2002, a substantial debt was accrued by those shareholders on account of unpaid rental, resulting in negotiations between the individual lessees and the lessor, Ms Paltoglou. Paltoglou believed that the individual lessees also owned the business.
The company then entered into a contract to sell the business. Paltoglou now became aware that the business was owned by a company. She entered into an arrangement with the company to grant it a lease backdated to 1 March 2002 to coincide with the arrears of rent and agreed to assign the lease to the purchaser of the business, on the basis that she would be paid out most of the arrears from the sale proceeds. The company also advised her that it would “pay off [its] outstanding trade accounts” from the sale proceeds. In fact, the sale would leave only about $30,000 for the company to pay out $100,000 owing to trade creditors and $300,000 owing to the Australian Taxation Office (although Paltoglou was unaware of this).
The company subsequently went into liquidation. The liquidator commenced proceedings in the District Court seeking to claw-back from Paltoglou both pre- and post- 1 March payments. The District Court held that those payments made by the company on behalf of the individual shareholders prior to 1 March 2002 resulted in no benefit to the company and, therefore, were uncommercial transactions under the Corporations Act. Paltoglou was ordered to pay those amounts back to the liquidator (her only remedy being to then prove in the winding up of the company).
In respect of the arrears of rent paid for the period after 1 March 2002, the District Court held that Paltoglou did not have to repay those amounts as she did not suspect, and no reasonable person in her circumstances would have suspected, that the company was insolvent when it made those payments.
The Court of Appeal disagreed, commenting that Paltoglou simply turned a blind eye to the evidence. It held that Paltoglou (even though not aware for a time that the shareholders did not also carry on the restaurant business) was aware that the lessees were in financial difficulty and that a notice to quit had previously been served. She was aware that one of the shareholders had actively been seeking a business partner to inject a large sum of capital into the business and in the days prior to the sale she became aware that the sale of the company’s only income-earning asset represented her best chance of repayment and that the company’s income itself was insufficient. She conceded that she had no reason to believe that the company would be in any better financial position than its shareholders (which she knew were experiencing financial difficulties).
Paltoglou was ordered to pay to the liquidator those contentious amounts she had received from the company, together with costs of the Court action.
The above is not intended to provide a guide to the legislation, which is both complicated and the subject of a voluminous amount of case law. The lesson is to ensure that a balance is struck between good client relations and debt recovery practices, and not allowing debtors to get out of hand. If a similar situation develops, seek appropriate legal advice – there are ways to legitimately minimise the risk of a claw-back by a liquidator. One point worth noting is that the onus is still on a liquidator to prove that he or she is entitled to claw-back the payment. If you can obtain payment, do so - a bird in the hand is worth two in the bush.