In Cant v Mad Brothers Earthmoving Pty Ltd  VSCA 198 the Victorian Supreme Court of Appeal considered the circumstances in which a payment by a third party during the relation back period will amount to an unfair preference and therefore be recoverable as a voidable transaction.
The Court found that a payment by a related company to an unsecured creditor of a company in liquidation will not give rise to an unfair preference unless the assets for distribution among creditors in liquidation are diminished. This is because if the assets for distribution are not diminished, then the payment will not meet the statutory requirement of the payment being 'from the company'.
Summary of Facts
The facts of the case involved four companies:
Eliana Construction and Developing Group (in liquidation) ('Eliana');
Rock Development & Investments ('Rock') (a related company of Eliana);
Nationwide Credit ('Nationwide'); and
Mad Brothers Earthmoving ('MadBrothers').
Eliana and Rock had the same sole director. Eliana incurred a debt of $220,000 to Mad Brothers for earthworks completed at various construction sites.
On 15 September 2016, a settlement agreement was executed under which Eliana agreed to pay Mad Brothers $220,000. On 16 September 2016, Mad Brothers was paid $220,000 from a secured loan facility that Rock had with Nationwide. On 3 November 2016, Eliana entered liquidation.
The liquidator sought to recover the $220,000 paid by Rock to Mad Brothers.
What is required for an unfair preference to arise?
The main issue for determination was whether the payment to Mad Brothers by Rock constituted an unfair preference under section 588FA of the Corporations Act2001 ('Act'), which provides:
'(1) A transaction is an unfair preference given by a company to a creditor of the company if, and only if:
(a) the company and the creditor are parties to the transaction (even if someone else is also a party); and
(b) 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 receive from the company in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in a winding up of the company;
even if the transaction is entered into, is given effect to, or is required to be given effect to, because of an order of an Australian court or a direction by an agency.
… [emphasis added]'
The Court found that:
Eliana, by authorising and ratifying the payment to Mad Brothers, was a party to the transaction for the purposes of subsection 588FA(1)(a); but
the payment was not 'from the company' (being Eliana) which is a necessary element under subsection 588FA(1)(b) for an unfair preference to arise.
The Court's reasons include a detailed consideration of other decisions which address the interpretation of the phrase 'from the company' under the Act, and the similar language of 'by the company' which appeared in the previous legislation.
The Court held that in order for a preference payment to be 'from the company', the receipt of the payment by the creditor must have the effect of diminishing the assets of the company available to creditors.
The Court found that '… the words "from the company" are intended to convey that the payment be made out of moneys or assets to which the company is entitled.' The Court further found that Eliana was not entitled to the money paid used by Rock to pay Mad Brothers because the liquidator did not establish that Rock was indebted to Eliana.
Summary of legal findings
The Court provided the following summary of section 588FA:
‘(a) The words "given by a company" in [the first sentence of] s 588FA(1) do not form part of the definition of an unfair preference. They are descriptive of the position when the elements of the definition in paragraphs (a) and (b) are met.
(b) A company may be a party to a transaction for the purposes of s 588FA(1)(a) as a result of giving a third party a direction as to the making of a payment to a creditor, or by authorising or ratifying such a payment. However, this does not necessarily mean that the payment is received "from the company".
(c) The words "from the company" in s 588FA(1)(b) have the effect of retaining the requirement under previous law that the preference be received from the company's own money, meaning money or assets to which the company is entitled.
(d) It is necessary, in order for a preference to be "from the company" that the receipt of it by the creditor has the effect of diminishing the assets of the company available to creditors.
(e) On the other hand, a payment by a third party which does not have the effect of diminishing the assets of the company available to creditors is not a payment received "from the company" and is therefore not an unfair preference.'
The Court distilled these relatively simple statements of principle from an extensive analysis of previous authorities regarding unfair preferences and third party payments.
Unfortunately, the apparently straightforward propositions set out by the Court leave a number of questions unanswered in relation to the application of section 588FA.
For example, the decision raises a question about whether a payment by a third party to an existing creditor of an insolvent company, which effectively substitutes an existing debt owed by the company for a new debt owed to the third party, can ever be preferential (even when the existing creditor is receiving a better outcome than it might in a liquidation).
In this regard, the Court (at ) recognised situations which could constitute a preference, but which would not reduce (or could even increase) the net assets available to creditors. However, the Court did not attempt to say more about those hypothetical circumstances in this decision.
The decision is a timely reminder to insolvency professionals that assessing whether a transaction involving a third party amounts to an unfair preference is not straightforward. For creditors seeking payment, and concerned about the possibility of receiving an unfair preference, the decision provides some helpful guidance, but little certainty.
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.