‘It’s not personal. It’s just business’.

We have all heard this line before in movies and television shows. Spoken where a relationship has been broken for the purpose of achieving some advantage, usually an economic gain. But for most people (and most of the Australian economy) it is all about business; especially small business.

Statistics show that small businesses (employing 19 people or fewer) make up around 97% of all of Australian businesses.¹ This is not hard to comprehend. Go for a walk through your local shopping centre or business hub. You will find that most of the shop fronts and offices are home to small businesses.

Liquidation

There are numerous pitfalls that arise in the course of running a business. It is essential that companies have ongoing relationships with other businesses to function. The coffee shop down the road doesn’t build coffee machines or make their own cups. They purchase these from other companies.

Companies that manufacture goods and provide services rely on various suppliers to provide materials needed to build their products or provide their services. So when one company hits hard times and can no longer trade, the effects can be far-reaching.

When a company can no longer pay its debts when they are due, it is deemed to be insolvent and must stop trading. A company in these circumstances may appoint an external administrator to oversee the company. In many cases, these companies are found to be unsalvageable and are wound up (placed in liquidation). Creditors of the company can also have the company put into liquidation.

Unfair Preference Claims

Liquidators are appointed to break up the liquidated company’s structure and review its prior conduct. The liquidator’s job is to locate all the liquidated company’s assets and revenue in an effort to repay the creditors. This task includes reviewing payments that may have been made before the liquidator was appointed. If a liquidator is of the view that:

• the liquidated company has made payments to a creditor while the liquidated company was insolvent,
• those payments would have been paid to the creditor from the liquidated assets, and
• those payments occurred within 6 months before the date of filing of the winding up application (called the “relation back period”),

then the liquidator may conclude that the payment (or payments) should not have been made, and may make an unfair preference claim under section 588FA of the Corporations Act 2001 (Cth) (“the Act”) against the creditor.

A transaction is seen to be “unfair”, under section 588FA of the Act, because the funds paid to a creditor (usually another business) should not have been paid. Those funds should be part of the assets held by the liquidated company, because they were paid while the liquidated company was insolvent. The creditor would be seen to have received a greater payment for the debt than they would have received when it was paid by the liquidator.

A practical example would be as follows:

Company A regularly purchases materials from Company B to build trailers. Company B regularly issues invoices to Company A for the material. Company A usually pays on time, but occasionally pays late (this is common in the industry). On 1 July 2019, Company A pays $15,000 to Company B in payment of an invoice given by Company B for supplying materials. As a result of that payment, Company A is no longer in debt to Company B.

On 1 November 2019, Company A is placed into liquidation. The liquidators review the payments leading up to Company A being wound up and discover the payment made on 1 July 2019 to Company B. The liquidators understand that if the payment on 1 July 2019 had not been made, Company B would have been a creditor of Company A and entitled to payment of a portion of the liquidated assets. That payment would (in all likelihood) be less than the $15,000 as Company B was not a secured creditor.

The liquidators send a letter to Company B, stating that the payment of $15,000 on 1 July 2019 was an unfair preference for the purposes of section 588FA of the Act. The liquidator demands repayment of $15,000 from Company B warning of legal action if the amount is not paid.

Defences To An Unfair Preference Claim

If you have received a letter from a liquidator relating to a liquidated company that you have previously had a commercial relationship with, don’t panic. There are defences to an unfair preference claim and we have experience dealing with these matters.

The defences to an unfair preference claim are found in section 588FG of the Act. In summary, they are:

• Being party to a transaction in good faith,
• Having no reasonable grounds to suspect that the liquidated company was insolvent at the time the payments were made, or
• Valuable consideration was provided for the payment.

Good Faith Defence to Unfair Preference Claim

The principle of good faith is a common legal principle applied in various areas of law. Generally it refers to parties who have entered into a relationship with good intentions. The courts will use a subjective test to determine if the parties entered into the transaction in good faith. In other words, the court will look at the transaction through the eyes of the party who received the payment. In most cases, the ongoing relationship between the parties is evidence that the parties entered into the transaction in good faith.

Suspicion Of Insolvency Defence to Unfair Preference Claim

Suspicion of insolvency is a significant part of defending an unfair preference claim. It is often the issue that is laboured the most by the parties. The liquidators bear the onus to prove that a creditor who received payment/s suspected, or should have suspected, that the liquidated company was insolvent at the time of the payment.

This can be difficult for the liquidators to prove. That makes it a good avenue to explore when defending an unfair preference claim. The court will consider numerous factors when deciding if a party had, or should have had, suspicion of insolvency. Those factors include:

Whether there were recurring late payments by the liquidated company;

• Previous payment arrangements with the liquidated company,
• Actions taken to recover the debt,
• The size of the debt,
• The contractual terms between the parties,
• Payment history, and
• Common industry standards.

Although some of the above may be clear, it still may not be enough to show that the creditor suspected, or should have suspected, insolvency. A lot of industries function on late payments and debt disputes. For example, the building and construction industry is rife with late payments.

Justice Brereton of the NSW Supreme Court remarked that late payments are not of themselves an indication that a creditor should suspect insolvency.² The case before Brereton J involved a liquidated company in the construction industry. Brereton J referred to a number of issues that need to be considered when looking at late payments as a reason to suspect insolvency, including the time of year (Christmas) and industry standards.³

The court may also decide (in relevant circumstances) that demands for payment do not equate to a suspicion of insolvency. In some cases, the courts have found that aggressive threats and demands for payment are not indicative of suspecting insolvency, but are instead typical approaches by certain people in certain industries.4

This element of the defence is one that will need to be considered on the facts of each matter individually.

Valuable Consideration For The Payment

In layman’s terms, this refers to something that is given (usually under a contract) in exchange for something else. The common example is goods exchanged for money. Generally, this is not a difficult element to prove. Most businesses can provide evidence that they have supplied something associated with the debt of the liquidated company.

How We Can Help

Contact our expert Commercial Lawyers if you have received a demand from a liquidator relating to an unfair preference claim.

Our team of lawyers are experts in their field and go above-and-beyond to deliver the best result, each and every time.

Contact Us

Received an unfair preference claim? Get the best representation. Call us on 1800 999 529, email mail@rmold.newwebsite.live or submit an enquiry below.

We are available to meet with you at any of our local offices (Brisbane, Gold Coast, Beenleigh, Cleveland and Jimboomba) or by telephone or video-conference.

References

1 Australian Government, “Small Business Courts: Small Business in the Australian Economy” (2016) 8.
2 In the matter of Heavy Plant Leasing Pty Ltd (In Liquidation) (ACN 151 786 677) [2018] NSWSC 707, [65] – [68].
3 Ibid, [67] – [68].
4 White & Templeton v ACN 153 152 731 Pty Ltd (in liq) [20017] WASC 52, [63].

This article is for your information and interest only. It is not intended to be comprehensive, and it does not constitute and must not be relied on as legal advice. You must seek specific advice tailored to your circumstances.

This article was originally posted on the31st of March 2020. It was last updated on the 12^th of October 2022.