Unfair Preferences: the recent shield given to directors against personal liability for insolvent trading may not protect creditors from clawbacks

Unfair preference overdue invoice letter
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The Coronavirus Economic Response Package Omnibus Act 2020 (Cth) may protect directors from personal liability for trading a company insolvently for the next six months, but it does not extend protection to unsecured creditors from unfair preference claims for transactions in this period.

This may mean that an unsecured creditor (such as a supplier of goods or services) who receives payment from an insolvent company in this period in which directors are protected, may have to pay that money back.

What is an unfair preference?

The law relating to unfair preferences is designed to prevent unsecured creditors having an unfair advantage over other creditors by receiving a payment which is higher than it would otherwise receive in a distribution through a liquidation.

A transaction which is an unfair preference is one where:

  1. the company and the unsecured creditor are parties to the transaction; and
  2. the transaction occurred whilst the company was insolvent, or the company became insolvent as a result of the transaction; and
  3. the transaction resulted in the unsecured creditor receiving more than it would have received in a distribution to unsecured creditors in a liquidation.

An unfair preference may be a voidable transaction, which may mean the money has to be paid back to the company.

What is an insolvent company?

Under the Corporations Act 2001 (Cth) (Corporations Act), a company is an insolvent company if it is not solvent, in other words if the company cannot pay all its debt as and when they fall due.

See: https://www.blackwattlelegal.com.au/shadow-director-insolvency/

Who are unsecured creditors?

An unsecured creditor is an individual or an entity that is owed money by a company and does not have a secured interest in respect of its debt. Unsecured creditors may include suppliers and retail customers however they do not include financial institutions or other persons that have collateral against an asset of the debtor company in respect of the particular debt in question.

What is a voidable transaction? 

In the context of unfair preferences, a transaction is a voidable transaction where:

  1. under the transaction, the company (debtor) transferred money or other property or some other benefit from the assets of the company to a third party;
  2. the transaction occurred at a time that the company was insolvent, or the company became insolvent as a result of the transaction; and
  3. the transaction was entered into during the 6-month period prior to the ‘relation-back day’ or after that day but before the day when the winding-up began.

Determining the relation-back day, and therefore understanding the period in which a transaction could be classified an unfair preference is complex. Section 91 of the Corporations Act identifies 15 scenarios to be considered in determining the relation-back day. There are a number of factors which need to be considered, such as (but not limited to) whether the company was subject to voluntary administration before a winding-up application was made, whether the liquidation of the company was the result of a Court ordered or voluntary resolution or whether the company is or has been the subject of a deed of company arrangement (DOCA).

Commonly, the relation-back day is:

  1. for a creditors’ voluntary liquidation, the date of liquidation
  2. if the company was in administration, the date the administrators were appointed
  3. in a Court appointed liquidation, the date the winding-up application was filed

What is the effect of a voidable transaction?

Among other remedies, the liquidator may be able to obtain a Court order directing the unsecured creditor to:

  1. pay the money (or money equivalent of the property) back to the company
  2. transfer the property received under the transaction back to the company
  3. pay the company an amount that fairly represents some or all of the benefit the unsecured creditor received as a result of the transaction

What defences can an unsecured creditor rely on?

There are several defences unsecured creditors should consider. Whether a defence is available will depend on the facts of each case. The defences include:

  • demonstrating that the debt was secured, rather than unsecured. For example, by pointing to a PPSA security interest
  • Good faith. That is:
    1. the defendant to an unfair preference claim received no benefit because of the transaction; or
    2. the person received the benefit in good faith, and at the time of receiving the benefit, the person:
      1. had no reasonable grounds for suspecting that the company was insolvent or would become insolvent at the time of the transaction, and
      2. a reasonable person in the person’s circumstances would have had no such grounds for so suspecting.

In considering whether there was a suspicion of insolvency, the Court will look closely at the evidence. Evidence which might lead a Court to determine there were reasonable grounds for suspecting insolvency include:

    • an uncharacteristic delay in the company paying the invoice in question
    • the company asking for more time to pay the invoice
    • an email from the company indicating that it is having cash-flow difficulties
    • Running Account. A creditor may rely on the ‘running account’ principle (which is not strictly speaking a defence). Under a running account defence, where the company and the unsecured creditor had a continuing business relationship which the transaction was an integral part of, and the indebtedness of the company to that unsecured creditor is increased and reduced from time to time, the Court may have regard to the net effect of all transactions in the relevant period, rather than the effect of an individual transaction. This defence is not a complete defence which means it may not result in the entire reduction a claim, however it may operate to reduce the amount a liquidator can claim.

Comment

In the current COVID-19 environment, it will be interesting to see how a Court would assess the question of suspicion given the Big 4 banks’ positive financial hardship response, landlord subsidies and Government stimulus packages.

Where a supplier who is owed money but continues to supply the debtor with the goods or services but now on a cash on delivery basis, if the supplier receives payment for outstanding invoices during the debtor’s insolvency, liquidators will no doubt argue that the move to a cash on delivery term demonstrates the supplier’s suspicion of insolvency.

Notwithstanding the new and temporary shield afforded to company directors against personal claims for insolvent trading, in the months ahead, liquidators may continue to investigate whether any transactions amount to voidable unfair preferences even though the transaction might have occurred during the period directors were, in effect, allowed to trade their companies insolvently.

If you are an unsecured creditor, and you receive payment from an insolvent company or one that becomes insolvent as a result of the payment to you, beware that this payment could be the subject of an unfair preference claim.

If you are a liquidator considering unfair preference claims, or a creditor who has received a demand for repayment, then as a specialist insolvency and commercial litigation firm we are well placed to advise.

Further information

For more information about unfair preference claims and voidable transactions, please contact:
Trevor Withane: trevor.withane@blackwattlelegal.com.au, tel +61 (0)418 717 001

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