Not many people know that they could also be on the hook if one of their customers goes into liquidation. Liquidators have broad powers to recover payments made by companies under liquidation to their suppliers. The most common way liquidators may seek to recover money from a supplier is by claiming the payment is an “unfair preference payment”.
What is an unfair preference payment?
When a company is in liquidation the Corporations Act 2001 allows a Liquidator to try to claw back payments made to a creditor by a company as an unfair preference payment. Trustees may also seek to recover preference payments in bankruptcy. These clawback attempts are referred to as an ‘unfair preference claim’. A ‘preference’ payment is one that is made where the creditor has received a greater payment than they would have received by proving their debt in the liquidation process.
The creditor must be an unsecured creditor for an unfair preference payment to have occurred. In order to claw back payments the transaction must have been entered into by the company and a creditor, the transaction caused the creditor to receive more than they would have in the liquidation process, the company was insolvent at the time or due to the transaction and there is a time frame of six months immediately prior. If the creditor was related to the company then this time frame is extended to four years and if there was fraudulent activity the time frame can be up to ten years. A unfair preference claim can be brought by the liquidator at any time up until three and a half years after the date of the transaction.
Continuing Business Relationship
The Corporations Act 2001 at section 588FA(3) provides that if the transaction was a part of a continuing business relationship and that in the usual course of the business relationship the debt increased and decreased from time to time then the net effect of the transactions between the relevant dates will be considered to decide if a preference payment was made.
How can a creditor defend a preference payment allegation?
Statutory “Good Faith” Defence
A statutory defence to a preference payment is provided in section 588FG(2) of the Corporations Act. If the creditor who is accused of receiving a preference payment can prove the following elements then the creditor will not be found to have received a preference payment. The creditor has the onus of proof in this instance.
1. The creditor was a party to the transaction in good faith;
2. When the transaction occurred the creditor had no reasonable grounds for suspecting the company’s insolvency or potential insolvency and a reasonable person would not have suspected the insolvency; and
3. Valuable consideration was provided by the creditor to the company as a part of the transaction.
A company’s late payment does not of itself indicate that the creditor should have or did suspect insolvency. See Seller & Anor v Offset Alpine Printing Pty Ltd.
Very commonly a ‘good faith’ defence will be used by a creditor attempting to defend a preference payment claim. A creditor should be very cautious about entering into a transaction with a company where they suspect the company may be insolvent or potentially insolvent.
The running account defence is not a total defence to a preference payment claim, however can minimise the amount a liquidator is able to claw back from a creditor. If there are numerous transactions between the creditor and company in the six month time frame then the amount assessed as the preference is the difference between the highest amount owed in the six months and the amount owed on the date of the relation-back not the total amount of all payments made in the six months.
How can a creditor minimise their risk of unfair preference claims?
It is far more simple to avoid an unfair preference claim than to defend one. If a creditor thinks that a company they provide credit to is struggling financially then they must take steps to minimise risks that a liquidator will seek to claw back the transaction later.
– Get security before credit is extended to the company such as a registered charge over company property. Registering a legitimate Purchase Money Security Interest on the Personal Property Securities Register (PPSR) is a simple method to gain protection from unfair payment claims brought by liquidators. A secured creditor cannot be pursued by the liquidator for an unfair preference claim, and the right to register a charge does not provide the same definitive protection as a registered charge;
– Request Cash on delivery or payment in advance;
– Ensure the terms and conditions include a retention of title clause (helpful with a secured debt argument);
– Get payment from a third party (i.e. director), or a letter of credit/bank guarantee; and
– Get legal advice before chasing payment (letters of demand etc.) as this could hurt the creditor’s argument of good faith.
If at any stage a creditor thinks that a company is insolvent or potentially facing insolvency then they should seek prompt legal advice before taking any further actions with the company. It is much more prudent to avoid any risk of possibly receiving a preference payment than to enter into a transaction they think may be a preference payment and then try to defend the transaction down the track when a liquidator brings a claim. Should a creditor receive correspondence from a liquidator intending to pursue an unfair preference claim then they should also seek prompt legal advice prior to communicating with the liquidator in order to explore the possible defences that are open to them at that time.
The above is just information and no substitute for legal advice. Let us know if you need to someone to help you defend an unfair preference payment claim. We can help you find a good lawyer if you need one (and if you don’t have one already). As mentioned on our about us page, we have a good network of different lawyers will help you find a lawyer that can assist you. As we work with a number of lawyers, we are able to negotiate better rates for you.
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Adam Ahmed is an Australian international tax lawyer. Adam has over a decade of experience working at 3 of the big 4 accounting firms and one of the top tax law firms in Australia. He is currently the managing director of Adam Ahmed & Co. This article is reproduced from Adam Ahmed & Co.