Creditors should be very wary when pressing debtors for payment in circumstances where the debtor may be insolvent due to the "claw back" provisions granted to liquidators. Liquidators may in certain circumstances claw back payments made by a company shortly before it is placed into liquidation.
Part of a liquidator's role is to ensure an orderly and equitable distribution of the company's assets between creditors. A liquidator will scrutinise company records to determine whether any creditor has received an inequitable distribution from the company before the winding up – that is, that the creditor received preferential treatment. Usually preferential treatment is in the form of a payment, but almost any transfer of property and even some creation of property (for example, a mortgage) may be an unfair preference.
Preference payments can be "unfair" in circumstances where:
- The creditor and debtor are parties to a transaction
- The debtor is insolvent
- The transaction results in the creditor receiving a payment from the debtor for an unsecured debt with the payment amount greater than what the creditor would have received if it had, instead of receiving the payment, lodged a proof of debt in the liquidation or bankruptcy of the debtor.
Such payments are called "unfair preferences" because after receipt of payment, the creditor recovers more than what it would have if the creditor had proved in the liquidation of the insolvent debtor, thereby obtaining an unfair preference over other creditors who have lodged proofs of debt in the liquidation. The Corporations Act 2001 (Act) provides liquidators with broad powers to recover "unfair preference" payments.
Resisting an unfair preference claim
In order to defend an unfair preference claim, a creditor must prove on both a subjective and objective basis that they had no grounds for suspecting the insolvency of the company. The defence is set out in section 588FG of the Act, and the creditor bears the onus of proof.
In establishing the defence the creditor must prove:
- It became a party to the transaction in good faith
- They had no reasonable grounds to suspect the company was insolvent at the time of the transaction
- A reasonable person in their position would have had no grounds for suspecting the company was insolvent
- They provided valuable consideration for the transaction.
Whilst each of these elements must be proved by the creditor, the main limb of the statutory defence is that the creditor had no suspicion of insolvency. An example of the operation of this limb is where a liquidator says that there were grounds for suspecting insolvency if the company was slow to pay the creditor, or that the creditor had demanded payment - however, this alone is generally insufficient to establish suspicion.
Additionally, creditors can resist an unfair preference claim by showing that they were trading with the company on a 'running account', also known as a 'continuing business relationship'. This applies where there is a continuous supply of goods or services by a creditor and intermittent paying down of the debt by the company. In these circumstances, the Court will consider the net reduction of the debt owed to the creditor over the relevant period of time. If the company's total debt owed to the creditor has increased or remained the same over that time, then there may be no unfair preference. If the total debt has decreased, there may have been an unfair preference for the amount of the decrease. The operation of 'running account' principles is technical and will depend on the particular circumstances.
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.
