August 15, 2014

Unfair Preferences in Insolvency

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.

Recovering unfair preferences

In order for preference payments to be recoverable, the creditor must have received more than it would receive from the company in respect of a debt if the transaction were set aside and the creditor were to prove for the debt in the winding up of the company.

Only liquidators may seek to recover unfair preferences.

The Corporations Act 2001 (Cth) provides that in order to recover an unfair preference, the liquidator must show that:

  • there was a transaction between the company being wound-up and one of its creditors;
  • the transaction occurred during the time the company was insolvent (for a non-related creditor, the relevant period is within 6 months before the relation-back day);
  • as a result of the transaction, the creditor received preferential treatment over other creditors; and
  • the creditor suspected or ought to have suspected that the company was insolvent at the time of the transaction.

Statutory defence

In order to maintain a defence to an unfair preferences claim, a creditor must prove on both a subjective and objective basis that the creditor had no grounds for suspecting the insolvency of the company.

The defence is set out in section 588FG of the Corporations 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;
  • at the time of the transaction, the creditor had no reasonable grounds to suspect the company was insolvent;
  • a reasonable person in the creditor’s position would have had no grounds for suspecting the company was insolvent; and
  • the creditor 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 there were grounds for suspecting insolvency if the company was slow to pay the creditor, or that the creditor had demanded payment.  Case law tells us however that this alone will generally be insufficient to establish suspicion.

Creditors who receive demands from liquidators in relation to unfair preferences should be aware that there may be a defence available to them in relation to all or some of the transactions.

If you would like more information about these issues, please contact Matthew Rouse or Eloise Pawley on +61 7 3648 9900.