In this podcast, Agnes Derrick from our Litigation, Dispute Resolution and Insolvency team discusses how to avoid unfair preference claims by liquidators.
We are here today with Agnes Derrick, Lawyer from our Litigation, Dispute Resolution and Insolvency team at Murdoch Lawyers to discuss how to avoid unfair preference claims by liquidators.
Firstly, what is an unfair preference payment?
An unfair preference payment is a transaction between a company and a creditor that can be “voided” by a Liquidator. There are a number of elements that a Liquidator must prove in order for such a payment to be an unfair preference payment, however it generally occurs when, at any time within the six months prior to a company entering into liquidation, and whilst the company is insolvent, the company pays the debt of an unsecured creditor, while other unsecured creditors are not paid.. Such a payment is called an unfair preference payment because the unsecured creditor who received payment has unfairly been given preferential treatment over other unsecured creditors of the company that were not paid.
What happens when a company that has gone into liquidation has made an unfair preference payment?
The liquidator may seek to recover the unfair preference payment directly from the creditor by the creditor voluntarily repaying the payment it received, or otherwise by Court order.
The liquidator has a duty to distribute the assets of the company to its unsecured creditors on an equal basis. As part of this process, the liquidator must determine whether the company paid the debts of any unsecured creditors prior to the liquidation, and more importantly, consider whether or not such payments were fair and equitable to all other unsecured creditors. For example, let’s say a company owes two unsecured creditors $30,000 each. Prior to entering into liquidation, that company then pays $20,000 to one of the creditors, and nothing to the other. If the company was insolvent when that payment was made, the liquidator will try to reclaim the $20,000 to add to the pool of company assets to distribute to all unsecured creditors on an equal basis.
Secured, rather than unsecured, creditors who receive payments in the 6 months prior to a company entering Liquidation cannot be pursued for unfair preference payments by a liquidator.
If the liquidator tried to reclaim this type of payment directly from the creditor, and the creditor refused to give it back, what would the liquidator do next?
If a creditor refuses to voluntarily repay the money to the liquidator, then the liquidator may commence Court proceedings to obtain an order from the Court that the money be repaid.
There are a number of essential elements the liquidator must prove, in order for the Court to make an order that the creditor received an unfair preference payment and so must repay the money to the liquidator on behalf of the company:
- A transaction was entered into between the company and its creditor;
- The transaction took place when the company was insolvent. This means the company must have either been insolvent at the time of the transaction, or became insolvent because the transaction was made;
- The payment(s) were made within the legal period after the relation-back day (6 month period);
- The transaction gave the creditor an advantage over other creditors of the company; and
- The creditor suspected, or had reason to suspect, that the company was insolvent.
To be considered a preference payment, the creditor must have received more from the transaction than it would receive if the creditor returned the money to the liquidator and was paid equally with other creditors. If that’s not the case, then it is likely there was no preferential treatment or advantage to the creditor.
Say I am a creditor and I have received payments from a company, which then goes into liquidation after a few months. What can I do to defend an unfair preference claim by a liquidator?
You should seek legal advice as soon as possible. The Liquidator needs to be able to substantiate to you as the creditor all the legal elements required for a preference payment transaction to have occurred (see above). These elements should be reviewed before repaying any money as demanded by the Liquidator.
Even if the Liquidator can substantiate all the elements required, there are defences then available to a creditor having received such a payment from a company. The most common defence to this type of claim is the “good faith” defence. Here, the onus is on the creditor to prove that the creditor:
- Provided consideration for the payment (such as the supply of goods/services in return for the payment, or a loan to the company);
- Received the payment in good faith; and
- Had no reason to suspect that the company was insolvent.
The last point is usually what creditors struggle to prove.
A company is considered solvent only if it is can pay its debts as and when they fall due.
In the lead up to the point where a company enters into liquidation, a company may start to delay payments and/or make part payments to creditors, and sometimes even notify its creditors that it is having cash-flow issues, hence the delayed/part payments . This being the case, and even if a company does not specifically tell creditors it is having cash-flow problems, it is usually clearly apparent to a creditor that the company is in financial difficulty and so becomes very hard for a creditor to say it had no reason to suspect the company was insolvent when it received the payment from the company.
If a company has made payments to me, and I have doubts about its solvency, what should I do?
If you have any doubts about a company’s solvency, and are owed money by that company, you should ask the company for proof of solvency before accepting any payment from it. Ask that a Director of the company provide an affidavit or statutory declaration that not only states that the company can pay its debts as and when they fall due, but also particularises why he or she believes that. This may include referring to, and attaching copies of, the company’s financial records, including up to date profit and loss statements and balance sheets which shows the company is solvent. This will be good evidence if you need to rely on the “good faith” defence in the future if approached by a Liquidator to repay any payment(s) received.
Is requesting proof of solvency something creditors should do on their own?
It may seem like an easy thing to do on your own, but you should really get some proper advice from your lawyer if you want to be able to rely on an affidavit or statutory declaration provided to you by a company to defend any possible unfair preference claims by a liquidator in the future. This is because the wording used in an affidavit or statutory declaration, as well as the information provided in any supporting documents, will ultimately determine whether or not the proof is good enough for you to be satisfied that the company is solvent.
Is this something that you could help with?
Yes. Our team at Murdoch Lawyers are experienced in all areas of insolvency law. If you need our help to review and respond to a demand for repayment you have received from a Liquidator, or require advice on how to best protect yourself before receiving payments from a company you suspect may be insolvent, please give us a call and we will be able to assist.