Defending an unfair preference claim

What is the issue?

A payment is an unfair preference where an unsecured creditor receives money (or other assets) from an insolvent company, and the amount of that money is more than they would have received from the winding up of the company. If you are dealing with companies, you should understand the circumstances in which money you receive from a company may be an unfair preference and what your defences may be.

Unfair preference claims are brought by a company's liquidator against an unsecured creditor. Where the parties are unrelated, a liquidator can wind back transactions entered into up to six (6) months earlier. It might seem a bit harsh that you can be forced to return money that was genuinely owed to you, but the role of the liquidator is to ensure the assets of the company are distributed equally between all unsecured creditors. As the name suggests, unfair preference laws prevent one creditor unfairly gaining a preference over another creditor.

Defending an unfair preference claim

There are two main defences to an unfair preference claim brought by a company's liquidator.

'Running Account' where you had an ongoing business relationship

Where you have an ongoing business relationship with the company, s 588FA(3) of the Corporations Act 2001 (Cth) provides that all transactions between the parties are to be looked at in aggregate, with the effect that monies paid to you are offset by the services that you provided as part of that ongoing relationship.

For example, say you hired out heavy equipment to a construction company that has now gone into liquidation. The company paid you $10,000 at the end of January, February and March to pay for the hire of the equipment for that month. You were aware from the start of the year that the company was having financial difficulties, but it was only at the start of March that you became aware that the company was about to go into liquidation and would not continue to hire the equipment into the future.

You have received $30,000 in total over the three months. You received the payments in January and February on the understanding that you would continue to provide the company with the equipment into the future (i.e. the payments were paid by the company to secure ongoing benefits, not just to pay off debts for services already rendered).

However, the $10,000 the company paid you in March was not paid to secure an ongoing benefit, since you were aware that the company could not continue to rent the equipment and the relationship would come to an end. Taken in aggregate, the unfair preference would only be the $10,000 received in March, not the $30,000.

Good faith and no reasonable grounds to believe the company was insolvent

Under s 588FG(2) of the Corporations Act, a defence to an unfair preference claim is available where you:

1. Entered a transaction with the company in good faith; and

2. You had no reasonable grounds for suspecting that the company was insolvent or would become insolvent as a result of the transaction; and

3. A reasonable person in your circumstances would have had no grounds for so suspecting; and

4. You provided valuable consideration (for example, you supplied the company with the heavy equipment) or otherwise changed your position in reliance on the transaction.

Good faith is not defined in the Act, but would include such things as entering the transaction on commercial terms, not suspecting that the company was insolvent, and not colluding with the company to obtain an unfair preference.

To claim this defence, the onus is on you to show that you (or a reasonable person in your circumstances) had no reason to suspect that the company was insolvent. Things that should put you on notice that a company may be insolvent include the failure to pay debts, requests for extensions of time to pay debts and the dishonouring of cheques.

How to avoid having an unfair preference claim brought against you

The best way to prevent having an unfair preference claim made against you is to avoid entering into transactions with companies that look like they may be insolvent or have trouble paying their debts in the future. In some circumstances, you may be able to take security over the assets of the company.

However, there is no guaranteed way of avoiding unfair preference claims. You may have taken all due diligence at the time the company incurred its debt to you, only to have the company become insolvent at a later date. In those circumstances, if you are receiving money from the company, be aware that a liquidator may wish to claim the money back from you.

How can Sharrock Pitman Legal help me?

Our law practice has Accredited Specialists in Commercial Law. Over many years now, we have helped many businesses with unfair preference claims, and it would be our pleasure to assist you. We provide fixed prices and offer substantive free benefits to all customers who run a business. Click here for full details. Call Sharrock Pitman Legal today on 1300 205 506.

The information contained in this article is intended to be of a general nature only and should not be relied upon as legal advice. Any legal matters should be discussed specifically with one of our lawyers.

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