When a company becomes insolvent, the liquidator is entitled to all of the assets that belonged to the company at the commencement of the winding up, so they can manage and distribute that property equally amongst the company’s creditors.
It can be difficult to determine when a winding up commences and the way in which this date is calculated is beyond the scope of this article.
It is not uncommon for a company to make certain transactions or otherwise attempt to dispose of property in light of impending insolvency proceedings, leaving little for the liquidator to distribute. To combat this, the liquidator is given wide ranging powers to ‘claw back’ disgorged property for the benefit of all the company’s creditors.
Transactions can be avoided on the basis they are:
- an unfair loan
- an unfair preference
- an uncommercial transaction
- an unreasonable director related transaction
- a transfer to defeat creditors
This article addresses what constitutes an unfair preference. Other articles on this website will address the other avoidance provisions.
What is an unfair preference?
An unfair preference occurs if the company and a creditor are parties to the transaction and the transaction results in the creditor receiving from the company a greater amount than it would have received in relation to a debt in the winding up of a company.
To establish that a transaction constitutes an unfair preference it must also be demonstrated that:
- The company was insolvent when they made the transaction or become insolvent as a consequence of it;
- There was a subsisting debtor/creditor relationship at the time;
- The creditor was receiving payment for an unsecured debt.
If any of these elements are not satisfied, there is no unfair preference. For example, if an insolvent company enters into an arrangement with a new supplier and pays cash on delivery for the product, there is no pre-existing debtor/creditor relationship and thus no preference.
In addition, the unfair preference must have occurred with a certain time period; 6 months ending on the ‘relation-back’ date. If the preference was granted to a ‘related entity,’ the time period extends to 4 years before the relation-back date. A related entity refers to parties such as relatives or spouse and body corporates such as subsidiary companies and companies with the same directors.
The time period can be tricky to work out as the relation-back day varies depending on whether different types of corporate insolvency proceedings (e.g. Administration, provisional liquidation) were already underway when the winding up commenced. It is generally either the day the company was placed into administration or the date on which an application to wind up the company was commenced - but not always.
Due to this difficulty we would highly recommend seeking legal advice when attempting to determine the time period within which an unfair preference could have occurred.
What if I am alleged to have received a preference?
If you are a creditor and you have received a preference, you could be in for a nasty surprise down the track as a liquidator can make a demand for repayment up to 3 years after the relation-back date.
You may be entitled to keep the property if you can prove that you acquired the property in the ordinary course of business, acting in good faith and after giving at least market value for the property. You will not be able to rely on this defence if it can be inferred from the circumstances surrounding the transfer that you knew or had reason to suspect that the company was insolvent and that the effect of receiving the property would be to give you a preference, priority or advantage over other creditors.
Although not a complete defence, the establishment of a ‘running account’ relationship with the company may significantly reduce the amount that can be clawed back. If you can show that regular payment was an integral part of the continuing business relationship, whether there is a preference is determined after taking into account the net effect of all the transactions over the relevant time period, that is, whether debt increased or decreased over the given period. Generally, only the amount which reduces the overall debt between the company and a creditor is potentially an unfair preference.
Often it can be difficult to decide from the facts whether or not a defence is likely to succeed.
Receiving a demand for repayment of money you believe you were rightfully owed can be very confronting and seem unfair. If you have received an unfair preference, it is vital to get legal advice in case you can avoid or at least minimise your liability. If you are in this situation, please contact us.