In brief - Courts identify three circumstances for ordering priority repayments

Third-party payers should be aware that preference payment provisions may apply to "Good Samaritan" payments if debtors are placed in liquidation or declared bankrupt. However, as shown in Young v ACN 081 162 512 and Anor [2005] NSWSC 139, the courts will consider certain circumstances where third parties may be able to recover the payment in priority to other creditors.

"Good Samaritan" payments may pose risks for third-party payers

It is commonplace for a debtor to seek the assistance of a third party, such as a director, to pay off a debt in order to forestall insolvency. This may be seen as an ideal arrangement when a creditor refuses to provide any further goods and services until outstanding invoices have been paid and the debtor is desperate to keep their business running.

However, if the debtor is later placed in liquidation or declared bankrupt, that "Good Samaritan" payment may be subject to a preference action where a court orders the return of the payment as being an unfair preference to the creditor who received it.

How preference payment provisions apply to third-party payments

Payments made to creditors in the six-month period before the debtor becomes bankrupt or goes into liquidation may be recovered by a bankruptcy trustee or liquidator and pooled into the funds to be distributed to the unsecured creditors. This power is given to bankruptcy trustees and liquidators so that they can make sure that one creditor has not been "preferred" over another.

Many creditors do not realise that the preference payment provisions may apply to "Good Samaritan" payments as well. Provided that the debtor is a party to the payment, the power will extend to these types of payments that are made by a third party, such as a director.

On the other hand, the risk to the third party who made the payment on behalf of the company or person is that they may never see the money again. If the trustee in bankruptcy or liquidator succeeds in clawing back the "preference" payment, the "Good Samaritan" must line up with all of the other creditors of the debtor in bankruptcy or liquidation.

But is that the end of the story for the "Good Samaritan"?

Courts may order repayment in priority under certain circumstances

If the third party has made a payment on behalf of the bankrupt or liquidated company and is forced to line up with the other creditors, there are certain circumstances in which they will be able to recover the payment in priority to other creditors. The courts have identified three circumstances in which they will order a payment made by the "Good Samaritan" to be repaid in priority to other secured and unsecured creditors.

In the Young v ACN 081 162 512 (formerly Dallen Design Pty Ltd) and Anor (Dallen Design) case, a third-party payer was able to receive priority repayment over other creditors of the company in liquidation. In reaching its decision, the court considered three circumstances in which a third-party payer may be able to recover its payment in priority:

1. An equitable lien  2. As a liquidator's expense  3. Applying the rule in Ex parte James

Equitable lien may be enforceable

A third-party payer may be able to rely on the principles of equity to enforce an equitable lien if they can show that:

  • the liquidated company or bankrupt had freely accepted the benefit of the third party's payment
  • that benefit is so undeniable that no reasonable person could say that the liquidated company or bankrupt was not enriched
  • by objectively valuing the benefit to the liquidated company or bankrupt, it would be unconscionable for the liquidated company or bankrupt to retain the benefit without paying for it

If the third party can satisfy these requirements, the third party may be able to argue an equitable lien over the payment it made on behalf of the bankrupt or liquidated company and be repaid in priority to other creditors. (See Young v ACN 081 162 512 and Anor at [15]; Shirlaw v Taylor (1991) 31 FCR 222 at 228.)

The courts are likely to find that there has been an undeniable benefit if the company or individual received a significant windfall as a result of the third party assisting it with the repayment of its debt. As an example, an undeniable benefit might be shown if the third party's payment was able to free up a trade creditor withholding supply so that the company or person was then able to finalise a significant sale, as was seen in Dallen Design (see Young v ACN 081 162 512 and Anor at [11].)

Liquidator's expense under section 556 of the Corporations Act

The second circumstance discussed in Dallen Design was where a "Good Samaritan" payer is able to prove the payment made on behalf of the company ought to be considered an expense which was properly incurred by the liquidator in preserving, realising or getting in property of the company or in carrying on the company's business under section 556(1)(a) of the Corporations Act 2001.

In order to prove that the payment was an expense of the liquidator, the third party will need to prove that either:

  • they were acting as an agent of the liquidator when they made the payment
  • the liquidator held the third party out to others as an agent when the third party made the payment, or
  • the third party purported to act as the liquidator's agent when it made the payment (see Young v ACN 081 162 512 and Anor at [20])

Rule in Ex parte James considered but not applied by court

Finally, in dicta, the court in Dallen Design considered (but did not apply) the old English decision of Ex parte James: Re Condon ((1874) LR 9 Ch App 609) where it was held that money, which in equity, belongs to someone else ought to be returned to its rightful owner. The decision in Ex parte James has been applied in later decisions which have established four conditions to satisfy the rule (Re Clark; Ex Parte Trustee of property of bankrupt v Texaco Ltd [1975] 1 WLR 559 at 563-4). The four conditions were considered in the present context as follows:

  1. The bankrupt or company in liquidation receives some form of enrichment of its assets as a result of the actions of the third party.
  2. The third party must not be in a position to submit an ordinary proof of debt so that the rule is not used to provide preference to an otherwise unsecured creditor but rather to provide relief where that claimant would otherwise be without relief.
  3. The rule only applies to nullify the claim of the liquidator where, in all honesty, it would be bound to admit that it would be unfair for it to keep the third party's money.
  4. The rule does not necessarily apply to restore the third party to the status quo ante but applies only to the extent necessary to nullify the enrichment of the company in liquidation or the bankrupt.

In considering the third-party payer's argument in favour of the application of the rule in Ex parte James, the court opined that the second condition was of particular importance in that it showed that the law had not yet developed enough to be able to convert a Good Samaritan's unsecured payment into a secured debt.

Further scrutiny of Ex parte James rule may eventually help third parties

It would seem that further scrutiny by the courts of the application of the rule in Ex parte James may lead to further avenues of redress for "Good Samaritan" third parties who step in to assist companies and individuals with the payment of their debts.