On 14 July 2015, the South Australian District Court in Matthews v The Tap Inn Pty Ltd  SADC 108 handed down a decision whose underlying reasoning could, if applied by superior courts around Australia, broaden the scope for liquidators to pursue unfair preference claims against secured creditors.
The central issue in Matthews related to s588FA(2) of the Corporations Act, which provides that for the purpose of the unfair preference provision in s588FA(1) of the Act, a secured debt is taken to be an unsecured debt to the extent that the debt is not reflected in the value of the security.
In Matthews, the defendant sold a hotel (the Tap Inn) to Pub Tap Investments Pty Ltd. The sale was financed by debentures granted by Pub Tap Investments, namely, a first debenture to a bank and a second debenture to the defendant. The first debenture had priority, being the earlier security. Both debentures created both fixed and floating charges over the present and future assets of Pub Tap Investments. Between 30 June 2008 and 27 April 2010, Pub Tap made 24 payments totalling almost $375,000 to the defendant pursuant to the terms of the sale. Of that total amount, almost $77,000 was paid within the six month relation back period prior to 16 June 2010, when Pub Tap Investments went into administration.
The plaintiff liquidators claimed that these latter payments were unfair preferences, as the payments discharged an unsecured debt by virtue of s588FA(2). In making this argument, the plaintiffs argued that the value of the defendant’s security should be assessed as at the date of the winding up. At that point in time, the defendant’s security had no value, which the liquidators argued meant that the defendant’s secured debt should therefore be regarded as being wholly unsecured. In contrast, the defendant argued that the value of its security should be assessed at the date it was created, when the amount secured was less than the value of the security, meaning that the debt was wholly secured and therefore beyond the operation of s 588FA.
Chivell J determined this contested interpretation of s588FA(2) as a preliminary question antecedent to the trial of the principal dispute in the proceeding. His Honour held that according to settled principles of statutory interpretation, the text, purpose and context of s588FA(2) resulted in a conclusion that for the purpose of assessing the value of a security pursuant to s588FA(2), the date of that assessment is the date of the winding up of the company that granted that security. In reaching this conclusion, his Honour did not consider the distinctions between fixed and floating charges to be of any assistance in resolving the question. His Honour also regarded as irrelevant the question of whether the creditor’s security was only a partial security or a full, “all monies” type security.
Section 588FA(2) has rarely been the subject of prior judicial consideration, so the Matthews case breaks new ground for that reason alone. However, the real potential significance of the decision lies in the following immediate implications which ultimately identify a potential new path for liquidators to pursue unfair preference claims against secured creditors.
First, the invariable outcome in the context of a winding up is that the effective value of a security can be minimal or zero because of factors such as:
- the security ranking behind other securities (such as a bank’s charge);
- the assets realised by the liquidators being of insufficient value to discharge the security either because the assets were only sufficient to discharge the first ranking security or were of minimal value because they were largely dissipated prior to commencement of the winding up.
Secondly, the immediate implication of the court’s finding is that payments that were previously thought to be beyond the reach of the unfair preference provisions in s588FA because they were payments made in repayment of a secured debt may now potentially be open to attack as unfair preferences. In short, if as at the date of commencement of the winding up of the company, the assets of that company which are the subject of the security interest in question are worth less than the quantum of the secured debt, the resultant shortfall is an unsecured debt which can then be compared with any payments made to the creditor during the relation back period in order to determine whether the creditor has received a preference when compared with what other unsecured creditors would receive in the winding up of the company.
In this respect, it follows from Matthews (although not expressly stated in the decision) that the “debt” against which the value of the security is to be assessed remains the quantum of the unsecured debt as at the date of winding up (assuming that the impugned transactions are successfully unwound).
Thirdly, the above outcome appears to lead to strange further results, for example, for a fully secured creditor whose debt is fully repaid during the relation back period and then releases the relevant security shortly before the winding up date. It would seem that the payments made to such a creditor could be open to attack under s588FA(2) despite the fact that those payments were made pursuant to a security, if it is shown that the value of the security as at the date of winding up was less than the quantum of the debt.
However, it is submitted that it is implicit (if not expressly stated) in Chivell J’s reasoning that the prospect of what would be an alarming outcome for secured creditors would be regulated and controlled by the application of other sections such as the “good faith” defence in s588FG and the “running account” provision in s588FA(3). In other words, such an outcome would appear to only be possible where a creditor knew or had reasonable grounds to suspect that the company was insolvent at the time of receiving the impugned payments or alternatively, that the company would not continue as a going concern and the payments would result in the company becoming insolvent.
In this regard, it is likely that many secured creditors (in particular, a secured creditor whose debt was fully repaid during the relation back period) will simply assert that they believed the debts owed to them were fully secured and consequently gave no thought to the financial position of the company and in turn, the value of the collateral. They would also be likely to assert (to the extent that there was a continuing business relationship between the parties) that any payments made were for the purpose of facilitating ongoing supply of goods and services and are therefore caught by the “running account” provision in s588FA(3).
Having said this, the matter could become quite problematic for a secured creditor where the evidence indicates that the security was obtained in circumstances where the creditor had prior knowledge or suspicion as to the company’s impending insolvency and consequently sought to obtain security in order to effectively “inoculate” itself from the consequences of that insolvency risk. As Chivell J himself noted, it is a common commercial practice for a creditor to take security from a debtor over whatever property is available in order to secure a debt in circumstances where the debtor’s financial position is deteriorating. This in itself suggests the potential application of s 588FA(2) to unwind the protection ostensibly afforded to payments made during the relation back period by a range of security mechanisms not otherwise extinguished by the vesting rules in s588FL of the Corporations Act and s267 of the Personal Property Securities Act, including charges, retention of title clauses and supplier’s liens.
In addition, a further significant implication arising from Matthews is that there may be a renewed focus by liquidators on the approaches taken by banks and other secured creditors in the period prior to commencement of the winding up in circumstances where those parties understood that the company was experiencing severe financial distress. In such a scenario, it has invariably been observed that secured parties have often resorted to threats of foreclosure in order to obtain either further repayments of the debt or additional security from the company and/or its directors in order to improve their security positions or reduce the level of indebtedness as much as possible to ensure that it is entirely covered by the true value of the security. It is entirely possible that these tactics are motivated by knowledge not only of the company’s parlous financial position, but also an apprehension that the security may not ultimately be of sufficient value to cover the quantum of outstanding debt. If it consequently transpires that the primary security had a nil or minimal value (thereby making the debt unsecured to the extent of the shortfall), any additional security obtained by the secured creditor from the company may be regarded as seeking to obtain security for what was previously effectively an unsecured debt, which in itself may be a transaction which could be impugned as an unfair preference under s588FA.
This in turn suggests that there may be significant scope for liquidators to use the Corporations Act’s provisions for the convening of public examinations of secured creditors (in particular, s596B) in order to obtain documents and other evidence in support of potential claims along these lines. Consequently, Matthews suggests that liquidators should not take it for granted that secured creditors are beyond the reach of an unfair preference claim and ought to proactively consider the availability of such claims from the outset of their appointment.
Given the paucity of decided case law regarding s588FA(2) and the fact that the Matthews decision is only a decision of an inferior court in South Australia which is not binding in superior courts in either South Australia or other Australian jurisdictions, it remains to be seen whether it creates significant new scope for liquidators to commence unfair preference claims against secured creditors.
Notwithstanding this, Matthews should be taken as a renewed message to secured creditors that the mere fact of having obtained security (even security perfected by registration under the PPSA) does not automatically put those creditors in a safe haven beyond the reach of a proactive and determined liquidator.