We have heard it many times: “the only people who win when a company goes into liquidation are the lawyers and the accountants”. 

Whether that is true or not, certainly it is the case that having a corporate customer go into liquidation can cause significant damage to your cash flow, your morale and ultimately your business.

YOU MIGHT NEED TO REPAY MONEY TO YOUR DEFUNCT CUSTOMER’S LIQUIDATOR

Ignoring for a moment the entirely unsatisfactory result that you probably won’t get paid any of the outstanding amounts that your customer owed you, insult can be added to injury when you get a letter from the customer’s liquidator asking you to repay amounts that you have managed to get from your customer in the six months before it ultimately toppled. 

Despite the many assertions from people who receive these letters that the process is unjust, the reality is that liquidators of companies have a duty to perform and one of them is to reclaim payments (called “unfair preferences”) made within the six months before the liquidation commenced. 

WHAT’S A LIQUIDATOR NEED TO PROVE?

Fundamentally, to make out an unfair preference claim the liquidator needs to establish that:

  1. The payment was made to you when the customer was insolvent;
  2. The payment was made within six months before the company commenced liquidation (called the relation back day, which is not always the first day of liquidation but frequently can be); and
  3. That you received more as a result of that payment then you would if you had to submit a “proof of debt” in the liquidation and receive a dividend with the other unsecured creditors.

THE “TOTAL IGNORANCE” DEFENCE

There are a number of technical arguments that you can run associated with unfair preference claims, but aside from contesting the solvency of the company, the first port of call for most recipients of such a letter is to plead your complete and total ignorance to the financial state of your customer. 

And here lies the problem for aggressive debt collection processes.  In order to establish your ignorance sufficient to give you a defence under the Corporations Act 2001 to a preference claim, you need to be able to establish that you have no reason to suspect, and that a person in your position would not have any reason to suspect, that the customer was insolvent or likely to become insolvent.

HOW DOES AGGRESSIVE DEBT COLLECTION HARM YOU?

The more aggressive and sophisticated your debt collection strategy is, the harder it is to establish such a defence. 

For example, what happens if your customer habitually pays you within the 14 day invoice terms, but has recently started paying you at 20 days?  Every follow up letter you send, every debt collector you engage, and every proceeding you commence will weigh against the argument that you had no reason to suspect the company was about to become insolvent. 

Of course, if you have issued a formal proceeding of any kind, or received a specific call or email from the director or proprietor of your customer telling you that they are having financial difficulties, and establishing the defence can become extremely difficult. 

SO WHAT’S THE ANSWER?

Obviously you cannot simply ignore people who do not pay their bills, but at the same time you probably want to minimise your exposure to a preference claim by a liquidator. 

The first practical strategy here is to ensure that as soon as you have any reason to believe that a company might be in financial difficulty you cease providing goods or services to it.  For the payments that have already occurred, you will likely be able to avail yourself of the defence.  If you have one invoice or so that is unpaid then at the very least you have minimised your exposure to that company. 

The second strategy is to ensure that, to the extent you have retention of title clauses, they are registered appropriately on the Personal Property Securities Register.  The ability of a liquidator to reclaim a preference only applies to unsecured debts.  Although registration will not offer you complete protection (for example, if your security is lower ranking, your debt might still be considered “unsecured”) it increases your prospects of arguing against the preference claim. 

The final strategy is to be mindful of changes in payment patterns.  When acting for liquidators, one of the things we assess when people claim the “total ignorance” defence, is the pattern of payments that have occurred over time.  if we see evidence of gradually increasing payment terms, slower payments, lump sum payments and other things that will give people pause for thought and should have put the relevant recipient on notice, then our advice is often that they may not be able to claim the benefit of the defence, because the circumstances should have put them on notice about the financial difficulty.  If you are aware of these changes in patterns then you can act accordingly.  Time and time again we see trading situations where the patterns have existed, but it is only with the benefit of hindsight that they become apparent. 

Preference claims are common but complex area when companies go into liquidation.  Proper forethought and can offer you much greater protection from claims as long as you are aware of the issues that might come up.