The Corporations Act (the Act) permits a liquidator to claw back preferential payments made to an unsecured creditor within the six (6) month period prior to the winding up: section 588FA of the Act.

Secured creditors have historically been safe from section 588FA which applies to unsecured debts only.  Most payments to a secured party are made pursuant to its security, particularly given the broad “all monies” reach of most modern securities.  In most cases only where the security itself is under attack (for example, by the security being voided under other provisions of the Act) does section 588FA come into play.

However, under section 588FA(2), a secured debt is taken to be unsecured to the extent the debt is not reflected in the value of the security.  This section has rarely been considered by the Courts. It could apply where for example a security is voided on the winding up.

There may be other circumstances however in which the practical value of a security as at a wind up is nil. For example:

  • The security is second ranking and realisations will not pay out the first ranking security in full;
  • The debtor company has transferred or sold all of its assets prior to the winding up

A recent decision of the South Australian District Court - Matthews v The Tap Inn [2015] SADC 108 - considered this position. A hotel owner (Seller) sold its hotel business to a New Co.  The consideration was payable by instalments and secured by a second ranking fixed and floating charge over New Co.  Some period later New Co was placed into administration then liquidation. The liquidator sought to claw back payments from New Co to the Seller under 588FA.  The liquidator alleged the Seller’s security had no value as at the winding up. The reason for this is not stated in the case but may have been because the Seller’s charge was second ranking and of no value.

The Court was asked to determine, as a preliminary question, the time at which a Court should assess the value of a security under section 588FA(2).  The Court found that the relevant date was the date of the winding up.  This conclusion potentially rendered payments to the Seller preferential notwithstanding they were pursuant to a security.

Implications of Decision

This decision is surprising. Secured creditors have usually been protected from 588FA.  If this decision is followed in other jurisdictions it creates the following problems:

  • Uncertainty for secured parties. Many securities have little recoverable value on a wind up. If this is to be the test (which is not clear) the scope for liquidator actions increases;
  • Additional risk assessment hurdles;
  • How to practically determine the “value” of a security as at the wind up.

Whilst the decision is not binding in New South Wales it does open up potential for liquidators to run similar actions in different jurisdictions. In the meantime lenders should continue to conduct themselves in the usual way but mindful always that holding security does not provide absolute protection to the lender.