If you've ever traded with a company that subsequently enters liquidation, you'll know that it can be very frustrating and disruptive to your business. If the company owes you money and you're an unsecured creditor, you'll join the (often long) line of other unsecured creditors and may see little or no money at the end of the process. To make matters worse, if you've received a payment from the company which can be classified as an unfair preference, the liquidator may write to you and demand that you repay the money to the company to be distributed equally among the creditors, or else they will commence recovery proceedings against you.
Fortunately, you do have options. If you receive a liquidator's demand, you should consider whether you can:
- Challenge the liquidator's claim that there is an unfair preference; or
- Rely on the "good faith" defence provided for in the Act.
These are discussed in more detail below.
What is an Unfair Preference?
The Corporations Act 2001 ("the Act") sets out the elements of an unfair preference. These are:
- A transaction to which the company and a unsecured creditor were parties; and
- In relation to an unsecured debt owed by the company to an unsecure creditor, the transaction results in the unsecured creditor receiving more than the unsecured creditor would receive if the winding up of the company.
An unfair preference must contain two further elements to be a "voidable transaction" under the Act. These are:
- The company either was insolvent when the transaction was entered into or became insolvent because of entering into the transaction; and
- The transaction was entered into during the six months prior to the "relation-back day". For court-ordered liquidations, this is the date the court ordered the winding up of the company.
The onus is on the liquidator to establish each of these elements, and, if successful, a court can make an order directing an unsecured creditor to repay the unfair preference to the company.
Challenge the Claim
When considering whether you may be able to challenge the liquidator's claim, you should consider the following questions:
- Was there a transaction?
A liquidator will need to prove that the alleged preference is a "transaction" as defined in the Act. It has a very broad definition and includes not only a payment of money by the company, but also a conveyance, transfer or disposition of the company's property.
- Who were the parties to the transaction?
The transaction must be one to which the company and the unsecured creditor are parties. Accordingly, a transaction that only involves either the unsecured creditor or the debtor and a third party cannot constitute an unfair preference.
- Was there a debtor-creditor relationship?
For a transaction to constitute an unfair preference, a debtor-creditor relationship must exist between the company and the unsecured creditor with respect to the transaction. For example, there is no debtor-creditor relationship where:
- The company merely paid the money to the unsecured creditor as an agent for someone else;
- The payment is made at the same time as the delivery of goods on the basis of cash-on-delivery; or
- An unsecured creditor receives a pre-payment for services to be rendered in the future.
- Did we receive an unfair benefit in relation to the transaction?
The liquidator must also prove that the unsecured creditor received more from transaction than it would have received in the actual winding up of the company. For example, if an unsecured creditor received $50,000 from the company prior to the winding up of the company but would have only received $5,000 in the winding up of the company, it can be said that the unsecured creditor has received an unfair benefit of $45,000.
The business purpose of the payment and its context in the general course of dealing are considered to determine whether it gives the unsecured creditor an unfair benefit. For example, there is no unfair benefit where:
- The payment is rent to enable the company to retain the use of the premises where it carried on business;
- The payment has the effect of cancelling out or setting off a debt owed by the unsecured creditor to the company;
- An unsecured creditor can show that the transaction was part of a "running account", whereby the amount owing fluctuated as monies were paid and further goods and services provided. The unsecured creditor usually needs to show that the payment was made on the mutual understanding that the unsecured creditor would provide further goods and services to the company as well as, or instead of, for the purpose of discharging an existing debt.
The Good Faith Defence
The unsecured creditor must establish that:
- It became a party to the transaction in good faith;
- It had no reasonable grounds to suspect the insolvency of the company at the time it became a party to the transaction;
- A reasonable person in the same circumstances would have had no such grounds to suspect insolvency; and
- The unsecured creditor provided valuable consideration under the transaction or changed its position in reliance on the transaction.
If the 'good faith' defence was successful, a court would not make an order requiring the unsecured creditor to repay the unfair preference to the company.
It can often be difficult to determine whether you can challenge, or have a defence to, a liquidator's demand. If you are unsure about your options, we recommend you seek legal advice as soon as possible after receiving a liquidator's demand.
This article was first published in Retail World.