During the administration of a company, liquidators may identify creditors who have received payments in preference to other creditors, and apply to the court pursuant to section 588FF of the Corporations Act 2001 (Act) to recover those payments in order to achieve a more equitable distribution amongst all creditors.

What constitutes a preferential payment?

Before a liquidator may pursue a creditor for the recovery of a preferential payment, he or she must first be satisfied that the payment in question meets the test specified in Chapter 5, Division 2 of the Act. In summary, a payment is a preferential payment if:  

  • a company and the creditor are parties to the transaction (even if someone else is also a party);  
  • the transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owed to the creditor, more than the creditor would receive from the company in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in the winding up of the company;  
  • the transaction was entered into, or an act was done, or an omission made, for the purpose of giving effect to the transaction at a time when the company was insolvent, or when an act or omission resulted in the company becoming insolvent; and  
  • the transaction was entered into or an act was done for the purpose of giving effect to it during the six month period prior to the date of liquidators being appointed, or the relation-back period (for example, if liquidators were appointed on 1 July 2010, then the relation-back period would run from 1 January 2010 to 1 July 2010).  

There are however 2 defences to a liquidator’s claim that a transaction is an unfair preference and is voidable under section 588FE of the Act.  

The first defence applies in the situation where an order would materially prejudice a right or interest of a person, and it can be proven that:  

  • the person became a party to the transaction in good faith; and  
  • at the time when the person became such a party:  
  1. the person had no reasonable grounds for suspecting that the company was insolvent at that time, or was likely to become insolvent; and  
  2. a reasonable person in the person’s circumstances would have had no such grounds for these suspicions.  

The second defence applies in situations where the person provided valuable consideration under the transaction, or has changed his, her or its position in reliance on the transaction.

Recent developments regarding preferential payments and floating charge assets

The case

The recent Federal Court decision in Cook (as liquidators of Italiano Family Fruit Company Pty Ltd (in liq)) v Italiano Family Fruit Co Pty Ltd (in liq)1 has meant that secured creditors (in this case, the National Australia Bank) may now have priority with respect to the proceeds of preference recoveries, where employee entitlements such as wages or superannuation have been paid out of floating charge assets. The relevant facts are as follows:

  • Following their appointment, the liquidators realised certain assets which were subject to NAB’s floating charge, which resulted in proceeds of approximately $500,000.  
  • These proceeds were not paid to NAB, but rather to employees of the company who enjoyed priority under section 556 of the Act (their claims were assessed at $245,983), and were subsequently applied to meet the costs of the liquidation.  
  • Although the liquidators liaised with NAB about realising the charged assets, they did not inform NAB of their intention to pay the employee entitlements, and proceeded to make the payments without NAB’s knowledge or consent.  
  • The liquidators subsequently settled unfair preference claims made against 2 former creditors, and the proceeds of those settlements were received in full.  
  • It is the balance of those proceeds (the liquidators’ fees having been deducted) which formed the basis of the liquidators’ application seeking directions as to how the remaining funds (approximately $50,000) should be distributed. That is, should they be paid to NAB, a secured creditor owed approximately $1.2 million, or should they be distributed amongst the unsecured creditors, with claims in excess of $3.8 million?  

Are preference recoveries subject to a charge?

The primary issue considered by the court was whether the preference recoveries were caught by NAB’s charge. The early cases which consider this issue draw a distinction between preferential transactions involving a transfer of money on the one hand, and a transfer of property, such as a conveyance of land or the transfer of a specific chattel, on the other.  

It was generally accepted in those cases that where monies had been preferentially paid and were subject to a charge at the time of payment, the monies subsequently recovered were not the same as the charged money.  

That is, the monies required to be paid by a creditor did not revest in the company, but rather were an amount equal to the value of the preferential payment, and not subject to the charge. Conversely, preference recoveries regarding specific property resulted in the title to that property being revested in the company or the liquidator, and the property remained under the prior charge.  

The court observed that these earlier cases which held that preference recoveries were not subject to a charge (but then went on to draw a clear distinction between specific property and money recoveries) have produced uncertainty. In particular, they raise questions about the power of liquidators to sell the proceeds of preference recoveries. If the proceeds cannot be seen as property of the company, then it should follow that the proceeds of those recoveries cannot be sold.

The Australian position

The UK and Australian courts cannot seem to agree on the current position in this regard. The English courts maintain that preference proceeds are not the property of the company, but are held on trust for unsecured creditors. The Australian courts have diverged from this view, and this case confirms the Australian position to be:  

  • Preference proceeds are property of the company;  
  • Liquidators are entitled to sell the proceeds; and  
  • Liquidators are able to claim the costs/expenses of the winding up in addition to his/her fees as they are property of the company.  

Section 561 of the Act requires a controller of floating charge assets to pay priority debts from floating charge assets, however, this is only in circumstances where it is clear that the company’s free, or noncharged assets will be insufficient to pay out these priority claims. In this case, the liquidators made only an initial assessment of the company’s assets and did not take into account potential realisations.  

The decision

Despite the common perception that the proceeds of preference recoveries are not available to secured creditors (being for distribution amongst unsecured creditors only, and to meet liquidators’ costs), it was held in this case that NAB did in fact have a priority claim to the proceeds over ordinary unsecured creditors. This is because NAB’s funds were essentially misapplied by the liquidators in breach of trust.

NAB was therefore entitled to be subrogated to the rights of the priority creditors who were paid out with bank’s funds, on the basis that had the employees’ claims been paid after the settlement monies had been received from the 2 preference actions, those settlement monies would have been used to pay out the employees.

The court’s reasoning was that it would have been inequitable for the company, and its unsecured creditors, to receive a benefit produced by the liquidators’ breach of trust.  

The decision means that secured creditors such as banks may now be afforded a higher claim over priority creditors where floating charge assets have been used to pay out these creditors.