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“Don’t take a slice of my pie!” Unfair Preference Payments

Commercial Law

Anyone who provides goods or services to a company expects and deserves to be paid.

Unfortunately in these times of economic uncertainty many companies are suffering cash flow issues and are extending themselves beyond their means. Creditors are too often being left in the cold.

Upon the liquidation of a company, the Corporations Act 2001 gives right to a liquidator to dismantle a company and sell off its parts in an effort to raise funds for creditors.  The creditors are then left to share what little is left after the secured creditors have taken the juiciest portions.

It is tough enough not recovering a debt that is due to you.  It is perhaps even crueller, though, for those who have had their properly incurred debts paid by the company prior to its liquidation, to be ordered to return that money in full.

Under section 588FA of the Corporations Act, a liquidator has the power to investigate the financial affairs of the company and to regulate the repayment of debts. One step that a liquidator can take is to see if there have been any ‘unfair preference payments’ to certain creditors of the company, and then take efforts to claw those payments back, to then distribute amongst all creditors.

A payment may be considered an ‘unfair preference payment’, if it occurs (up to) 6 months prior to the appointment of a liquidator or administrator, and results in the paid creditor obtaining a greater amount than they would have in the normal course of the liquidation.

In other words, you might get a $100,000 debt paid in full 5 months before a company goes into liquidation, only to discover 7 months later that the liquidator may require repayment in full, and then gives you 3 cents on the dollar for your debt.  $100,000 becomes $3,000.

Whilst you might be able to raise a defence against the liquidator’s claim, such a defence will only be successful in certain narrowly defined circumstances, and the manner in which you behave prior to the liquidation, and particularly when you receive the payment, is extremely important.  The onus is on you to prove that you did not have any suspicion that the company may be insolvent when you received the payment, and that no reasonable person in your shoes would have had such a suspicion.

In other words, if you have taken debt recovery proceedings against the company, stopped supply or threatened to stop supply, accepted an extraordinarily late payment or even made a strong demand for late payment, these will be hurdles in any defence against such a claim.

Unfair preference claims can have a severe effect on the health of your company, especially if the money claimed has already been invested in other areas, and therefore much like with your physical health, avoidance or prevention is always the best policy. These claims generally only affect unsecured creditors, and therefore securing your debt, much like the annual flu shot, will go a long way to securing your companies financial stability.

Wherever possible, as a supplier you should always attempt to have in place an agreement that includes a ‘retention of title’ clause, this being a written condition which says that ownership of the goods which you have supplied to your customer does not pass to that customer until you have been paid for those goods in full. Your interest under this clause must also be registered with the Personal Properties and Security Register within 20 business days of the interest being borne.

The inclusion of a personal guarantee clause within your agreements, personally indebting the directors of the debtor to the contract, as well as an assurance as to the companies financial well being, are encouraged.

Further, if you can make inquiries as to a company’s financial health prior to providing it with valuable goods or services (for example, if it owns real property, if it owns substantial commercial assets, if it has substantial revenue and work in the pipeline), this can also assist to mitigate the risk.