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What is an unfair preference claim?

When a company is wound up in insolvency, a liquidator is appointed to manage the winding up process, investigate the company’s affairs and realise any return to its creditors. In discharging its duties, amongst other things, the liquidator will call in the assets of the company, including any transactions that are voidable under the Corporations Act 2001 (Cth) (Act). Ultimately, a liquidator’s main role is to ensure that any distribution of the company’s assets to creditors is fair and equal (that being, pari passu).

In the lead up to a company being wound up in insolvency, a liquidator will often discover transactions that are classed as an ‘unfair preference’. A payment from a company to its creditor is an unfair preference if:

• the company and the creditor are parties to the transaction; and
• the transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor, more than the creditor would receive from the company if the transaction were to be set aside and the creditor were to prove for the debt in a winding up of the company.[1]

In other words, if a company, prior to its winding up, makes payment to an unsecured creditor for goods or services provided, and the payment is more than what the creditor would have received pari passu if it were to prove for the debt in the company’s liquidation, then the payment is an unfair preference.

When is an unfair preference voidable?

If the liquidator identifies that a transaction is an unfair preference, it can be claimed from the creditor as a ‘voidable transaction’.[2] Most unfair preferences are classed as voidable transactions on the basis they were entered into when the company was insolvent (or caused the company to become insolvent) during the 6 months ending on the relation-back day.[3] The liquidator bears the onus of proving that the company was insolvent at the relevant time.

Unfair preference claims
If a transaction is an unfair preference and is voidable under section 588FE of the Act, the Court has broad powers to order the creditor to repay the money to the company via its liquidator. This stands to be the case even where the creditor was paid in good faith, by the company, for goods or services it provided to the company’s benefit.

Defences
If a creditor receives a letter of demand or claim with respect to an alleged unfair preference payment it made, it may rely on the ‘good faith’ defence. To succeed in proving the defence, the onus is on the creditor to show:

• the payment was received in good faith;
• when the payment was received, the creditor:
  • had no reasonable grounds for suspecting that the company was insolvent (or would become insolvent by virtue of the transaction); and
  • a reasonable person in the creditor’s circumstances (being an ordinary business person) would have had no such grounds for so suspecting; and
• the creditor provided valuable consideration for the payment.[4]

Grounds for suspecting insolvency are unconfined by the Courts and vary depending on each case’s circumstances as no two cases will be entirely analogous for the purposes of proving the ‘good faith’ defence. A suspicion of insolvency requires more than an idle wandering – it is a positive feeling of actual apprehension or mistrust without sufficient evidence.[5] Rather than being considered in isolation, reasonable grounds to suspect insolvency must be considered cumulatively and with respect to the commercial context underpinning the unfair preference.[6]

Alternatively, if the creditor can show that it received no benefit because of the transaction, the Court is unable to make an order under section 588FF of the Act voiding the transaction.  In this case, the creditor does not need to establish the ‘good faith’ defence.

Summary
In a nutshell, in determining whether a payment is preferential, the Court will consider whether the transaction:

• was entered into (or a benefit was received);
• was between the company and its creditor;
• was entered whilst the company was insolvent or caused the company to become insolvent;
• was entered during the relevant period[7];
• caused the creditor to receive more than what it would have been entitled to if it were to prove for its debt in liquidation amongst other creditors; and
• was entered by a creditor who had reasonable grounds for suspecting that the company was insolvent, and a reasonable person in the creditor’s circumstances would have had grounds for so suspecting.

Most unfair preference claims relate to payments made by a company to its creditors, however, the principles also extend to cases of bankruptcy in which bankrupts have made preferential payments to creditors leading up to sequestration.[8]

There is no jurisdictional limit in Western Australia on the quantum of an unfair preference payment that can be claimed. The Supreme Courts and Federal Court of Australia have jurisdiction to determine unfair preference claims of any amount as they are claims arising under the Act. In Western Australia, the Magistrates Court of Western Australia has jurisdiction to determine unfair preference claims not exceeding $75,000.

Should you suspect that you may have received an unfair preference payment from a company, consider seeking legal advice.

[1] Corporations Act 2001 (Cth) s 588FE (definition of ‘voidable transaction’).
[2] The relation-back day of a company that is wound up in insolvency by court order is usually the day that the winding up application was filed with the court.
[3] Corporations Act 2001 (Cth) ss 588FG(2).
[4] Hussain v CSR Building Products Ltd [2016] FCA 392 [194].
[5] Heavy Plant Leasing Pty Ltd (In Liquidation) (ACN 151 786 677) [2018] NSWSC 707 [55] citing Sydney Appliances Pty Ltd (in liq) v Eurolinx Pty Limited [2001] NSWSC 230.
[6] See generally, Corporations Act 2001 (Cth) ss 91 and 588FF.
[7] See generally, Bankruptcy Act 1966 (Cth) s 122.
[8] See generally, Bankruptcy Act 1966 (Cth) s 122.

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