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Unfair Preference Claims

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What is an Unfair Preference Claim?

An Unfair Preference Claim occurs when a liquidator seeks to recover payments or asset transfers made by a company to a creditor shortly before the company’s insolvency. This is done on the basis that those payments unfairly preferred one creditor over others. The aim is to preserve the principle of pari passu, meaning that all unsecured creditors should be treated equally during the liquidation process.

The Legal Framework

Sections 588FA to 588FI of the Corporations Act 2001 govern the process of bringing an Unfair Preference Claim. These provisions allow a liquidator to challenge certain transactions that occurred within a specific “clawback” period before the liquidation or administration of a company. The clawback period is usually six months before the Relation Back Day (the date when the liquidation process begins), but can extend to four years for transactions involving related parties.

The critical test is whether the creditor received more than they would have in the liquidation. If the payment or transfer of assets gave the creditor a preferential position compared to other creditors, the liquidator has the right to seek its recovery.

The liquidator has three years from the relation-back day to file a claim, or 12 months from the appointment of the liquidator, unless the Court extends the time.

Key Conditions for an Unfair Preference Claim

For a liquidator to successfully pursue an Unfair Preference Claim, they must prove the following conditions:

1. The company must have been insolvent at the time of the transaction, or it must have become insolvent as a result of the transaction.
2. There must have been a debtor-creditor relationship between the company and the recipient of the payment or transfer.
3. The recipient must have been an unsecured creditor at the time of the transaction. This is important because secured creditors are generally not subject to Unfair Preference Claims.
4. The creditor must have received more than they would have received in the liquidation process, where all creditors share in the remaining assets of the company proportionally.

The Relation Back Day

The Relation Back Day determines the start of the clawback period. This involves:

• For a voluntary liquidation: The date the liquidation began.
• For a court-ordered liquidation: The date the winding-up application was filed.
• For a creditors’ voluntary liquidation: The date the application for winding up was filed with the court.

The liquidator can only challenge transactions that occurred before this date, within the prescribed clawback period.

Running Accounts and the Ultimate Effect Doctrine

A Running Account occurs when a creditor and company have an ongoing business relationship involving regular transactions. In such cases, payments made during the relevant period may not be considered an unfair preference if they are tied to a continuing supply of goods or services. The courts examine the net effect of the relationship, rather than focusing on individual payments. If the overall debt to the creditor is substantially reduced by ongoing supplies, the payment might not be considered preferential.

Additionally, the Ultimate Effect Doctrine comes into play. Courts look at whether the payment ultimately benefited the creditor at the expense of the general body of creditors. If the payment helped to secure goods or services that benefited the company’s ongoing operations, it might not be considered an unfair preference.

Defences Against Unfair Preference Claims

If you’ve been accused of receiving an unfair preference, there are several defences you might be able to raise:

1. Good Faith Defence: Under section 588FG of the Corporations Act, a creditor can defend an Unfair Preference Claim if they received the payment in good faith and had no reasonable grounds to suspect that the company was insolvent. Essentially, if you acted in good faith and weren’t aware of the company’s financial troubles, you may be able to avoid liability.
2. Running Account Defence: If there was a Running Account between you and the company, the liquidator will assess the totality of your transactions, not just individual payments. This defence can be used if the payment was part of a continuing business relationship.
3. Set-Off Defence: In certain circumstances, creditors may be able to use a set-off defence if they are owed money by the insolvent company. However, this defence is limited and may not apply if the creditor knew or should have known that the company was insolvent when the set-off occurred.
4. Secured Creditors: If you are a secured creditor, you may not be subject to Unfair Preference Claims. For example, if you have a valid security interest over the company’s assets, your priority rights generally override the unfair preference provisions.

Managing the Risk of Unfair Preference Claims

Creditors can reduce the risk of a claim by:

• Receiving timely payments.
• Monitoring for signs of insolvency, such as unpaid invoices, late payments, or defaults on credit reporting agencies.
• Seeking security interests to protect yourself in case of insolvency. This could include retention of title clauses, PPSR entries or personal guarantees from company directors.
• Ensuring your business has terms of trade and indemnities that protect you in case an Unfair Preference Claim is made.

Conclusion

If you are faced with an Unfair Preference Claim, it is essential to understand the elements involved and the possible defences available to you. Taking proactive steps to secure your debt, monitor your customers, and obtain legal advice can help you manage the risks and minimise exposure to potential claims.

If you receive a demand from a liquidator for repayment of an unfair preference, it is vital to seek legal advice immediately to understand your position and maximise your chances of successfully defending the claim.

Contact our Brisbane office today on (07) 3229 4459 to speak with one of our experienced insolvency lawyers.

Focused on Results

It is essential that you have experienced solicitors when dealing with an Unfair Preference Claim. If a liquidator is trying to claw back what they claim is a preferential payment, our litigation and dispute resolution lawyers will make sure your rights are protected.

Aitken Whyte Lawyers Brisbane are focused on results. Our solicitors can assist you with all insolvency matters. Call today to discuss your needs.

Office Location and Contact Details

Brisbane

Aitken Whyte Lawyers Brisbane
2/414 Upper Roma Street
Brisbane QLD 4000

Ph: 07 3229 4459
Fax: +617 3211 9311
E: enquiries@awbrisbanelawyers.com.au