Unfair preference payments- protect yourself from the void

What are unfair preference claims?

A preference is defined as where a creditor receives payment and the payer is insolvent at the time, and the creditor has received more than they would have in an orderly winding up of the payer.

A Liquidator of an insolvent company has the powers to recover unfair preferential payments from unsecured creditors. The rationale for this power is to prevent creditors exerting undue pressure on a company with limited funds that is heading for liquidation in order to obtain payment of their debt ahead of other creditors. By clawing back preferential payments, the Liquidator restores the funds to the pool available to all creditors to be distributed on an equitable basis.

In order for a Liquidator to recover an unfair preference payment, they must first establish:

  • The transaction was between the company and its creditor ;
  • The company was insolvent at the time the unfair preference was paid to the creditor;
  • The payment to the preferential creditor falls within 6 months prior to the date of liquidation ;
  • The preferential transaction resulted in the creditor receiving more than they would have received in the event of a liquidation.

What defences can I rely on?

Firstly, the payments are voidable not void. That is, the Liquidator must establish a number of facts and prove the claim. Even if the liquidator has deemed that the transaction is a preferential payment, the transaction may not be voidable if:

  • The payment was made due to the creditor providing a benefit to the company (e.g. goods or services provided of current consideration);
  • The creditor received payment in good faith;
  • At the time when the creditor received the payment, they had no reasonable grounds to suspect that the company was insolvent and that a reasonable person in the same circumstances would not have suspected insolvency; or
  • A continuing business relationship exists, which allows for all payments and supply of goods and services provided in the 6 months prior to liquidation to be considered one transaction (running account). This means supply provided in the 6 months prior can be offset against payments received to mitigate or eliminate completely the exposure to a claw back.

What is a Liquidator looking for when investigating unfair preferences?

Incidents that will raise a Liquidator’s suspicions of a potential preference payment are:

  • Rounded payments not directly attributable to a specific invoice.
  • Stop of supply.
  • Payment after formal or statutory demands.
  • Written admissions of insolvency by the debtor (this will unlikely to be a straight-out admission, however, beware of the phrases such as ‘no cash available’ or ‘awaiting receipt before payment can be made’ or ‘request for payment arrangement’).

It is important to remember that you shouldn’t base a business decision solely on avoiding a preference action, however the above factors are useful to consider as part of the decision-making process.

How to protect your interests?

Preferential payments can only be recovered from unsecured creditors. Accordingly, you should consider the option of registering a security interest on the Personal Properties Securities Register (PPSR). This will ensure that in the event of a liquidation, if the value of your security is higher than payments received, you are a secured creditor and therefore cannot be pursued for an unfair preference payment claim.

Most critically, your business should have a strong documented credit policy that is followed for all customers. This is important as exerting pressure to obtain payment may not be considered bad faith if the steps taken to obtain payment from (what may be an insolvent) company aligns with the steps taken to extract payments from all other customers who breach their credit terms, most of who will not be insolvent. That is, payments are recovered under usual circumstances and applied to all customers breaching usual trading terms. This can assist in establishing that you did not pursue recovery because of concerns about insolvency, rather because payment was due or overdue and you followed standard process.

If you suspect your customer is insolvent, William Buck’s insolvency experts will be happy to discuss your options.