Insights

In brief – Preference claims intended to prevent favouritism

The reason for preference actions is to ensure that the assets of an insolvent person or company are distributed equally among the creditors and that no one creditor receives a preference over the others. However, if your business receives a preference claim from a liquidator, don’t assume you can’t fight back.

Beware of debtors going into liquidation

It is not uncommon for a diligent credit controller to chase and recover from a recalcitrant principal or head contractor debts which are well and truly past their due date, only then to find that the debtor goes into liquidation and the liquidator seeks to claw the money back.

If and when your business receives such a claim it should not, as so many do, write back saying, in effect:

"We were not preferred. We had to chase our money."

Such a response is music to the liquidator’s ears.

Liquidator must prove three things in a preference claim

What a liquidator or a trustee in bankruptcy (because preferences exist in bankruptcy as well) needs to do is:

  • Establish that at the date your business received the payment the debtor company was insolvent.
  • Establish that the payment was made within six months of the commencement of the winding up.
Generally that means within six months of the filing of the winding up application but it can, in some cases, be a little longer.
The six month period is extended to four years where the entity that receives the money is found in the Corporations Law to be a "related entity" to the debtor. A related entity includes a director of the company paying the money, his or her spouse, another company within the group as well as others. 
  • The liquidator has to show that the creditor was "preferred".
At a practical level, the liquidator must establish that the creditor who received the alleged preference received more than it would have in the winding up.

How to respond to a liquidator’s preference claim

One of the hardest things that a liquidator has to do is to prove that a company was insolvent at the time your business received payment from it. It is not unreasonable to ask the liquidator to provide evidence of the assertion that the debtor company was insolvent at that particular time.

A liquidator often labours under the difficulty of having uncooperative directors who have not provided the liquidator with all of the books and records of the company. Consequently the reconstruction exercise of the company’s accounts may be just be too difficult for the purposes of pursuing a preference, especially if that preference is for a relatively small sum.

Even if the liquidator can prove insolvency, there are still defences available to the preference claim.

Defence against claim you knew the company was insolvent

Your business may have a defence against the claim that you knew the company you were dealing with was insolvent on the basis of two criteria.

First, your business needs to be able to demonstrate that at the time it became a party to the transaction, generally defined for the purpose of preferences as the time when it received the money, it had no reasonable grounds of suspecting that the company it was dealing with was insolvent or had become insolvent as a result of the transaction.

The second criterion is that a reasonable person in your business’ circumstances would have had no such grounds for suspecting insolvency.

Suspicion of insolvency

For your business to have a suspicion of insolvency, all the liquidator needs to show is that your business had an apprehension amounting to an opinion which was not supported by sufficient evidence that the company it was dealing with might be insolvent.

Care should therefore be taken in drafting any letter or e-mail your credit department sends to the debtor business. Communication which suggests that your business has formed the suspicion that the debtor might be insolvent will help the liquidator make a case against you.

Reasonable grounds for suspecting insolvency

In determining whether or not a business has reasonable grounds for suspecting insolvency, the Court of Appeal in Neil Robert Cussen as Liquidator of Akai Pty Ltd (in liq) v Commissioner of Taxation [2004] NSWCA 383 ruled that the test to be applied is whether or not a reasonable person would have a suspicion that the company it was dealing with was insolvent, based on what was actually known to the creditor business at the time it dealt with the debtor company.

In other words, the courts will not allow a liquidator to argue against a "reasonable grounds" defence on the basis that the creditor business did not make reasonable enquiries.

The court will simply say what enquiries did the creditor business make? Would a reasonable person, based on those enquiries, have been suspicious that the debtor company was insolvent at the time it made the payment?

If the answer to that last question is no, then in all likelihood the liquidator will fail in its preference claim.

Take care with debtors who may be insolvent

If in your business you find yourself dealing with the debtor who is behind in its payments and has failed to meet promises as to payment, either orally or by its cheques being presented and then you subsequently get paid, then there is the beginning of a possibility of a preference claim arising.

You should always remember that generally if you receive the payment outside of the six-month period from the commencement of winding up proceedings, then no preference issue arises at all.

If you believe the debtor may be insolvent then some care should be taken as to how you receive payment. In some circumstances, receipt of payment through a third person, provided it did not come from the debtor at all does not give rise to preference issues.

If you are unlucky enough to receive a preference claim then consider your position. A carefully worded letter to the liquidator from someone who understands insolvency law may be all that is needed to make the claim go away.

This article has been published by Colin Biggers & Paisley for information and education purposes only and is a general summary of the topic(s) presented. This article is not specific legal advice. Please seek your own legal advice for any questions you may have. All information contained in this article is subject to change. Colin Biggers & Paisley cannot be held responsible for any liability whatsoever, or for any loss howsoever arising from any reliance upon the contents of this article.​