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If you own a business, you’ll know how difficult it can sometimes be to chase up payment from clients or customers. This can be so difficult that many businesses decide to enter into payment arrangements with their customers. This is so that there is a steady cash flow up until the time that the customer has repaid the debt. But when can accepting such payment arrangements be viewed as a preference payment? This article explains what preference payments are and what you can do to avoid a potential claim.

What is a Preference Payment?

If a company goes into liquidation, they must pay their debts back to those that they owe (creditors). If one creditor is given preferential treatment over other creditors that are also owed money, this is called a preference payment. It is an illegal practice.

To recover a preference payment, a liquidator can seek recovery of the funds directly from the creditor. If that fails, an order of the court will need to be obtained. The ability to recover a preference payment is only available to a liquidator.

A preference payment does not apply to a creditor that holds a valid security interest in the assets of the company. This is namely when the value of the secured assets is greater than the payment amount. Validly registering such a security interest is important. If you haven’t registered the interest validly, the liquidator may render it void. If the security interest is also created within six months of the date of liquidation, it may also be considered a preference.

Why Recover Preference Payments?

When a company appoints a liquidator, the liquidator’s duty is to distribute the assets of the company to its creditors on an equal basis. When doing this, a liquidator must determine whether the company paid a creditor out before their  liquidation. They must also prove that this treatment was not fair or equitable to the other creditors.

For example, let’s say you are a creditor owed $100,000. Another company is also owed $100,000 and has already received payments before the liquidation amounting to $70,000. You would likely not consider this as fair or equitable and would want the liquidator to void those transfers and distribute the money evenly to all creditors, including yourself.

What are the Legal Elements of a Preference Payment?

If a liquidator takes the matter to Court, they must establish that a preference payment took place. To do so, they must prove that:

  • a transaction was entered into;
  • such transaction was between the company and its creditor;
  • such transaction took place when the company was insolvent. For a preference payment, the company must have either been insolvent at the time of the transaction or became insolvent because the transaction was made;
  • such payment(s) took place within the legal period after the relation-back day. The relation back-day is the recognised commencement day of the liquidation;
  • the transaction gave the creditor an advantage over the other creditors of the company; and
  • the creditor suspected, or had reason to suspect, that the company was insolvent.

To be considered a preference payment, the creditor must ultimately have received more from the transactions than they would have received had they returned the money paid by the company. If this is not the case, then it is likely that no advantage or preferential treatment occurred.

I Think I May Have Received a Preference Payment. What are my Defence Options?

If you have received a preference payment and wish to defend it, you must prove that you:

  1. provided something in return for the payment (e.g the supply of goods/services, a loan, etc);
  2. received the payment in good faith; and
  3. had no reason to suspect that the company was insolvent.

Time Limits for Recovering a Preference Payment

A liquidator must file proceedings generally within three years from the relation-back day.

How to Avoid Preference Payment Claims

There are a number of ways that businesses can avoid preference payment claims. You may wish to have a comprehensive terms and conditions agreement in place. On this agreement, include your rights to register security interests on the Personal Property Securities Register (PPSR). Also, prescribe your legal ability to obtain personal guarantees from the company’s directors. It is also important that if you are a secured creditor, that you register your security interest validly on the PPSR.

Key Takeaways

If a liquidator contacts you regarding your receiving of an alleged preference payment, it is crucial that you are aware of what exactly a preference payment is. Nesure that you are aware of the elements of preference payments and your defences if you are accused of accepting one. If you have any questions about preference payments, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

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