If you own a business, you’ll know how difficult it can be getting paid. So much so that many businesses enter into payment arrangements with their customers so that there is, at least, a steady cash flow up until the time the debt is repaid. But when can accepting such payment arrangements be viewed as a preference payment? For instance, if a liquidator is appointed over the debtor company. Below, we take a closer look at preference payments, defences to a claim and what you can do to assist avoiding a potential claim.

What is a Preference Payment?

A preference payment (or preferential payment) is a payment or asset transfer that can give a creditor an ‘advantage’ over other creditors. Typically, preferences are payments of money and any payment made to a creditor before a liquidation may be eligible for recovery by a liquidator.

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 and not to a provisional liquidator, administrator, receiver or manager.

According to the Personal Property Securities Act (PPSA), a preference payment does not apply to a creditor that holds a valid security interest in the assets of the company – namely, when the value of the secured assets are greater than the payment amount. Whether such a security interest is validly registered is important. If the security is not created or registered properly, then the liquidator may render it void and the debt may then be deemed to be an unsecured debt. If the security interest is also created within six months of the relation back day (which is the date the liquidation is deemed to have started), then 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 a particular creditor received treatment before the company’s liquidation which was not fair or equitable to the other creditors. 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 (i.e. claw back the $70,000) to distribute evenly to the other creditors including yourself. The creditor who received the preference would also be paid as part of this equitable distribution.

What are the Legal Elements of a Preference Payment?

If a liquidator takes the matter to Court, it must satisfy the Court of the following elements:

  • A transaction was entered into;
  • Such transaction was between the company and its creditor;
  • Such transaction took place when the company was insolvent (i.e. could not pay its debts as and when they fell due. 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. The duty is on the liquidator to prove the insolvency);
  • Such payment(s) took place within the statutory period from the relation-back day. These periods are typically six months for non-party related transactions, four years for related party transactions and ten years if there is evidence of an attempt to defeat, delay or interfere with the rights of creditors;
  • The transaction gave the creditor an advantage over the other creditors of the company (if, for example, the balance owing decreased, this is usually deemed the potential preference amount. If, on the other hand, the balance owing increased, there is likely no preference/advantage, as the transactions disadvantage the creditor); 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?

Section 588FG of the Corporations Act 2001 provides a statutory defence and the onus is on the creditor to satisfy all three elements:

  1. The creditor gave valuable consideration for the payment (i.e. the supply of goods and/or services, a loan, etc.);
  2. The creditor received the payment in good faith (i.e. normal trading conditions, not cut off supply or threatened legal action, etc.);
  3. The creditor had no reason to suspect that the company was insolvent (i.e. could not pay its debts as and when they fell, which is based on a reasonable person).

Time Limits for Recovering a Preference Payment

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

Key Takeaways

Businesses can avoid preference payment claims by having comprehensive terms and conditions in place, including a right to register security interests on the PPSR (if applicable) and obtain a personal guarantee(s) 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.

If a liquidator contacts your seeking payment for an alleged preference, we strongly recommend you obtain legal advice. LegalVision’s team of skilled commercial lawyers can assist you by ensuring you have the necessary documentation in place, that your PPSR security interests are validly registered and by advising you on your position if a claim is made. Questions? Get in touch.

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