What is an Unfair Preference Payment?

So you have received a scary looking letter from a liquidator informing you that you have received an unfair preference payment from a company they are now liquidating, and demanding you pay it back.

What are preference payments?

Preferences are payments that give a creditor an advantage over other creditors in the liquidation process. Any payments or transfers made to a creditor before to liquidation may be recovered by liquidators in certain circumstances. Liquidators can recover preferential payments; however, recovery may require a court order to do so if the payment is not made voluntarily.

What can you do about it?

If you are the unfortunate recipient of such a demand, you should first assess whether any of the defences apply, in which case you will not be ordered or required to repay those funds. Those defences are, in summary,

1. “Good Faith” Defence – here, if you can show you did not know or suspect that the company was insolvent (unable to pay its debts as and when they fell due) at the time the payment was made, the defence will apply.
2. Running Account Defence – The running account ‘defence’ does not provide a complete defence to a claim, but may reduce the amount to be repaid to the liquidator.  Here, where there are multiple transactions (an “active account”) between the Debtor and Creditor over the relevant six month period, the court will assess the amount of the preference not as the total amount of all payments made over the period, but rather as the difference between the maximum amount of the debt during the six month period, and the amount owed on the “relation-back” date, so only the ‘profit’ is considered the unfair preference. .
3. Doctrine of Ultimate Effect Defence – The Court will consider the net effect of a payment when considering whether it amounts to an unfair preference by examination of, for example, trading accounts. The High Court has summarised this doctrine as follows: “Resort must be had to the business purpose and context of the payment to determine whether it gives the Creditor a preference, priority or advantage over other Creditors, the payment must ultimately result in a decrease in the net value of the assets that are available to meet the competing demands of the other Creditors.” (Airservices Australia Pty Ltd v Ferrier (1996) 185 CLR 483). Accordingly, if you received the payment in question for supply of certain goods, which goods were on-sold to companies’ benefit, this defence may apply.

Defences

Some practical matters a lawyer and the Court may look at in determining the application of such defences include:

• If there was a history of delay in payment;

• Whether any delay in payment would or ought to ring alarm bells with the recipient of the funds;

• Any other factors which would indicate insolvency;

• The ongoing nature of commercial relationships;

• Whether the monies were receipted good faith;

• The trading accounts between you and the company in liquidation;

Conclusion

So if you’ve received such correspondence from a liquidator, all is not lost. You should talk to a lawyer about the application of defences, and how best to respond.