Liquidator Demands for Preferential Payment
When a company cannot pay its debts as and when the debts become due, it is insolvent. If a company is insolvent, it must cease operating and will often enter into liquidation. When a company goes into liquidation, and its creditors have to be repaid, there is an order of priority according to the law, by which they should be paid. However, liquidators sometimes make demands for preferential payments. This article discusses liquidator demands for preferential payments when a company is in liquidation.
The priority order is covered by section 556 of the Corporations Act 2001. It is as follows:
- Fees of the liquidator;
- Secured creditors – Secured creditors hold some form of security in the company’s assets, e.g. a mortgage;
- Preferred creditors, e.g. employees;
- Unsecured creditors;
When a liquidator is appointed to wind-up a company, part of its role is to ensure that the assets of the company are appropriately distributed according to this order of priority.
Some transactions entered into by a company that is in financial difficulty are considered voidable transactions. Such voidable transactions may have been made to “related parties” or “unrelated parties” to the company. A party is regarded as a “related party” if a Director of the insolvent company is related by birth, marriage or adoption to that party. An “unrelated party” is a party where there is no such relationship.
A creditor who has received a payment from a company when it was in financial difficulty may receive a demand for preferential payment from a liquidator. A demand for preferential payment asserts that a payment was made by the company when it should not have been and is a voidable transaction. The liquidator seeks return of the payment to ensure that all money and assets are properly distributed to creditors.
When can a liquidator serve a demand for preferential payment?
Payments made in the six months before the date of the start of the liquidation can be recovered from creditors by liquidators where:
- The creditor has received an unfair preference, i.e. received payment not in accordance with how payments should be made in the hierarchy of priorities;
- The creditor was an unsecured creditor, i.e. they did not hold any form of security against the company’s assets;
- The company in liquidation was insolvent a the time the payment was made, and the creditor knew or ought to have suspected that the company was insolvent; and
- The creditor is in a better position due to the payment than they would otherwise be compared to other unsecured creditors.
A liquidator demand for a preferential payment can be made if the relevant payment was within one of these timeframes:
- After the date of insolvency;
- Within six months of the date the company went into liquidation (unrelated parties);
- Within four years of the date of the liquidation (related parties);
- Within ten years of the date of liquidation for a transaction where there is evidence of attempts to defeat, delay or interfere with creditors rights.
Defences to liquidator demands for preferential payments
There are various defences for preferential payment claims made by liquidators. Some of the common defences are considered below. The burden of proof lies with the creditor to prove their defence.
Good faith defence
Section 588FG(2) of the Corporations Act 2001 provides a statutory defence for the demand for preferential payment from a liquidator. For this defence to be made out, the creditor must prove:
- No benefit was received from the relevant transaction; or
- The creditor received the benefit in good faith; and
- When receiving the benefit, the creditor did not suspect and had no reason to suspect that the debtor was trading while insolvent; and
- At the time of the transaction, a reasonable person would not have suspected that the relevant company was trading while insolvent.
Running account with the company
A reduction of the amount claimed by the liquidator may be made where the creditor had a running account with the relevant company, and continuous supply is considered. Section 588FA of the Corporations Act 2001 outlines this defence. The liquidator may consider the business relationship’s entirety to determine whether fewer or more payments from the relevant company to the creditor should be regarded as preferential.
The payment did not increase the value of the creditor’s assets
This defence is sometimes referred to as the doctrine of ultimate effect. If the assets of the company in liquidation are not decreased due to the transaction, then the transaction cannot be considered a preferential payment. This could occur where the payment was made for the supply of goods and services for a lesser value than the company in liquidation could re-sell those goods and services. This defence was considered in Airservices Australia v Ian Douglas Ferrier and Anor (1996) 185 CLR 483.
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