Navigating a relationship with a financially distressed debtor is both stressful and challenging. Any transaction made by a distressed company to unsecured creditors within the six months prior to the relation-back day (or up to four years for transactions involving related entities) may be subject to an unfair preference claim. Most commonly, the relation-back day typically aligns with the appointment date of an administrator or liquidator, or the day on which the winding up application was filed.

Unfair preference claims allow the liquidator to “claw back” funds that were transferred by the company. The basis of the claim is that it creates an unfair advantage over the other creditors.

The Good Faith Defence to an Unfair Preference Claim

S 588 FG (2) of the Corporations Act 2001:

  1. The creditor received the payment in good faith; and
  2. The creditor had no reasonable grounds for suspecting the company was insolvent and a reasonable person in the creditor’s circumstances would not have suspected insolvency; and
  3. The creditor provided consideration.

The most challenging aspect of this defence is proving the creditor had no “reasonable suspicion” of insolvency. This is because creditors usually contact the distressed debtor to request payment, and then become informed about the financial difficulty as the justification for delay. There is usually a digital or paper trail for an insolvency practitioner to call upon to indicate the creditor possessed knowledge of insolvency. Creditors should therefore exercise caution when seeking repayment, as notices and letters of demand will only inhibit the success of a “good faith” defence.

Risk Reduction Strategies for Creditors

Become a Secured Creditor at the Commencement of Dealings

  • Secured creditors are not subject to unfair preference claims. Consider registering a security interest on the PPSR (Personal Property Security Register). This can include fixed and floating charges over property owned by the company.

Trade Using Cash-on-Delivery

  • Cash-on-delivery reduces “days receivable” and prevents the buildup of large debt. This method obviously has its own limitations and may not be compatible with some business models.

Third Party Payments

  • If you have a debtor company, payment from a third party (outside of the transaction) may be a viable option. Third party payments can still be subject to unfair preference, so consult with your lawyer regarding execution of transfer and appropriate third parties. The critical issue is whether the payment has diminished the assets of the debtor company available to creditors.

Other Considerations

Negotiate with the Liquidator

  • Open and honest communication with the appointed liquidator is often the best way to navigate an unfair preference claim. Liquidators are concerned with commercial viability and will be unlikely to pursue small sums of money.