An unfair preference claim occurs where a creditor has received an advantage over other creditors, by receiving payment (or other type of transaction) for their outstanding liabilities and does so in circumstances where they knew, or ought to have known, that the company was insolvent. The payments must have been received within the six month period prior to the commencement of the liquidation.
For example, say you have a client or customer who owes you $30,000 and is behind on their payments. In the six month period before they enter liquidation, they pay you to clear the debt and stay on good terms. However, in doing so, they have not paid their other creditors. The Liquidator may claim that the payments you received during this six month period are unfair preferences and repayable to the company.
However, there are ways to fight the claim so that you aren’t left further out of pocket.
1. Running account defence
The liquidator is required in an unfair preference claim to demonstrate that the payment(s) gave you an advantage over the other creditors as a direct result of the payment (i.e. you received more than you would have received in respect of the debt if the transaction were set aside and you were to prove for the debt in the liquidation). So, you have an opportunity to counter demonstrate that it did not give you an advantage. Where there has been ongoing trade and ongoing supply during the relevant period where the debt has gone up and down, liquidators sometimes chase the payments back without considering that there was further supply in that period.
TIP - Creating a chronological list of the customers transactions, including invoices raised and payments made during the relevant period of the alleged unfair preference(s) to identify what the outstanding debt was at any given point in time, is advisable. This gives you a running account. Look for the point in time where the debt owing to you was at its highest and then subtract the amount still owing to you at the date of the liquidation. This gives you the potential quantum of the potential preference.
2. Payments were received in good faith
A defence to not have the credited money taken away by the liquidator is to demonstrate that the money was received in good faith, without any prior knowledge the client/customer was insolvent and there were no reasonable grounds to suspect they would be. This can’t be demonstrated by simply saying you weren’t paying attention; you need to show that there were no reasonable signs that could be recognised by a reasonable person that the company or client was on insolvent.
TIP - Review what communications were had with the client/customer and what demands if any were issued in an attempt to obtain repayment. Common factors which may suggest a knowledge of insolvency to a reasonable person include:
- Engaging a solicitor or debt collection agent to recover the debt,
- Cancelling the client/customers account or varying the payment terms to COD
- Refusing supply until outstanding invoices are repaid
- Commencing legal action
3. Set-off debt has occurred
As a creditor, you may be able to set-off what is owed to you against the unfair preference claim made However, the right to set-off is not available when the creditor had notice of the company’s insolvency.
4. It was a secured debt
For a liquidator to bring an unfair preference claim against you, the payment must be made in relation to unsecured debts. This means if you can demonstrate that you held security over assets of the client/customer, there may be no unfair preference given. The most common form of security is the retention of title over the goods supplied to the client/customer until they goods are paid for in full.
Have you been targeted for an unfair preference claim?
Shaw Gidley are experts in restructuring, turnaround and insolvency and provide free initial advice on these matters. Please contact our offices on (02) 4908 4444 or (02) 6580 0400.