Unfair Preferences, Creditors Beware
7 March 2017
There are provisions in the Corporations Act that allow an insolvent company’s Liquidator to recover property or compensation for the benefit of creditors. Certain transactions entered into by the company may be deemed to be ‘voidable’. Unfair preferences are a type of voidable transaction.
What is an unfair preference?
Section 588FA of the Corporations Act deals with unfair preferences and provides that a transaction is an unfair preference given to a creditor of the company if, and only if:
- The company and the creditor are parties to the transaction (even if someone else is also a party); and
- The transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor, more than the creditor would receive from the company in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in a winding up of the company
Even if the transaction is entered into, is given effect to, or is required to be given effect to, because of an order of an Australian court or a direction by an agency.
Any creditor that has entered into a repayment arrangement with a debtor is at risk of being required to repay amounts received if the debtor company is wound up within 6 months of any preferential payments being made.
An unfair preference gives one creditor an advantage over other creditors of the company as they have received full or partial payment of their debt whilst other creditors may have received nothing. If all creditors were to prove in the winding up, they may (depending on the availability of company assets for distribution) receive a cents-in-the-dollar return which results in a payment proportional to the quantum of their debt.
Timeframe for recovery of an unfair preference
A company may enter into a payment arrangement with a creditor in the months or years leading up to the company being wound up. The payments made under this arrangement may be deemed to be voidable transactions if they are made within a specific timeframe prior to the company being wound up and at a time when the company is deemed to be unable to pay their debts as and when they fell due.
To determine if payments are voidable, a Liquidator will calculate what is known as the Relation-Back Period for the company. Any payments made during this period that are unfair preferences will be voidable and may be recoverable by a Liquidator.
The Relation-Back Day is determined as, if the company was previously in voluntary administration, the date of administration. If there was a winding up order against the company prior to the date of voluntary administration, in this instance the relation back day will be the date the earlier winding up application was filed. Otherwise the earlier of the date of the filing of a winding up application and the date the members resolve to wind up the company.
The Corporations Act provides in Section 588FE(2) that an unfair preference will be voidable if:
(a) It is an insolvent transaction of the company; and
(b) It was entered into, or an act was done for the purpose of giving effect to it:
(i) During the 6 months ending on the relation-back day; or
(ii) After that day but on or before the day when the winding up began.
In summary, any unfair preference payments made to a creditor during the 6 month period prior to the relation-back day, will be a voidable transaction and may be recoverable from a creditor by the Liquidator.
How will a Liquidator recover an unfair preference?
Once a Liquidator has identified an unfair preference that is a voidable transaction, he/she will request the creditor to repay the amount to the company.
A Liquidator may apply to the Court for an Order. If the court is satisfied that a transaction of the company is voidable because of Section 588FE, the Court may make an order under Section 588FF of the Corporations Act.
The funds recovered by the Liquidator will be added to the pool of company assets and used to make a cents-in-the dollar distribution to all creditors of the company, so each creditor will receive a return proportional to the amount of their debt.
If you are a creditor of a company and have been negotiating with a company to receive payments of an outstanding debt, it is important to be aware that should the debtor company be wound up, the payments you received may be deemed to be voidable unfair preference payments. A Liquidator has the right to recover these payments from you.
If you have any queries in relation to what constitutes an unfair preference, or if you would like advice in relation to your specific business circumstances, contact Rodgers Reidy now for a confidential discussion. Obtaining the right advice at the right time can help protect your business.
1. ASIC Information Sheet 45 – Liquidation: A Guide for Creditors