This is the third part of a 3-part series on a practical summary of the law concerning unfair preference claims. In this part, I will:
• discuss how you can reduce your chances of receiving a preference claim; and
• provide a checklist on what to consider if a preference claim is made against you.
How can you reduce the chances of a preference?
a) Encourage the debtor company to pay its creditors proportionately. The Corporations Act encourages insolvent companies to pay all their creditors proportionately – by penalising those that have received a preference.
The best way to avoid a preference is for the debtor company to adhere to this objective. This may require the company to appoint a Voluntary Administrator and creditors agreeing to a Deed of Company Arrangement.
Payments made to creditors under a Deed of Company Arrangement are not liable to be repaid as preferences – even if the Deed is terminated and the company enters liquidation, as suggested by the reasoning in case Cresvale Far East Ltd v Cresvale Securities Ltd (2001) 19 ACLC 659.
b) Trade on a COD basis. As mentioned above, where trading is on a cash-on-delivery basis there is no debtor/creditor relationship. Therefore COD payments are not liable to be repaid as preferences.
However, it is common for credit managers to place customer accounts on stop credit until a pre-existing debt is repaid. Whilst the COD payments are protected, any payments towards the pre-existing debt can be liable to be repaid as preferences.
c) Take security – register on the PPSR. Payments to secured creditors cannot be deemed as preferences (subject to the value of the creditor’s security).
If security is taken over a company’s assets at the same time as advancing credit, then the payments cannot be preferences. However, if a security was granted over a pre-existing debt within the six months, the security may be void as against a Liquidator. Furthermore, in some circumstances the granting of security itself can be a preference if the security was given within the relation-back period.
If you supply goods, registering your security interest over the customer on the PPSR is a cost-effective way of preventing preference claims (and reducing bad debts).
However, the law relating to PPSR is still developing. It may not be a complete answer to a preference claim, depending how the Courts will treat the value of the security against the value of the preference claim.
d) Exercise a lien. In the case Bennett and Co v CLC Corporation (2001) 37 ACSR 96 – it was held that the holder of a lien is effectively a secured creditor for the purposes of an insolvency administration. Whilst that case did not concern a preference claim, it has the potential to suggest that payments to holders of liens cannot be preferences, on the basis that the creditor has security. Once again, there is some uncertainty as to when this form of defence might apply. For example, the defence is likely to apply where a creditor has a right to enforce a lien and then has enforced that right and then receives payment. It may not apply where a creditor has a right to enforce a lien but hands back the property over which it could have exercised the lien and then receives payment.
e) Request personal guarantees. When your suspicion about a debtor company’s insolvency arises, a further form of protection is to request that the directors (or the individuals behind the company) guarantee your debt. Whilst payments from the company are at risk of being preferences, you will have some recourse against the guarantors (provided they have sufficient assets).
Usually, there is a high degree of reluctance by directors to give guarantees to trade supplies. However, you may have greater bargaining power to request guarantees if the company needs your goods/services to continue trading.
The guarantee ought to be worded as a “personal” guarantee rather than a “director’s” guarantee to avoid the claim by a director who resigns that the guarantee is no longer binding on him or her.
f) Take the risk. It is human nature to want a customer to repay the whole of its debt even though you suspect that by receiving payment you might be subjected to a preference claim at a later date.
It might be that even if the company is insolvent, it will enter Voluntary Administration and then enter a Deed of Company Arrangement (“DOCA”) in which case you would not have to repay the preference unless the DOCA fails.
But if the debtor company does enter liquidation within the six months, and you are confronted with a preference claim, there is often the opportunity to settle the Liquidator’s claim for less than the full amount claimed.
The earlier in time that a preference claim is settled, the greater discount the Liquidator may be prepared to take. The longer a preference claim takes to resolve, higher legal costs will be incurred and a Liquidator may be unwilling to offer a discount on the claim.
Action plan if you receive a preference claim from a Liquidator
1. Check that the Liquidator is not out of time (statute barred) from issuing the claim – 3 years from the relation-back day, or 1 year from termination of a DOCA.
2. Check that you did receive the payments claimed by the Liquidator. Payments to suppliers with similar names can create confusion.
3. Verify that the payments were within the permitted timeframe – the “relation-back” period.
4. If you are in doubt whether the debtor company was insolvent at the time of the payments, ask the Liquidator for evidence of the company’s insolvency – such as the financial records of the company or a Report on Insolvency. Consider seeking your own opinion or report from another insolvency practitioner if you are still in doubt.
5. Consider whether you have a running account defence.This will involve determining the balance of the debtor company’s account over the relation-back period. If, after this analysis, you believe you have a partial or complete running account defence, write to the Liquidator asking that the claim be amended or withdrawn.
6. Consider whether you have a defence of no reasonable grounds to suspect insolvency [s. 588FG(2)]. Has the Liquidator provided reasons why they believe this defence is not applicable to you? If you believe that this defence applies, write to the Liquidator and explain why you consider this defence applies.
It is useful if you can state that you continued to give credit to the debtor company after you received the payments (and therefore did not suspect insolvency) – although this will not always be a defence as further credit may be given to an insolvent company to induce payments for an old debt.
7. Consider of you are a secured creditor (PPSR registration), whether you exercised a lien before the payment, or can claim a set-off.
8. If you consider that the defences may not apply, or wish to avoid the risks of litigation, attempt to settle the claim for an amount less than the claim. Sometimes Liquidators will settle preference claims at a discount, before legal proceedings are issued, to save their own legal fees.
9. If you are in doubt at any stage, seek legal advice.
*Nick Cooper is a Partner of the Adelaide office of Worrells Solvency & Forensic Accountants. He is qualified as a Chartered Account and hold a Bachelor of Laws. He is an Official Liquidator and a Registered Trustee in Bankruptcy. Nick has worked in the insolvency practice for 20 years. He has acted as an Administrator, Liquidator and Receiver of companies in a diverse range of industries.
He has acted on behalf of major banks and in respect of clients of many accounting firms. In his role as a Liquidator and as a Trustee in Bankruptcy, Nick is often involved in litigation to recover assets for the benefit of creditors.