Legal Unfair preferences and how to avoid them – Part 3

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.

By Nick Cooper* Nick Cooper

How can you reduce the chances of a preference? c) Take security – register on the PPSR. Payments to a) Encourage the company to pay its secured creditors cannot be deemed as preferences proportionately. The Corporations Act encourages (subject to the value of the ’s security). insolvent companies to pay all their creditors If security is taken over a company’s assets at the proportionately – by penalising those that have received same time as advancing credit, then the payments a preference. cannot be preferences. However, if a security was The best way to avoid a preference is for the debtor granted over a pre-existing debt within the six months, company to adhere to this objective. This may require the security may be void as against a . the company to appoint a Voluntary Administrator Furthermore, in some circumstances the granting of and creditors agreeing to a Deed of Company security itself can be a preference if the security was Arrangement. given within the relation-back period. Payments made to creditors under a Deed of If you supply goods, registering your security Company Arrangement are not liable to be repaid interest over the customer on the PPSR is a cost- as preferences – even if the Deed is terminated and effective way of preventing preference claims (and the company enters , as suggested by the reducing bad debts). reasoning in case Cresvale Far East Ltd v Cresvale However, the law relating to PPSR is still developing. Securities Ltd (2001) 19 ACLC 659. It may not be a complete answer to a preference claim, depending how the Courts will treat the value of the b) Trade on a COD basis. As mentioned above, where security against the value of the preference claim. trading is on a cash-on-delivery basis there is no debtor/ creditor relationship. Therefore COD payments are not d) Exercise a . In the case Bennett and Co v CLC liable to be repaid as preferences. Corporation (2001) 37 ACSR 96 – it was held that the However, it is common for credit managers to place holder of a lien is effectively a for the customer accounts on stop credit until a pre-existing purposes of an . Whilst that debt is repaid. Whilst the COD payments are protected, case did not concern a preference claim, it has the any payments towards the pre-existing debt can be potential to suggest that payments to holders of liable to be repaid as preferences. cannot be preferences, on the basis that the creditor

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has security. Once again, there is some uncertainty as Liquidator. Payments to suppliers with similar names can to when this form of defence might apply. For example, create confusion. the defence is likely to apply where a creditor has a right to enforce a lien and then has enforced that right 3. Verify that the payments were within the permitted and then receives payment. It may not apply where a timeframe – the “relation-back” period. creditor has a right to enforce a lien but hands back the property over which it could have exercised the lien and 4. If you are in doubt whether the debtor company was then receives payment. insolvent at the time of the payments, ask the Liquidator for evidence of the company’s insolvency – such as the e) Request personal guarantees. When your suspicion financial records of the company or a Report on Insolvency. about a debtor company’s insolvency arises, a further Consider seeking your own opinion or report from another form of protection is to request that the directors (or if you are still in doubt. the individuals behind the company) guarantee your debt. Whilst payments from the company are at risk of 5. Consider whether you have a running account defence. being preferences, you will have some recourse against This will involve determining the balance of the debtor the guarantors (provided they have sufficient assets). company’s account over the relation-back period. If, after Usually, there is a high degree of reluctance by this analysis, you believe you have a partial or complete directors to give guarantees to trade supplies. However, running account defence, write to the Liquidator asking you may have greater bargaining power to request that the claim be amended or withdrawn. guarantees if the company needs your goods/services to continue trading. 6. Consider whether you have a defence of no reasonable The guarantee ought to be worded as a “personal” grounds to suspect insolvency [s. 588FG(2)]. Has the guarantee rather than a “director’s” guarantee to avoid Liquidator provided reasons why they believe this defence the claim by a director who resigns that the guarantee is is not applicable to you? If you believe that this defence no longer binding on him or her. applies, write to the Liquidator and explain why you consider this defence applies. f) Take the risk. It is human nature to want a customer to It is useful if you can state that you continued to give repay the whole of its debt even though you suspect credit to the debtor company after you received the that by receiving payment you might be subjected to a payments (and therefore did not suspect insolvency) – preference claim at a later date. although this will not always be a defence as further credit It might be that even if the company is insolvent, may be given to an insolvent company to induce payments it will enter Voluntary Administration and then enter for an old debt. a Deed of Company Arrangement (“DOCA”) in which case you would not have to repay the preference unless 7. Consider of you are a secured creditor (PPSR the DOCA fails. registration), whether you exercised a lien before the But if the debtor company does enter liquidation payment, or can claim a set-off. within the six months, and you are confronted with a preference claim, there is often the opportunity to 8. If you consider that the defences may not apply, or wish settle the Liquidator’s claim for less than the full amount to avoid the risks of litigation, attempt to settle the claim claimed. for an amount less than the claim. Sometimes Liquidators The earlier in time that a preference claim is settled, will settle preference claims at a discount, before legal the greater discount the Liquidator may be prepared proceedings are issued, to save their own legal fees. to take. The longer a preference claim takes to resolve, higher legal costs will be incurred and a Liquidator may 9. If you are in doubt at any stage, seek legal advice. be unwilling to offer a discount on the claim.

*Nick Cooper is a Partner of the Adelaide office of Worrells Solvency & Action plan if you receive a preference claim Forensic Accountants. He is qualified as a Chartered Account and hold from a Liquidator a Bachelor of Laws. He is an Official Liquidator and a Registered Trustee in . Nick has worked in the insolvency practice for 20 years. 1. Check that the Liquidator is not out of time (statute He has acted as an Administrator, Liquidator and Receiver of companies barred) from issuing the claim – 3 years from the relation- in a diverse range of industries. back day, or 1 year from termination of a DOCA. 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 , Nick is often involved in litigation to recover assets for the 2. Check that you did receive the payments claimed by the benefit of creditors.

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