An unfair preference is a transaction (commonly a payment of funds or a transfer of assets) entered into by an insolvent company which provides an unsecured creditor of the company who received the benefit of the transaction with a priority or advantage over other creditors. It is a defence to an unfair preference claim if the creditor received the benefit of the transaction entered into in good faith and at the time of the transaction, they had no reasonable grounds for suspecting that the company was insolvent or would become insolvent and a reasonable person would have had no such ground for so suspecting (“Good Faith Defence”).
A Liquidator can pursue unfair preferences against unsecured creditors if the transaction occurred within 6 months prior to the relation back day or 4 years prior to the relation back day in the event the creditor is a related entity of the company.
If a Liquidator successfully pursues a claim for an unfair preference they are entitled to various relief including recovering the property which was the subject of the transaction or monetary consideration.
Elements of an Unfair Preference
In order to recover a transaction as an unfair preference payment a Liquidator must establish that:
- There was a transaction (usually the payment of funds or the transfer of an asset) between the company and an (unsecured) creditor of the company;
- The company was insolvent at the time when it entered into the transaction;
- The creditor received more as a result of the transaction than they would have received in the liquidation of the company; and
- The transaction occurred during within 6 months prior to the relation back day or 4 years prior to the relation back day in the event the creditor is a related entity of the company.
The relation back day is commonly:
- For a creditors’ voluntary liquidation, the date of liquidation; or
- If the company was in administration prior to being placed in liquidation, the date of the Administrator’s appointment; or
- For a court appointed liquidation, the date of the filing of the winding up application.
Defences Available to an Unfair Preference Claim
Section 588FG of the Corporations Act 2001 (Cth) provides for the Good Faith Defence. This is a defence to an unfair preference claim which a creditor must prove and in order to rely on this defence, the creditor must establish:
- The creditor provided valuable consideration for the transaction;
- The creditor received the benefit of the transaction in good faith; and
- At the time of the transaction the creditor had no reason to suspect that the company was insolvent and a reasonable person in the creditor’s position would have had no reason for suspecting the company was insolvent.
Whilst not specifically a defence to a claim for an unfair preference, Section 588FA(3) of the Corporations Act 2001 (Cth) sets out a principle commonly known as the running account defence. The running account defence provides that in certain circumstances where the company and a creditor have an ongoing commercial relationship, rather than considering each individual transaction alone to determine if it results in a creditor receiving an unfair preference, a Court will have regard to the net effect of all of the transactions between the parties during the relevant period. For example if a creditor received $100,000 in payments from a company during the relevant preference period, but the overall debt to the creditor only reduced by $10,000 due to continued supply of goods or services by the creditor then there may only be a $10,000 preference claim available against the creditor who received the payments.