Claw Back: Recovering Payments from Creditors
By Stephen Williams, Solicitor, Lovegrove Solicitors.
It is not uncommon for companies in difficult financial circumstances to make arrangements for the payment of its creditors. However, trouble may arise for the creditors where a company who makes such payments subsequently becomes insolvent.
If payments are made to creditors within the 6 months prior to the company going into liquidation, it may be possible for the company’s liquidator to “claw back” those payments on the basis that they are “unfair preferences”. This article will explore the circumstances in which a liquidator is entitled to recover such payments and what arguments a creditor may rely upon in order to avoid a liquidator’s claim.
Section 588FE of Corporations Act 2001 (Cth) (“the Act”) outlines four categories of voidable transactions, including:
- uncommercial transactions;
- unfair preferences;
- unfair loans; and
- unreasonable director-related transactions.
However, this article will only consider unfair preferences.
An “unfair preference” is defined by section 588FA(1) which states a transaction is an unfair preference given by a company to a creditor of the company only if:
- the company and the creditor are parties to the transaction; and
- the transaction results in the creditor receiving from the company more than the creditor would receive from the company in a winding up of the company.
A transaction will not be voidable under section 588FG(2) of the Act where it is proved that:
- the creditor became a party to the transaction in good faith;
- the creditor has provided valuable consideration or has changed its position in reliance on the transaction; and
- at the time when the creditor became such a party:
- the creditor had no reasonable grounds for suspecting that the company was insolvent at that time or would become insolvent; and
- a reasonable person in the creditor’s circumstances would have had no such grounds for so suspecting.
This defence is somewhat difficult to establish, as it requires the creditor to demonstrate that it had no reasonable grounds for suspecting that the company was insolvent or would become insolvent.
Even if it can be established that the creditor had no reasonable grounds, it is also necessary to prove that a reasonable person in the creditor’s circumstances would have had no such grounds for suspecting insolvency.
As is the case with many companies, even solvent ones, creditors may have many grounds for suspecting insolvency, one common indication where payments are not made when they become due and payable.
However, there is a distinction to be made between a temporary lack of liquidity and insolvency. Sometimes it may be successfully argued by a creditor that it did not suspect insolvency but was nonetheless aware of a short-term cash flow problem. What is accepted by a court will depend on the evidence before it and the surrounding circumstances.
Another common defence to allegations of unfair preferences is contained in section 588 FG(3) which is effectively a codification of the “running accounts” rule. It provides that where a transaction is part of a continuing business relationship between a company and its creditor, the net effect of these transactions must be assessed. If the total balance outstanding to the creditor increased during the 6 month period leading up to the liquidation, there will be not necessarily be an unfair preference.
The consequences of having to return money to a company in liquidation well after the transaction was entered into can be financially crippling. So, if a liquidator is attempting to recover an unfair preference or other transaction from you or your company, it is essential that you seek advice from an experienced legal professional immediately.
By Stephen Williams, Solicitor, Lovegrove Solicitors.
www.lclawyers.com.au
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© Lovegrove Solicitors 2013
