Navigating a relationship with a financially distressed debtor is both stressful and challenging. All transactions made by a distressed company in the 6 months leading up to the incident of insolvency can be subject to an unfair preference claim. This allows the liquidator to “claw back” funds that were transferred by the company to unsecured creditors. The basis of the claim is that it creates an unfair advantage over the other creditors.
The Good Faith Defence to an Unfair Preference Claim
S 588 FG (2) of the Corporations Act 2001:
- The creditor received the payment in good faith; and
- The creditor had no reasonable grounds for suspecting the company was insolvent and a reasonable person in the creditor’s circumstances would not have suspected insolvency; and
- The creditor provided consideration.
The most challenging aspect of the above defence is proving the creditor had no “reasonable suspicion” of insolvency. This is because creditors usually contact the distressed debtor to request payment, and then become informed about the financial difficulty as the justification for delay. There is usually a digital or paper trail for an insolvency practitioner to call upon to indicate the creditor possessed knowledge of insolvency. Creditors should therefore exercise caution when seeking repayment, as notices and letters of demand will only inhibit the success of a “good faith” defence.
Risk Reduction Strategies for Creditors
Become a Secured Creditor at the Commencement of Dealings
- Secured creditors are not subject to unfair preference claims. Consider registering a security interest on the PPSR (Personal Property Security Register). This can include fixed and floating charges over property owned by the company.
Trade Using Cash-on-Delivery
- Cash-on-delivery reduces “days receivable” and prevents the buildup of large debt. This method obviously has its own limitations and may not be compatible with some business models.
Third Party Payments
- If you have a debtor company, payment from a third party (outside of the transaction) may be a viable option. Third party payments can still be subject to unfair preference, so consult with your lawyer regarding execution of transfer and appropriate third parties. It is important that the payment was made without direction from the distressed debtor (voluntarily).
Negotiate with the Liquidator
- Open and honest communication with the appointed liquidator is often the best way to navigate an unfair preference claim. Liquidators are concerned with commercial viability and will be unlikely to pursue small sums of money.