It’s tough to make a buck at the moment. In these uncertain times, financial difficulty is more common and company liquidations are on the increase. One of the more unpleasant consequences of increased liquidations is the increased likelihood of being on the receiving end of a claim from a liquidator for an unfair preference.
What is an unfair preference? If a distributor, wholesaler, retailer or anyone who you sell your product to goes bust and has a liquidator appointed to it, you can find yourself on the end of a nasty demand letter, or even worse, a Court claim issued by the liquidator for you to pay back a number of the payments you received from your now financially defunct trading partner.
Unfortunately it isn’t about right and wrong. The way the liquidator and the Corporations Act sees it, if you received a payment in the six months leading up to the date of the liquidator’s appointment, you are taken to have received more than your fair share. The law wants you to pay it back so it can be distributed by the liquidator to all the unsecured creditors evenly.
The liquidator needs to prove a bunch of things before the payments can be recovered (including that the relevant company was actually insolvent at the time the payments were made) but it is reasonably common for the liquidator to prove everything necessary at least for payments made shortly before the liquidation.
If there is an ongoing trading relationship with payments and further supply taking place on a regular basis, the liquidator generally has to consider the entire relationship on a running account or net basis and can’t pursue each payment individually without taking the further supply into account. However, certain actions can bring this “running account” relationship to an end.
There are a number of things you can raise in response and you can avail yourself of certain defences to claims for unfair preferences. The most common is the “good faith” defence which is basically made out if you can show that you had no idea at the time you received the payment that the company was unable to pay its debts on time. This is sometimes not the easiest thing to prove as it largely relies on existing documentation to show your state of mind at the relevant times.
This means your credit people need to walk a fine line as it is usually their paper trail which either wins or loses these cases. We have seen comments in internal credit files such as “I think they are stuffed”. These types of notes make it hard to successfully argue the good faith defence.
The most damaging information is generally contained in internal documents. It is important to keep in mind that if Court proceedings are commenced, internal documents that relate to your trading relationship and credit collection efforts need to be provided to the liquidator and his or her lawyers. They will ultimately see all your dirty laundry.
What can you do to avoid being pursued for an unfair preference claim? Unfortunately there is no fool-proof way of avoiding claims of this kind. Invariably the cost of doing business these days will involve dealing with trading partners that go under. This may result in a liquidator coming back to you to “claw back” unfair preference payments that you have received. Here are some suggestions:
- get appropriate expert advice early in the piece
- be mindful that internal files and documents may ultimately be seen by liquidators
- seek security of some sort – secured debts are outside the scope of unfair preference recoveries
- if in doubt, get payment up front
- check in with your insurer to see whether any debtor insurance policy you have extends to “voidable transaction claims” which is the broad umbrella under which unfair preference claims fall.
Michael Frost and Daniel Zabow