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Law Clarified in respect of Unfair Preference Claims

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By Philip Colman, Principal, MST Lawyers

The High Court of Australia has recently clarified certain aspects of the law in relation to unfair preferences under the insolvency provisions of the Corporations Act.

In this (not technical) article, I will broadly (not exhaustively):

  • outline what is an unfair preference;
  • outline what rights the existence of an unfair preference may give a liquidator; and
  • give an illustrative example that shows the impact of this two High Court decisions.

Unfair preference laws contained in Part 5.7B of the Corporations Act 2001 (Cth) come into play when a company goes into liquidation,  Broadly speaking, if a creditor receives a payment or part-payment of a debt from the Company in the 6 months before a winding up is deemed to commence (Relation Back Period) at a time when the company was insolvent, that payment is liable to be clawed back by the liquidator if the effect of the payment was that the creditor received more than it would have received in the winding up of the company had it not received the payment.

There are numerous defences to these types of claims, but my focus in this article will be on two aspects of these laws that were clarified by the High Court of Australia.

Continuing Business Relationship

Creditors and companies often have a continuing business relationship where there is a running account recording debits (for supplies by the company to the creditor), credits (for payments) and a running balance.

Where this exists, the Corporations Act allows a creditor, in a preference claim, to treat the various debits and credits as one transaction.  Were this not the case, a creditor might have received, say $100,000 in payments during the relation back period and supplied $70,000 worth of goods, but would still be liable for an unfair preference claim of $100,000.

Until the High Court’s decision in Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2 (8 February 2023), there was a line of authority to the effect that, when assessing the quantum of an unfair preference, you would deduct the balance owed by the company to the creditor at the time winding up is deemed to commence (Final Balance) from the highest level of indebtedness in the Relation Back Period.  This rule, known as the “peak indebtedness rule” was abolished by the High Court.

This is illustrated by the example below.  Assume that:

  • The relation back day is the day the company went into liquidation (it can be earlier in some circumstances), being 31 December 2022
  • The Relation Back Period was from 1 July 2022 to 31 December 2022
Date Debits (new purchases) Credits (payments) Balance

 

1 July 2022 $100,000
1 August 2022 $10,000 $90,000
30 September 2022 $50,000 $140,000
5 October 2022 $20,000 $120,000
15 October 2022 $80,000 $200,000
31 December 2022 (Final Balance) $150,000 $50,000

 

Before the High Court’s decision, the quantum of a possible unfair preference would be $150,000, being the difference between the point of peak indebtedness ($200,000 on 15 October 2022) and the Final Balance ($50,000).

As a result of the High Court’s decision, the quantum of a possible unfair preference would be $50,000, being the difference between the balance owing at the start of the Relation Back Period ($100,000) and the Final Balance ($50,000).

Set-Off

The other High Court case, Metal Manufactures Pty Limited v Morton [2023] HCA 1 (8 February 2023), considered whether a creditor facing an unfair preference claim, could set-off (deduct) the Final Balance against the amount claimed, based on certain provisions in the Corporations Act that allow set-offs in certain circumstances.  There had been some lower court decisions suggesting this was possible.  The High Court made it very clear that this was not possible.

Again, using the above example, the creditor would have been able to deduct the Final Balance from the amount ultimately claimed by the liquidator.  If the claim was made before the peak indebtedness rule was abolished, the liquidators claim would have been reduced from $150,000 to $100,000.

The effect of these two decisions is that the creditor will face a claim of $50,000 and will not be able to set-off the $50,000 Final Balance.

Creditors have many other defences to unfair preference claims and these should always be explored.  MST’s dispute resolution and litigation lawyers are very experienced in this area and can help creditors and liquidators navigate these types of claims.  We can advise of likely liability and make recommendations as to how those claims might be commercially resolved before legal costs get out of hand.