Key points

• A creditor may receive an unfair preference if their unsecured debt is repaid by a company which goes into liquidation soon afterward.
• ARITA has recently released a short, plain-English guide for liquidators to provide to creditors when seeking to recover unfair preferences from them.

Overview

ASIC’s most recent figures¹ confirm what many businesses have been experiencing first-hand: that company insolvencies have been increasing in recent months.

Anecdotally, businesses are increasingly receiving requests from liquidators for repayment of unfair preferences – that is, to return money paid to them for a debt that was owed to them.

ARITA, the professional body for registered liquidators, has recently developed a guide explaining unfair preferences. Liquidators can send the guide to creditors when seeking to recover a preference from them, to help explain the claim. Of course, it is preferable for businesses to understand the potential for payments to be recovered as unfair preferences before they extend credit to their customers.

What is an unfair preference?

When a company is placed into liquidation, its unsecured creditors can lodge a proof of debt which claims the amount they say they are owed by the company.

The company’s assets will usually be sold, and the proceeds applied to pay its creditors. Secured creditors are generally paid from the security property, with unsecured creditors lining up for what is left over. There is then a general rule that, where the proceeds are insufficient to pay all of the debts of a particular class of unsecured creditors, the available proceeds will be distributed equally to those creditors, in proportion to the value of their debt.

This means that unsecured creditors often receive much less than full payment of the debt they are owed.

If the company pays a debt owed to one of its unsecured creditors shortly before entering liquidation, that creditor may have received an ‘unfair preference’. The creditor has received full payment of its debt, while other creditors in the same class can only expect a proportionate distribution from the available proceeds (if any).

To be an ‘unfair preference’, a payment must in most cases (among other criteria):

• Have been made in the six months prior to the liquidation (three months for simplified liquidation);
• Have been made while the company was insolvent (or caused the company to become insolvent); and
• Have resulted in the creditor receiving more than they would have received in the company’s winding up.

The position is more complicated where the payment takes place as part of a continuing business relationship between the company and the creditor, for example where invoices and payments are netted off in a running account.

Defences to preference claims

There are defences available, depending on the circumstances. A common defence raised is to the effect that the creditor received the payment in good faith and had no reasonable grounds for suspecting the company was insolvent or would become insolvent.

If a creditor raises a defence, the liquidator can apply to a court for orders that the creditor repay the amount to the company. If those orders are made, the creditor is left to prove for their debt alongside other creditors.

Notes for businesses

Unfair preference claims are a threat to the cashflow of any business.

Businesses should be aware when extending credit to customers at risk of insolvency, that even if the customer pays their debt, the payment might be recovered by a liquidator.

Where a customer might be at risk of insolvency, businesses may consider requiring security or cash-on-delivery terms, to help mitigate this risk.

Unfair preference claims by liquidators sometimes involve legal and factual issues which require careful consideration. For example, whether the company was insolvent at the time of a payment, or whether the creditor should have suspected the company was insolvent at the time.

If you receive a preference claim from a liquidator, it may be worthwhile seeking legal advice as to the risks.

1. ASIC Australian insolvency statistics released 11 November 2024.