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When a company goes into liquidation, the liquidators can recover monies from creditors they believe have been given an unfair preference.
What’s an “unfair preference”? In most cases, it means the company has made a preferential payment to one creditor over others.
Laws now exist to ensure creditors are treated equally by preventing any unsecured creditors from receiving an advantage.
Recovering an unfair preference
To obtain a court order for recovering an unfair preference payment, a liquidator must establish:
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the transaction was between the company and a creditor
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the company was insolvent at the time of the transaction
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the transaction was entered into within the relevant time period (see below)
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the debt was unsecured
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the creditor received an unfair preference.
Relevant time periods
To recover an unfair preference payment, the transactions must have occurred within a specified period before liquidation began. The relevant periods are:
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six months for transactions with unrelated parties
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four years for transactions with related entities
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ten years for transactions made to defeat, delay or interfere with the creditors’ rights.
Defences to an unfair preference claim
A creditor challenged with receiving an unfair preference can render the otherwise void payment irrecoverable by the liquidator by showing either:
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The creditor received no benefit from the transaction; or
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While the creditor did receive a benefit from the transaction:
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the creditor received the benefit in good faith; and at the time of receiving the benefit:
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the creditor had no reasonable grounds to suspect the company was insolvent when they received it; and
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a reasonable person in the creditors’ circumstances would have no grounds to suspect the company was insolvent.
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3 ways to avoid an unfair preference claim
When it comes to unfair preference claims, prevention is always better than cure. Here are a few ways your client can protect themselves.
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Taking out security. An unfair preference can only be recovered from an unsecured creditor.
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Cash On Delivery (COD). If your client supplies everything by COD they could argue they gave valuable consideration for the transaction, and did not suspect the company was insolvent.
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Up-front payments. Getting paid up front avoids the issue of getting payment for an existing debt for past good or service provided.
When it comes to business finance and the law, it pays to get the right advice. If one of your clients receives a demand for an unfair preference from a liquidator, talk to us. We’ll make a time to review your client’s position and run through the options, free of charge.