Two recent cases have made the Liquidator’s task in recovering preference payments a lot tougher.  Decisions that have been relied on for decades – on the ‘running account’ and third-party payments – have been overturned.

Recovering unfair preferences is a useful tool given to company Liquidators to bring all creditors back to being on a level playing field and treated equally.

In summary, the unfair preference regime allows a Liquidator to recover payments made by insolvent companies to creditors in the six months prior to the “relation-back day” (which depends on how the liquidation was initiated).   The payments must have resulted in the creditor receiving more for its debt than if it simply lined up in the liquidation with everyone else.

Naturally, the creditor being pursued for recovery of the preferences will not consider the scheme to be fair – and there have been a number of cases challenging the fine points of the regime.

Here, we discuss two recent cases of interest:

The running account:  Badenoch Integrated Logging Pty Ltd v Bryant [2021] FCAFC 64

Many readers may be familiar with the “running account” theory (often erroneously called the running account “defence”).

The theory (which is recognised in the Corporations Act) is that if, over the preference period, there have been supplies of goods and services (which benefit the company), and payments for those supplies (which benefits the supplier), the net benefit to the supplier is taken to be the preferential amount recoverable from the creditor.

To explain, using a worked example:

The balance due to a creditor at the start of the preference period is $20,000.  Over the period $50,000 of supplies are made.  Over the period $60,000 is paid against the account.

The history of the account is shown in the below table:

Until now, the law and practice in considering this scenario has been that the Liquidator may choose when the running account starts.

Naturally, the Liquidator will choose the point of maximum indebtedness and claim the difference between that figure and the closing balance as the preference received by the supplier.  The Courts have consistently said that all points of commencement of the running account are as arbitrary as every other point and so have allowed the Liquidator to make this choice.

So, in the example above, the net preferential effect to the supplier is the difference between $45,000 (peak indebtedness) and $10,000 (closing indebtedness), being $35,000.

The value of the Liquidator’s preference claim is therefore $35,000 (which is less than the total payments of $60,000 received by the creditor over the period).

However, a recent decision of the Full Court of the Federal Court of Australia has swept away that analysis.  Instead, the creditor is entitled to have all supplies during the preference period taken into account in making the assessment.

So, in the above example, the net preferential effect is the difference between $20,000 (opening balance) and $10,000 (closing balance), being $10,000.

Under this new decision, the value of the Liquidator’s preference claim is therefore $10,000.

The implications of this decision are clear.  Many preference claims being prosecuted by Liquidators are now being amended or reviewed.  Over 25 years of law and practice and the treatment of running accounts has been overturned. 

At the time of writing no application for special leave to appeal has been filed at the High Court, but the insolvency profession anticipates that this will happen.

We will keep readers of The Oracle updated.

Payment “from the company” – not from an overdraft: Cant v Mad Brothers Earthmoving Pty Ltd [2020] VSCA 198

In another case which has turned a decades-old understanding on its head, the Court of Appeal of the Victorian Supreme Court has recently fundamentally changed the treatment of preference payments which come from borrowings.

The previous law since 1995 (as set out in the Emanuel (No 14) case in the Full Court of the Federal Court) has been that a payment of a creditor drawn from borrowings is still recoverable by a Liquidator thanks to the broad wording of section 588FA(1), which relevantly provides:

588FA(1)  [What is an unfair preference] A transaction is an unfair preference given by a company to a creditor of the company if, and only if:

       (a)     the company and the creditor are parties to the transaction (even if someone else is also a party); and

       (b)     the transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor, more than the creditor would receive from the company in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in a winding up of the company.

The words “the company and the creditor are parties to the transaction (even if someone else is also a party” have, since 1995, been relied upon by Liquidators to recover payments made to creditors by third parties (such as financiers, directors and other interested persons) at the request of the company on account of the company’s debt to that creditor.

However, in Cant v Mad Brothers, the Court closely examined the issue of the source of the relevant payments being claimed by the Liquidator, and the effect on the company’s general asset pool.  In this case the payments to the creditor were made from the company’s overdraft facility and not from a bank account with a credit balance.

The Court then considered the impact on the company’s assets of these payments and held that, as the payment simply increased indebtedness and did not reduce assets, there was no reduction in the assets otherwise available to the company’s creditors.  In these circumstances there was no preference to the creditor and the Liquidator’s claim failed.  In short, the payment was not “given by the company” as required by the opening phrase of section 588FA(1).

However, the security position of the financier that provided the overdraft facility is relevant to this question.

Again, many preference actions by Liquidators have had to be reconsidered.

We are not aware of any appeal from this decision.