Are unfair preferences… now fair?

Prior to the recent Federal Election, the Morrison Government had announced an intention to implement a number of insolvency reforms. One (1) such announcement was the proposal to amend the rules for Liquidators’ unfair preference claims.

It was suggested that the intention of this reform was to simplify unfair preference claims in order to protect creditors who act at arm’s length and in good faith against being pursued by a Liquidator for small payments once a company they have been transacting with, enters into liquidation.

What is Considered an Unfair Preference?

Unfair preferences are payments or transfers of company assets to a creditor of a company, which gives that creditor an unfair advantage over other creditors of the company; i.e., they are paid more than another creditor, generally in the six (6) months immediately prior to the liquidation commencing. In certain circumstances, those payments or transfers meeting all of the requirements of an unfair preference, may be recovered by a Liquidator for equal distribution amongst all of the company’s proven creditors.

Summary of Proposed Changes

Whilst there was previously no minimum amount for a payment or transfer to potentially be considered an unfair preference, it is proposed that transactions of less than $30,000 or those entered into more than three (3) months prior to the external administration of the company, will no longer be recoverable by a Liquidator – as long as the creditor is not considered a related entity of the company and the transaction was within the ordinary course of the company’s business.

There are no other specific changes to unfair preferences identified, particularly in relation to the other elements (i.e., those not relating to the transaction timing or amount, or the relationship between the parties) that need to be proven in order for the transaction to be recoverable by a Liquidator, such as:

1. There was a transaction between an unsecured creditor and the company.
2. When the company entered into the transaction, it was insolvent.
3. The creditor received more from the transaction than they would have received as a distribution in the liquidation of the company.

Importantly too, there have been no changes to the defences available to unsecured creditors when presented with a claim from a Liquidator for an unfair preference, namely:

1. At the time of the transaction the creditor acted in good faith (i.e., they had no reasonable grounds, or a reasonable creditor in the circumstances would have no grounds for suspecting that the company was insolvent or would become insolvent).
2. The creditor provided valuable consideration in the transaction.

Another commonly cited defence is known as the “running account” principle, where the ongoing business relationship between the company and the creditor is examined over the relevant period as a whole (as if it were one (1) transaction) rather than each transaction separately in order to determine whether overall, the creditor received a preference over other creditors.

Similarly, Liquidators could until twelve (12) months ago, calculate the amount of an unfair preference claim by taking the highest point of debt owing to the creditor under the running account principle during the relevant period and comparing it to the debt owing to the creditor on the date of liquidation, in order to establish the unfair preference amount. This is known as the “peak indebtedness rule”.

However, a May 2021 Federal Court of Australia – Full Court decision in Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (In liq) (receivers and managers appointed) FCAFC 64 found that when a Liquidator calculates the amount of an unfair preference claim, the peak indebtedness of a running account does not apply.

Timing of the Changes

Now that the Morrison Government are no longer in power, the likelihood and possible timing of this proposed reform being implemented is far less clear. Only time will tell as to whether it will be sanctioned and implemented under the current Albanese Government.

An Important Message

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