Preference payments in liquidation
Imagine finding out that one of your clients is going into liquidation, and then discovering that accepting a previous payment put you in the cross hairs of other creditors! Sounds like an ‘out of the frying pan and into the fire’ situation. What exactly are preference payments, what happens when the debtor goes into liquidation, and how can you protect yourself and your business?
What is a preference payment?
A preference payment is when a debtor pays back one of its creditors before others when it is undergoing liquidation. This can be due to friendly relations (reimbursing a family member that invested in the venture), a promise of future business (working together later in a different industry) or even charitable (rewarding individual staff members).
These actions are considered preferable treatment and are illegal under Australian law.
The only scenario in which preference payment to a creditor does not apply is when they hold a valid security interest in an asset in the liquidating firm. If the assets far outweigh the payment amount on offer (say a supplier of raw materials with the goods still secure onsite), then they will get preferred treatment by the liquidator.
Can you be on the hook for payment as a creditor?
What happens if your business or yourself has been given a payment from a company about to undergo liquidation?
The liquidator has every right to seek recovery of those funds if they are proven to be a preference payment. It will split them equally among creditors, and if there are many creditors, then you might end up with far less than you hoped for.
To understand the law’s reasoning behind this, consider a scenario in which you as a creditor only received 20% of money owing to you, whilst another creditor received 100% of money owed. The preferential payment stipulations ensure all creditors receive equal shares of the assets made available through liquidation.
How to prove a preference payment?
If a liquidator suspects that you have received a preference payment (or perhaps it came to your attention that another creditor got paid more), then they will attempt to seek recovery of the funds through regular communication. This might include a friendly phone call, letters of demand or even engagement of recovery experts. However, they will not have any right to the money until they take it to Court.
The liquidator will need to prove that this payment took place to get a court order. It will need to prove the following:
● That there is evidence of the transaction between the debtor and the preferred creditor
● That the transaction took place when the firm was insolvent or caused the business to become insolvent (such as transferring a large number of funds to a different company)
● That the creditor knew that the transaction was a preferred payment and made by an insolvent company
The liquidator has up to three years to file a claim of preferred payment. The history of transactions made by the firm can be examined up to six months before the liquidation for non-related parties, or four years for those who know the directors of the liquidating firm intimately. There is even case law to examine transactions up to 10 years before the liquidation, to prove that they planned to cut off creditors in the future.
Did I get a preferred payment?
There is an easy test to prove whether or not you have received a preferred payment. You will need to show that:
● You provided a service or goods to the firm in return of payment (that it was a standard order and that no additional funds were transferred)
● You completed the order in good faith
● You were not aware that the company was insolvent.
Additionally, to prevent a preference payment claim in future, be sure to register a security interest on any assets you provide (including services). As mentioned, the only waiver for a firm to get a preferred payment is if they have an asset interest in the liquidation. That way, if things go bust for your client, you are well within your rights to get your debts back first.
If you’re unsure about the legality of a payment you’ve received, be sure to contact us to discuss further.
