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When a business is facing insolvency, there are clear processes to follow. One of these relates to the way debts are resolved.
It can be tempting for the Directors to quickly distribute funds to creditors who have been waiting for a long time, but this can result in clawbacks and accusations of preferential payments.
What are preferential payments?
The goal of the liquidation process is to resolve debts as a business is wound down. As part of this, funds will be distributed to pay staff and creditors, and assets will be sold to cover as many unresolved expenses as possible.
However, sometimes when a business liquidates, it can intentionally or inadvertently pay a “preferential payment”. This means paying friends, family, or preferred clients ahead of other creditors like banks or the ATO.
In official terms, a preferential payment in liquidation is a transfer of funds or assets to specific creditors that give them an advantage over other creditors.
A relevant extract of Section 588FA of the Corporations Act 2001 states the following:
A transaction is an unfair preference given by a company to a creditor of the company if, and only if:
- the company and the creditor are parties to the transaction (even if someone else is also a party); and
- 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.
Here’s an example:
Your business is owed $200k by one of your clients. This client also owes another company, operated by a relative, the same amount. The relative’s company receives $100k right before the business goes into liquidation, then claims there are no funds left for you. In this case, the liquidator is likely to have grounds to intervene and ensure the money is clawed back and evenly distributed to everyone.
In another case, you may receive a call from a client who has become a good friend. They apologise for owing you money and transfer most of the amount owed. If they have similar debts to other clients that are left unpaid, you may receive a call from the liquidator because the payment is under review.
Defence against preferential payments
If a liquidator perceives preferential payments have been made and has evidence of dates and transactions, they can take legal action in order to ‘claw back’ those payments.
There are some cases where a business may be able to put forward a valid argument for making a payment that is accused of being preferential, for example if the transaction is an integral part of a continuing business relationship between a company and creditor.
A business that has received a preferential payment may be able to come forward with the defence that:
- It did not benefit from the transaction
- The benefit was received in good faith
- It was unaware that the payee was facing insolvency
- The payment did not increase the value of its assets
Accused of making or accepting preferential payments? Reach out to a legal professional
If you need help to prove payments were not preferential, it’s important to work with a legal team that has experience in this area. An experienced professional can help you gather evidence to put forward your case.
Need help to overcome a preferential payment or insolvency-related problem? Reach out to Crest Lawyers today.
Disclaimer: The information contained in this news post is general in nature and is intended to provide a general summary only and should not be relied on as a substitute for professional advice. Whilst the information is considered to be true and correct at the date of publication, changes in circumstances after the time of publication may impact upon the accuracy of the information.
