The ‘good faith’ defence to an unfair preference claim

This is the third article in our series on Unfair Preference payments.    The scenario that is common is that a business does the work or delivers the goods, invoices its customer and is eventually paid.   Three months later the business owner receives a letter from a liquidator demanding under threat of legal action that they be paid the money received on the basis the payment received was an unfair preference (Unfair Preference). 

What is an Unfair Preference?

In an earlier article we discussed in detail the meaning of the term unfair preference and what it was.  To recap, under section 588FA of the Corporations Act 2001 (Act) an Unfair Preference received by a creditor can occur when:

  • a debtor company owes a creditor an unsecured debt; and
  • the debtor company and a creditor are parties to a transaction (usually payment of some or all of the unsecured debt); and
  • receipt of the payment results in the creditor receiving more than it would have received had the debtor company been in liquidation and the liquidator paid all unsecured creditors a dividend, such as $0.10 for every dollar of debt owed to them.

Pursuant to section 588FE of the Act, an Unfair Preference is a voidable transaction if the payment was received by the creditor within the six (6) months prior to the debtor company being placed into liquidation.  The transaction, being receipt of the payment, can be set aside by a Court upon application being made by a liquidator pursuant to section 588FF of the Act.  The Court can then order repayment to the company in liquidation of an amount equal to the amount of the Unfair Preference received by the (usually disgruntled) creditor.

Are there any defences to an Unfair Preference claim?

The short answer is that there are various defences depending on the circumstances.  Below we discuss the “good faith defence”

The Good Faith defence

Under section 588FG(1) of the Act, the transaction will not be voidable if:

  • the benefit (i.e. the payment) was received in good faith (i.e. honestly);
  • at the time the payment was received, there were no reasonable grounds for the creditor to suspect the debtor company was insolvent or that the payment would make the debtor company became insolvent; and
  • a reasonable person in the creditor’s circumstances would have had no grounds for suspecting the debtor company was insolvent or that the payment would result in the debtor company becoming insolvent.

Reasonable grounds for suspecting the creditor was insolvent?

The first response of most creditors when they receive an Unfair Preference claim is to assert they had no idea the debtor company was insolvent.

However, to make out this defence the creditor must establish that there were no reasonable grounds for suspecting the debtor company was insolvent.

This may be difficult to establish, particularly where the Courts have found the grounds for suspecting insolvency can include:

  • the debtor company failing to comply with credit account payment terms;
  • the debtor company asking for a payment plan;
  • the creditor suspending credit terms / refusing to supply goods on credit;
  • the debtor company being subjected to final payment demands by the creditor;
  • the creditor only supplying goods to the debtor company on a COD basis; and
  • the debtor company making payments which are not readily identifiable or reconcilable with invoices issued by the creditor.

This list is not exhaustive.

Most liquidators when making an Unfair Preference claim anticipate a disgruntled creditor will try to raise the Good Faith defence.  The letter of demand will usually outline the basis why the liquidator asserts a creditor will not be able to make out a Good Faith defence.  The demand itself is normally a lengthy and technical recitation of the law as it applies to Unfair Preference claims and defences therein.

That said, Unfair Preference claim demands are typically made early in the winding up process in circumstances where the liquidator may not know the full facts as they apply to every individual creditor, is short of funds and is looking to recover money to cover costs moving forward.

Accordingly, each case turns on its individual facts.

Take aways

Receipt of an Unfair Preference claim is a serious issue.  If you receive an Unfair Preference claim demand, legal advice should be sought immediately in respect of defences available to such claims.

Further references

Legislation

Corporations Act 2001 (Cth)

Related articles by Dundas Lawyers

What is an unfair preference claim?
Unfair preference payments and third-party payments

Further information

If you need assistance in respect of a defences to an Unfair Preference claim, please telephone me for an obligation free and confidential discussion.

Mitch Brown Dip.T.,BA.,LL.B.,MQLS.Mitch Brown - Dundas Lawyers
Legal Practice Director
Telephone: (07) 5646 9174
Mobile 0420 205 105
e: mbrown@dundaslawyersgc.com.au

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

 

 

 

 

 

Dundas Lawyers
Street Address Suite 12, Level 9, 320 Adelaide Street Brisbane QLD 4001

Tel: 07 3221 0013

Send this to a friend