The running account defence to unfair preference claims

You continued to supply a customer goods on credit, notwithstanding that despite payments being made, the customer’s overall level of indebtedness remained basically the same.  The customer is then placed into liquidation.  You are owed thousands of dollars.  Then, to make matters worse, you receive a letter from a liquidator demanding under threat of legal action that you pay to him the money you received on the basis the payments received was an Unfair Preference.

What is an Unfair Preference?

In an earlier article we discussed in detail the nature of what an unfair preference 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 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 there are various defences depending on the circumstances.  Below we discuss the Running Account defence.

The Running Account defence

The Running Account defence is very technical and is found at section 588FA(3) of the Act.

What the section basically says is that where the parties had an ongoing commercial relationship (i.e. the creditor continued to supply goods on credit to the debtor company which in turn made payments) during the six (6) months prior to the debtor company being placed into liquidation, then regard has to be had to the net cumulative effect of all the transactions which formed part of the ongoing commercial relationship to determine whether in fact the payments so received amounted to an Unfair Preference.

If the payments were made to ensure the continuation of supply of goods and services on credit and the level of indebtedness, while fluctuating, does not significantly alter and the creditor continues to provide a similar a level of goods and services on credit, then the defence may be available.

This process involves an examination of the statement of the account to ascertain whether it was mutually assumed from a business point of view that each particular payment was connected with the subsequent provision of goods or services on account and it was implicit in the circumstances in which each payment was made that there would be a continuance of the relationship of debtor and creditor.

For example, at the beginning of January the debtor company owed the creditor $10,000. During the  course of the six (6) months to the end of June, the debtor company purchased stock on credit to the value of $30,000 and made payments of $20,000 in order to induce ongoing supply.

The $20,000 in payments so made are not preferential in nature as the debtor company’s overall level of indebtedness didn’t reduce, it in fact increased.

If however, the debtor company purchased stock on credit only to the value of $5,000 and made payments of $10,000, then the liquidator would claim that $5,000 of the $10,000 in payments so received is recoverable on the basis that component was unfairly preferential as the net indebtedness to the creditor was reduced.

Takeaways

Many creditors are unaware of the existence of the Running Account defence.  Those that are aware of it often have difficulty properly applying it to their particular circumstance.

Receipt of an Unfair Preference claim is a serious issue as such claims are not made lightly by a liquidator.  If you receive an Unfair Preference claim demand, legal advice should be sought immediately as, depending on the jurisdiction invoked and the nature of the demand made by the liquidator, time limits in responding to it may apply.

Links and further references

Legislation

Corporations Act 2001

Further information about unfair preference claims

If you need advice on any unfair preference claim related matter, contact us for a confidential and obligation-free discussion:

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.

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