Unfair preferences – the Doctrine of Ultimate Effect

Under section 588FA of the Corporations Act 2001 (Cth), an unfair preference is defined as a transaction, such as payment of an outstanding debt, between a company and a unsecured creditor which results in that unsecured creditor receiving more than it would have received if it had to prove in the winding up of the debtor company.  It is unfair because the payment the debt results in the net value of the assets of the debtor company being reduced, to the detriment of the body of unsecured creditors as a whole.

One of the rarer defences to an unfair preference claim is known as the Doctrine of Ultimate Effect or the ‘landlord’s defence’.  Essentially, if the payment results in the debtor company being in a better asset position because of the payment, the ultimate effect has not been to decrease the net value of the debtor company’s assets.

The Doctrine of Ultimate Effect in Operation

One of the leading cases in this area is Airservices Australia v Ferrier (1996) 185 CLR 483, otherwise known as the Compass Airlines case.

Compass Airlines was operating a commercial passenger airline service, its aircraft flying at altitudes only possible under the Instrument Flight Rules and requiring the use of air traffic control.  The then Civil Aviation Authority (CAA) provided en route and terminal navigation services, firefighting and meteorological services for a fee.

Throughout the second half of 1991, Compass paid CAA approximately $10.3 million for those services, but the cost of those services to CAA was approximately $19 million.  The payments made were in discharge of specific debts, not in reduction of the balance of a running account.

The High Court held that as the value of the services provided exceeded the amount of the payments received during the relevant period, the payments did not deplete or diminish the assets of Compass available for distribution to other creditors.

Had the services not been provided by CAA, Compass would have had far less means to pay any creditors, let alone the remaining balance demanded by CAA. The ultimate effect of the payments were not deemed to be preferential as they did not decrease the amount of money available to other creditors.

This may seem similar to, but it is not the same as a running account defence.

Where a debtor owes a number of distinct debts and the debtor, on paying an amount, directs the payment be appropriated to one of those debts or the creditor thereafter elects to appropriate the payment to one of those debts, the debt to which the payment is appropriated is discharged.

In the case of a running account, when no appropriation of a payment to a particular debit item is made either by the debtor or creditor, the immediate effect of the payment is not the discharge of a debt itemised in the account but the reduction in the balance of the account.

In Beveridge v Whitton [2001] NSWCA 6 a company was in financial difficulties owing the ATO $200,000 and a bank a substantial overdraft.  Its accounts had not been prepared for two years and its books had not been prepared for over two years.

On the bank’s recommendation, Beveridge, an accountant, was engaged by the company in July 1994 to get the company’s books and accounts into order and advise on financial matters and the like.  It was agreed his fees would be paid within one week of an invoice being issued.

The company was placed into liquidation in February 1995.

At first instance, it was found that by July 1994 the company was insolvent and this fact would have been known to Beveridge.  His engagement was not beneficial to any other creditors – thus, the company’s payments to him were unfairly preferential.

On appeal, Beveridge argued:

• he only accepted the engagement on the proviso he was paid speedily;
• the services he provided were necessary whether the company was solvent or not;
• even if they did not immediately increase the company’s income, management of the company’s finances was clearly a required action.

The liquidator argued Beveridge’s services did not increase the amount of money available for other creditors, hence the company’s payments were unfairly preferential.

The Court of Appeal held the Doctrine of Ultimate Effect did not depend on the transaction’s ability to improve or worsen a company’s position, but it was the ultimate effect of the transaction itself.  The support of the bank and the services of Beveridge were needed for the trading life of the company, the ultimate effect being to the benefit of the company.

Takeaways

If it can established that any payment made resulted in an insolvent debtor company receiving a benefit greater than the value of the payment, then the Doctrine of Ultimate Effect may afford a defence to an unfair preferential payment claim asserted by a liquidator.

Links and further references

Cases

Airservices Australia v Ferrier [1996] HCA 54

Beveridge v Whitton [2001] NSWCA 6

Legislation

Corporations Act 2001 (Cth)

Further information about unfair preferences

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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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