Let’s start with the theory

The reason that the unfair preference provisions exist is to ensure that all unsecured creditors of an insolvent company are treated equally.

On that basis, any person who received a payment in the six months prior to the liquidation of a customer, must pay that money back to the liquidator. The liquidator then pays dividends to all creditors such that they all receive the same proportionate amount.

The main defence to an unfair preference claim is that the payment was made at a time when you did not know or suspect your customer was insolvent or no reasonable person in your position would have known or suspected.

And now the reality

The reality is that dividends from insolvent companies are rare and if paid, are not large. It is quite difficult to make out the defence about knowledge or suspicion of insolvency and the unfair preference provisions punish the diligent credit manager, who does everything they can to ensure that payment is made.

So, what steps can be taken to avoid an unfair preference if you have concerns a customer is insolvent?

If you have a personal guarantee of a customer’s debt – use it. Insist that payment be made by the guarantor – not from your potentially insolvent customer. You will then be able to argue that you did not receive a preference because you received payment from the guarantor. You should ensure that payment – and this part is very important – is made pursuant to the guarantor’s liability not the customer’s liability. There are several techniques you can undertake to ensure that you are protected in that regard.

Terms and conditions of your guarantee

If you obtain personal guarantees from directors of companies, it is vital that they are as effective as possible. This includes clauses allowing you to sue the guarantor for any amounts that you are obliged to pay a liquidator for an unfair preference.

Certain terms and conditions are a lot more effective than others in this regard.

If you receive a letter of demand

  1. Check that you have actually received an unfair preference. Liquidators often claim all payments that have been made in the prior six-month period are unfair preferences. You may be also able to reduce or eliminate the amount of the preference by the supplies that you have made during that time;
  2. Check whether your terms and conditions allow you to recover an unfair preference claim from a guarantor and if not, why don’t they?
  3. Unfair preferences only apply to payments from a customer whose debt is unsecured. I have seen a number of instances where clients assumed that they did not have a security because they had not realised their terms and conditions did provide a security. Alternatively, they assumed because they had not registered the security on the PPSR, that the security was of no value. In such situations, we have been able to write to the liquidator noting that the client was secured at all times and was therefore not liable to pay the unfair preference.

Careful review of your terms and conditions and your guarantee will provide protection from many, if not all unfair preference claims.

Need specialist insolvency advice? Contact Mark Harrick on (03) 9670 2266 or