Unfair preference claims: know your risk

Imagine, you chased an overdue invoice from a customer, they finally paid, and you moved on. Months later, a letter arrives from their liquidator. The customer has gone into liquidation, and the liquidator wants the money back.

This is called an "unfair preference claim", and it catches many small and medium businesses by surprise. With the current economic condition, unfair preference claims are on the rise.

The Corporations Act 2001 (Cth) gives creditors real defences, and a few simple habits can reduce your risk well before any letter arrives.

A 60-second self-check of your risk of exposure

Think about your customers over the past six months, and answer yes or no:

1. Has a customer paid you after a long delay, or only after repeated chasing?

2. Have you agreed to a payment plan, or accepted part-payments of old invoices?

3. Have you threatened legal action, a statutory demand or a winding-up application to get paid?

4. Has a customer told you they are struggling, or had payments bounce?

5. Do you supply on credit without a registered security interest on the PPSR?

Each "yes" does not mean you will face a claim. But it is the kind of fact a liquidator looks for, and knowing it now helps you manage your risk.

What is an unfair preference claim?

When a company is wound up, the law aims to treat its "unsecured creditors" equally. If one creditor was paid in full shortly before the collapse while others got nothing, the liquidator can ask that creditor to repay the money so it can be shared among everyone.

Under the Corporations Act 2001 (Cth), a liquidator generally has to show that:

• the payment was made within six months before the liquidation process formally began (four years if you are a related party);

• the customer was insolvent at the time, or became insolvent because of the payment; and

• you received more than you would have as an unsecured creditor in the liquidation.

The liquidator has three years from the start of the liquidation process (or 12 months from their appointment, if later) to start court proceedings. That is why these letters often arrive long after you thought the matter was closed.

You may have defences

A liquidator's letter is a claim, not a court order. Many claims can be reduced, defeated or negotiated.

• Security. Payments to a creditor holding valid security, such as a retention of title clause properly registered on the PPSR, are generally not unfair preferences to the extent of that security.

  
  

• Good faith. You have a defence if you received the payment in good faith, had no reasonable grounds to suspect the customer was insolvent, and gave value, such as goods or services. The weaker the warning signs at the time, the stronger this defence.

  
  

• Running account. If you kept supplying the customer while being paid, the law looks at the net effect of the whole trading relationship during the six-month period, not just each payment. In 2023, the High Court confirmed that liquidators cannot cherry-pick the high point of the debt to inflate their claim.

  
  

• Set-off. If you also owed the customer money, mutual debts may be set off against each other, reducing what you have to repay.

  
  

• No insolvency. The liquidator must prove the customer was insolvent when it paid you. It is often a difficult defence to establish.

  
  

Four habits that reduce your risk

1. Take security. A signed credit application with a retention of title clause, registered on the PPSR, is one of the best protections against preference claims. Directors' guarantees add a second avenue of recovery.

   
   

2. Keep supplying on a running account where it is safe to do so. Ongoing supply against payments can reduce the net preference. Stopping supply while collecting old debts tends to increase it.

   
   

3. Move to cash-on-delivery terms. For customers who are unable to pay invoices, move to COD terms.

   
   

4. Watch what goes in writing. Emails noting a customer "can't pay" or is "in trouble" can later be used to argue you suspected insolvency. Keep communications factual.

   
   

5. Keep good records. Invoices, statements, delivery dockets and payment history across the whole relationship are the raw material of every defence.

   
   

Received a letter from a liquidator?

Don't ignore it. Instead:

1. Note the deadline and the payments the liquidator is claiming.

   
   

2. Gather your records for the whole trading relationship, not just the six months.

   
   

3. Get advice early. A lawyer can check the dates, test the evidence of insolvency, apply the running account and other defences, and negotiate. Many claims settle for far less than the amount first demanded.

   
   

Let's look at it together

Whether you have answered "yes" on the self-check or already have a liquidator's letter on your desk, we can help. The lawyers at M6:8 Legal act for businesses responding to unfair preference claims, and help suppliers put security, credit applications and terms and conditions in place before a customer fails. We work with businesses across Perth from our office in Myaree.

Call (08) 9316 8363 or email admin@m68legal.com.au.

This article contains general information only and is not legal advice. You should obtain advice specific to your circumstances before acting.