Unfair preferences and mothership proceedings
It has been 3 years since our landmark successful defence on behalf of CSR Building Products Ltd of an unfair preference action by liquidators of a company that traded with CSR.[1]
The defence centred on the proposition that a retention of title clause constituted a valid security interest sufficient to resist the unfair preference action. It also involved, amongst other things, the successful opposition of the liquidators’ expert evidence regarding the insolvency of the company in liquidation.
The case has been repeatedly cited and followed by the courts since.
With a marked increase in litigation by liquidators pursuing creditors for unfair preferences, it is very important to understand your rights, defences available and the right commercial approach to navigate and resolve these claims.
The following is a snapshot of relevant issues in an unfair preference action.
What is an unfair preference action?
The action itself is technically complicated. It is based on the notion that in the last 6 months (the relation-back period) before a company appoints an administrator or liquidator, directors are more likely to prefer certain creditors by paying their debts in preference to others.
Often those preferred creditors are related to the directors or have debts which the directors personally guaranteed.
The purpose is to allow a liquidator to claw back those preferential payments and re-distribute them proportionately amongst creditors in the liquidation.
There are common elements in unfair preference actions:
The company in liquidation must have been insolvent at the time of (or because of) the payments which the liquidator is trying to claw back. The liquidator must prove insolvency by providing expert opinion evidence on the issue at trial.
Creditors who received the payments must not hold valuable security e.g. a property mortgage, equitable charge, retention of title security interests.
Creditors must be in a better position by retaining the payments than paying them back to the liquidator and going through the proof of debt process in the liquidation.
Creditors might be able to claim the good faith defence to resist an unfair preference claim in full. This means that if a creditor (or a reasonable person in their circumstances) did not know about the company’s financial distress, and a reasonable person in their shoes ought not to have known, then they will not be forced to repay to the liquidator any unfair preference payments.
Creditors can take advantage of the running account principle if they had a continuing credit / debit relationship with the company. If this is available, then creditors can substantially reduce the amount of the liquidator’s claim.
Finally, if the liquidated company still owes a debt to the creditor, then the creditor can potentially set off that debt against the liquidator’s claim.
Recent trends
We are witnessing an environment where liquidators are taking a more robust approach in pursuing unfair preference claims against trading companies and businesses.
A recent trend we are seeing is that liquidators who have unfair preference claims against multiple defendants are filing ‘mothership proceedings’. These are single court actions designed to accommodate actions against multiple defendants where there is a common question of fact or law.
In the case of unfair preferences, the common question of fact will be whether the company in liquidation was insolvent during the relation-back period when the payments the liquidator is trying to recover were made.
In these mothership proceedings, each defendant will have the opportunity to challenge the question of the company’s solvency either individually or collectively, or otherwise abide by the decision of the court. This results in significant cost efficiencies and other benefits for the parties.
If you receive an unfair preference demand from a liquidator, you should take immediate steps to consider your position and respond to the liquidator.
As a firm, we have significant experience in dealing with liquidators. Please feel free to contact Tony Scoglio or David Tooth on (07) 3833 2100 or info@scogliolaw.com.au if you have any questions.
[1] Hussain and anor -v- CSR Building Products Ltd; In the matter of FPJ Group Pty Ltd (in liq) [2016] FCA 392