Preferential Payments

Preferential payments refer to the act of giving one creditor special treatment at the disadvantage of other creditors. If your company is insolvent, a primary guideline to paying debts to creditors is that payments are distributed appropriately.

For example…

You are a creditor who is owed $150,000 by a company facing insolvency, but it turns out that the insolvent company also owes $150,000 to another company. Before the insolvent company enters liquidation and a registered liquidator has a chance to arrange for debts to be settled fairly, it turns out that the other company has received $100,000 in debt repayments by the insolvent company. This is a preferential payment and can be considered a transaction of unfair preference under section 588FA of the Corporations Act 2001 (Cth).

Preferential payments can occur when a company faces insolvency at a future date and directors decide to take control of their money before liquidation, by paying certain creditors like relatives, friends, preferred suppliers or somebody that holds a director’s personal guarantee.

Rectifying Preferential Payments

If a liquidator can prove a preferential payment has occurred within six months prior to a company declaring its insolvency, the liquidator has the power to ‘claw back’ or recall those funds from the creditors. However, if the payments stretch beyond this six month period then the recovery of the money usually requires a court order. In order to get the courts involved, a liquidator must:

• Prove that the transaction was between the company and the alleged recipient and that it occurred during the relevant statutory timeframe;
• Prove that the company was insolvent when the alleged preferential payment occurred;
• Prove that the transaction gave the recipient a financial advantage over other creditors of the company; and
• Be able to demonstrate that the recipient either knew, or reasonably should have suspected, that the company was not in a position to pay all its debts as and when they fell due at the time the preferential payment was made.

Reclaimed funds that were previously preferential payments are then added to the liquidator’s pool of money to be evenly distributed among creditors at the end of the liquidation process, in the manner required by law.