Legal Developments With Unfair Preference Claims

What is an unfair preference

An unfair preference occurs when one creditor receives payment from a company where:

• the payment is made to the creditor within six months of the company entering into external administration;
• the payment received is more than the creditor would have received had the payment not been made and the creditor proved for their full debt in the liquidation; and
• the transaction resulting in the payment occurred whilst the company was insolvent and/or the transaction resulted in the company entering insolvency.

A payment which is an “unfair preference” is recoverable by the liquidator against the creditor.

Defences to an unfair preference claims

It has generally been accepted that creditors have four “defences” to unfair preference claims:

1. Good faith defence under s 588FG(2) of the Corporations Act (Act);
2. the doctrine of ultimate effect;
3. the Running account; and
4. the statutory set off under s 553C of the Act.

There have been a number of recent court decisions considering the operation of the running account and the statutory set-off. Here we focus on the latter.

Rejection of the statutory set-off as a defence to preference claims  

In Morton & Anor v Rexel Electrical Supplies Pty Ltd [2015] QDC 49, the District Court of Queensland considered the availability of set-off under s 533C of the Act as a defence to preference claims. In essence, the court accepted that a creditor who was required to repay amounts to a liquidator as an unfair preference was entitled to set-off those amounts against other debts owed to the creditor by the company in liquidation. The practical effect of this was that the creditor could avoid repaying the unfair preference where other debts owed to the creditor by the company exceeded the amount of the preference.

The Federal Court in Stone v Melrose Cranes & Rigging Pty Ltd, in the matter of Cardinal Project Services Pty Ltd (in liq) (No 2) [2018] FCA 530 accepted that the statutory set-off is available in answer to a preference claim. However, the court found that the creditor in that case could not do so because it had knowledge of the company’s insolvency.

There was significant disquiet amongst insolvency practitioners and lawyers as to the correctness of the decision in Rexel Electric. In late 2021, these concerns were relieved with the Full Court of the Federal Court in In Morton as Liquidator of ML Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228 rejecting the availability of the statutory set-off in unfair preference claims. Pending any appeal to the High Court, the decision in Woodman means that creditors can no longer claim a statutory set-off in unfair preference claims.

Key considerations

With a statutory set-off having been rejected by the Full Federal Court above, businesses are now left with three possible defences or answers to preference claims:

1. good faith defence under s 588FG(2) of the Corporations Act (Act); 

2. the doctrine of ultimate effect;

3. the running account. 

Despite the availability of these defences, best practice for businesses is to adopt the following risk management strategies: 

• identify whether or not they are dealing with an industry subject to a heightened risk of liquidation such as building and construction and/or hospitality; 

• where it supplies goods, ensure that it has appropriate security interests in the relevant goods; and 

• closely monitor debtor’s are complying with terms of trade and carefully consider any conduct by debtors which may suggest that they are experiencing financial difficulties.