The notion of unfair preferences is well-known to liquidators, accountants, lawyers and many in business (often from the unfortunate experience of receiving a demand from a liquidator for return of an unfair preference).
The concept of an unfair preference is not controversial: an unsecured creditor that receives a payment from a debtor company whilst the debtor is insolvent receives an unfair preference over other unsecured creditors of the company to whom the insolvent debtor still owes money. Subject to some limited defences, the recipient of the unfair preference must pay back the money to the debtor company’s liquidator, and then prove for the debt in the winding up along with the other unsecured creditors.
What is the subject of controversy, is what is the status of a payment which the creditor receives not from the debtor company itself, but from a third party?
That question was the subject of a decision handed down by the Supreme Court of New South Wales earlier this year in the matter of Western Port Holdings Pty Ltd (receivers and managers appointed) (in liq) [2021] NSWSC 232.
The decision in this case is an important lesson for creditors who, knowing that a debtor is insolvent, seek to avoid the risk of an unfair preference claim by having a related party of the debtor company (such as a director or shareholder) pay the debt instead of having the debtor company pay the debt.
The facts
The liquidators of Western Port Holdings Pty Ltd (Company) sought to claw back from the Commissioner of Taxation (ATO) over $2 million which the ATO had received in payment of the Company’s tax liabilities, on the basis that those payments were unfair preferences within the meaning of section 588FA of the Corporations Act 2001 (Cth) (Act).
Subsection 588FA(1) of the Act provides that:
“(1) A transaction is an unfair preference given by a company to a creditor of the company if, and only if:
- the company and the creditor are parties to the transaction (even if someone else is also a party); and
- the transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor, more than the creditor would receive from the company in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in a winding up of the company;
even if the transaction is entered into, is given effect to, or is required to be given effect to, because of an order of an Australian court or a direction by an agency.”
[emphasis added]
The Company had previously been subject to a deed of company arrangement (DOCA) administered by the current liquidators, the aim of which had been to ensure that employee creditors of the Company were paid their entitlements in full and that all other unsecured creditors received between 5.13 and 8.36 cents in the dollar. However, the Company repeatedly defaulted in its obligations under the DOCA and the creditors ultimately resolved to terminate the DOCA and wind up the Company in May 2017.
During the 18-month period that the DOCA was on foot, the ATO had received 37 payments in respect of the Company’s tax debts, only 26 of which had been paid directly from the Company’s accounts and the remaining 11 of which had been made by related third parties.
When the matter came to hearing, Rees J had to determine (among other issues) whether the payments which the ATO received directly from the third parties were payments received from the Company, that is, whether the third-party payments amounted to unfair preferences given by the Company.
Were the third-party payments unfair preferences given by the Company?
Her Honour noted that, when determining whether an unsecured creditor has received a payment from a debtor company that has in fact been paid by a third party, the existing authorities require the Court to have regard to the following matters:
- whether the benefit conferred by the third party on the creditor was a benefit to which the company was otherwise entitled (for example, by reason of a contract between the company and the third party or because the third party owed money to the company)?
- whether the third party was a related entity to the company, by reason of common directors or shareholders, or interdependence of financial arrangements, such that payment by the third party could be regarded as effectively payment by or at the direction of the company?
- whether the third party payment was a loan to the company (namely, was the payment recorded as a loan in the books of the company)?
In the present case, the third party payments received by the ATO had consisted of:
- A payment of $81,830 made by Mr O’Hare, a director of the Company from his personal bank account to the ATO directly. At the time the payment was made, Mr O’Hare owed some $120,000 to the Company and following the payment, his loan account on the Company’s balance sheet was reduced by an equivalent $81,830. In those circumstances, her Honour inferred that the payment was made by the director at the direction of the Company. Applying the decision in Cant v Mad Brothers Earthmoving Pty Ltd (in liq) [2020] VSCA 198, her Honour found that as the Company was no longer able to demand that $81,830 from Mr O’Hare, that payment represented an asset which was no longer available for distribution to the creditors, notwithstanding that the payment had not resulted in any change to the net assets of the Company.
- One payment funded by a loan from Mr O’Hare’s father-in-law, Mr Duthrie. That loan had been made in haste, in response to a threat by the administrators to terminate the DOCA if the Company’s tax debt was not immediately reduced. Although the monies were initially paid into a director’s account before being on paid to the ATO, the loan was subsequently recorded in the Company’s books. Her Honour looked at the totality of the dealings and found that the payment was a simple loan transaction between the Company and Mr Duthrie. Her Honour concluded that the situation was no different than if the Company had borrowed money on an overdraft from its bank and paid the money to the ATO with those funds. Applying the reasoning in Commissioner of Taxation v Kassem (2012) 205 FCR 156, her Honour found that the funds had been received by the ATO from the Company.
- Six payments received from SHA (Vic) Pty Ltd (SHA) and Services and Maintenance Group Pty Ltd (SMG). As with the Company, the shareholders and directors of SHA and SMG were also members of the O’Hare family and there was a long-standing practice between the companies that the Company would pay the day-to-day expenses of SHA and SMG, which would then be reimbursed from time to time. At the time the initial payments were made to the ATO, SHA and SMG each owed money to the Company. However, there came a point where the payments made by SHA and SMG exceeded the monies owing to the Company, such that SHA and SMG provided loans to the Company. With the exception of the final payments, which had been made shortly before the company went into liquidation, each of the payments made by SHA and SMG were recorded in the Company’s books first as a reduction of those company’s loan accounts and then as loans to the Company. Her Honour applied the same reasoning with respect to the payments from Mr O’Hare and Mr Duthrie in finding that to the extent that:
- the payments resulted in a reduction of the monies owed by SHA and SMG to the Company that payment represented an asset which was no longer available for distribution to the creditors; and
- the payments were loans from SHA and SMG to the Company, the situation was no different from that which would apply if the Company had borrowed money on its overdraft to pay the ATO.
Given the close relationship between the Company, SHA and SMG, and their respective shareholders and directors, her Honour had no difficulty in finding that each of the payments made by SHA and SMG to the ATO had been made at the direction of the Company.
- Three payments from Hermes Capital Australia Pty Ltd (Hermes), the Company’s invoice financier. The loan facility provided by Hermes to the Company was secured by security over the Company’s all present and after acquired property, the Company’s book debts and registered mortgages granted over property owned by members of the O’Hare family. Her Honour noted the reasoning in Cant v Mad Bros concluded that where a loan is drawn down to pay a company’s debts, and that loan is secured, the transaction will result in a diminution of assets available to the unsecured creditors. Applying that reasoning, her Honour found that the payments made by Hermes to the ATO at the Company’s direction resulted in a net diminuition of the assets available to the Company’s creditors.
As such, Her Honour was satisfied that the assets available for distribution among unsecured creditors had been diminished by the third party payments received by the ATO, and that those payments were unfair preferences for the purposes of section 588FA of the Act.
The decision
The ATO was ordered to repay over $2 million to the company, with interest, and slapped with an order to pay the liquidators’ costs of the proceedings, which no doubt have been substantial.
Rees J’s decision highlights the broad statutory powers that liquidators have to claw back payments received by creditors in the period before a company goes into liquidation, even when those payments have been made by third parties. It is also a timely reminder of the need for creditors to exercise due diligence and proceed with caution before accepting payments from, or on behalf of, bad debtors.
Further information
Pigott Stinson regularly advises and acts for clients in relation to insolvency and debt recovery matters. If you have any questions regarding issues with your debtors or any other insolvency matter please contact Daniel Fleming or Eleni Bastoulis.