Case Update: Unfair Preferences Payments made by Third Parties

Case Update: Unfair Preferences Payments made by Third Parties

Under section 588FA of the Corporations Act 2001 (Cth), a liquidator is entitled to claw back payments made by a company in the lead up to its liquidation that unfairly prefer or prejudice the company’s creditors. But what about when the payment is not made directly by the company, but by a third party to satisfy a debt, or at the direction, of the Company?

In the recent matter of Western Port Holdings Pty Ltd (receivers and managers appointed (in liquidation) [2021] NSWSC 232, Rees J attempts to reconcile the various case law regarding preference payments made by third parties and provides further clarification regarding the types of third-party transactions that are caught under section 588FA.

In summary, some $2 million was paid to the ATO over an 18 month period while the company was subject to a deed of company arrangement, which was found to be an unfair preference and the ATO was ordered to repay $2 million in voidable transactions to the liquidator, with costs.

Takeaways from Western Port Holdings

In her judgment, Rees J used a practical approach to assessing this issue. Rather helpfully, Rees J noted that a third-party payment to a company’s creditor will be “from the company” with reference to the following factors:

(a) Did it confer to the third party a benefit to which the company is otherwise entitled? (for example, by reduction or set off to a loan account or other debt or obligation owed by the third-party to the company);

(b) Was the payment made by a related entity at the effective direction of the company? (where effected by a common director/shareholder on behalf of the company);

(c) Was the payment made by a loan to the company? (where recorded as a loan in books of the company, or otherwise constructively was a loan by the third party to the company).

Unfair Preferences

Section 588FA of the Corporations Act relevantly provides:

(1) A transaction is an unfair preference given by a company to a creditor of the company if, and only if:

(a) the company and the creditor are parties to the transaction (even if someone else is also a party); and

(b) 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…

Cant v Mad Brothers

Just prior to the Western Port Holdings decision, the Victorian Court of Appeal delivered a judgment relating to third-party preference payments in Cant v Mad Brothers Earthmoving Pty Ltd [2020] VSCA 198. In that case, the Court of Appeal appeared to take a more narrow approach on the issue and set out at [120] the following circumstances relevant to whether a third-party payment amounts to an unfair preference:

  1. The preference must be received from the company’s own money, meaning money or assets to which the company is entitled; and
  2. The receipt of the preference by the creditor must have the effect of diminishing the assets of the company available to its creditors; noting
  3. If the preference does not have the effect of diminishing the assets of the company, then it is not a payment received ‘from the company’ and is therefore not an unfair preference.

Cant dealt with a payment that was made to the creditor (Mad Brothers Earthmoving Pty Ltd) by a company (Rock Development) that shared a director with the company in liquidation (Eliana). Although the payment was authorised and ratified by Eliana and made towards a debt owed by Eliana, the Court held that there was no unfair preference where Eliana’s books indicated that Eliana was indebted to Rock Development at the time of the relevant payments (there was no debt owed to Eliana by Rock Development and no evidence that Rock Development was more than a volunteer in making the relevant payments which were not recorded as a further loan by Rock Developments to Eliana).

As there was no diminution of Eliana’s assets recorded in the books because of the payment, the Court held there was no unfair preference from the company.

Western Port Holdings

In Western Port Holdings, Rees J comments on the reasoning of Cant saying at [38]:

“I am left with some disquiet by the reasoning in Cant v Mad Brothers. The language of section 588FA(1)(b) does not readily permit a construction that it is necessary to demonstrate a diminution in the assets of the company for there to be an unfair preference”.

Rees J noted that there may be other transactions where there is no diminution of the company’s assets and yet should be considered an unfair preference, such as where the company directs one creditor to pay moneys owed by the company to another creditor [36].

Notwithstanding Rees J’s concern with the reasoning of Cant v Mad Brothers (and noting that she was bound to follow it where it was not clearly wrong), Rees J at [40] points to the following factors relevant to establishing a third-party payment as an unfair preference:

  1. “Was the benefit, which was conferred by the third party on the creditor, a benefit to which the company was otherwise entitled, for example, by reason of a contract between the contract and the third party (Re Emanuel) or because the third party owed money to the company (Evolvebuilt; Cant v Mad Brothers)?
  2. Was the third party 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 may be regarded as effectively payment by or at the direction of the company (Burness; Kassem; Cant v Mad Brothers)?
  3. Was the third party payment a loan to the company: Kassem? If it was recorded as a loan in the books of the company, this will obviously support such a finding: Cant v Mad Brothers.”

At [41] to [42], Rees J noted the difficulties that a liquidator may face in discharging their onus of proof, whether the company records may not have been kept up to date, and how the law is applied in such circumstances.

Third-Party Preference Payments

The following types of transactions were considered by Rees J in Western Port Holdings to have been “from the company” within the meaning of section 588FA(1)(b) and therefore unfair preferences from the Company to the ATO:

  1. A payment made from a bank account of a Company director to the ATO, which reduced the amount owed by the director to the Company (under his loan account) and by the company to the ATO, at [170]-[171].
  2. A loan from another family member that was paid into the bank account of a Company director and then on-paid to the ATO (to reduce the Company’s tax debt) and recorded in the Company’s records as a loan to the Company, at [172]-[174].
  3. A number of payments made from related companies directly to the ATO (to reduce the Company’s tax debt), which were recorded in the Company’s books as loans to the Company, at [175]-[177].
  4. A number of other payments made from related companies to the ATO (to reduce the Company’s tax debt), which were not recorded in the Company’s books as loans to the Company, but were constructively found to be loans by the related entities to the Company where that was consistent with the parties’ prior conduct and where the books of the related entities recorded the payments as loans to the Company, at [175]-[177].
  5. The use of loan funds from a third-party financier secured over the Company’s invoices/receivables to pay tax debts owed by the Company to the ATO, at [178]- [179]. This secured loan facility had the effect of reducing the Company’s unsecured assets, where drawn down to pay unsecured tax debts by securing the Company’s receivables (and all its present and after acquired property) in favour of the financier.

The judgment also dealt with preferences made whilst the company was subject to a DOCA, which we cover in a separate article here.

In this author’s opinion, Rees J has correctly found a practical way to apply the relevant case law to identify where third-party payments should be treated as “from the company” in liquidation.

 

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