Unfair Preference Claims – Part 2

Welcome back to part 2 of our unfair preference claims series, and arguably the most important part, you’re going to want to bookmark this one for future reference!

Defences to Unfair Preference Claims

There are three (3) main defences to an unfair preference claim:

1. The good faith defence;
2. The running account/continuous business relationship defence; and
3. The set off defence.

Good Faith Defence 

Arguably the most relied upon defence, the good faith defence is pretty self-explanatory; you received the funds in good faith i.e. you had no reason or there were no reasonable grounds for you to suspect the company paying was insolvent.

In order to succeed, you need to establish the following:

1. You received the benefit of the transaction in good faith;

2. At the time of the transaction, you have no reasonable grounds for suspecting that the company was insolvent and a reasonable person in your circumstances would have no reason for suspecting the company’s insolvency; and

3. You provided valuable consideration for the transaction, or you changed your position in reliance on the transaction.

As previously outlined in part 1 of this serious, there are a number of indicators that may give rise to suspicion that a company may be insolvent or heading into insolvency. Although, it may seem simple on the face of it, element 2 is a very contentious matter and liquidators have relied on a number of things to help establish that a creditor ought to have known that the company they are dealing with was insolvent or heading into insolvency.

Claims Running Account Defence/Continuous Business Relationship Defence

Another defence depends on the relationship between the parties. This isn’t generally a whole defence (however it can be in certain circumstances), however where the principle applies it can aid in reducing the amount a liquidator can claim. The running account principle[1] relies on the following two elements:

1. The transaction was an integral part of a continuing business relationship, for example for commercial purposes a credit account is established by suppliers to provide goods, where the account is paid periodically without clear differentiation between transactions; and

2. The amount of new indebtedness increases and decreases over time as part of that relationship.

This principle may allow for all transactions to be viewed as one transaction, thus potentially acting as a full defence, however if there is a period of change in the level of indebtedness by the company (now in liquidation) which coincides with the relation back period, then a liquidator may argue they have a claim. There claim, however, will most likely be in relation to a portion of the transactions as opposed to the full amount.

Set Off Defence

The defence put simply allowed a creditor to defend a claim of unfair preference on the basis they have set off another debt owed by the company (in liquidation) to the creditor. In order to succeed, a creditor needed to establish:

• there are mutual credits, mutual debts or other mutual dealings between an insolvent company and a creditor;
• the creditor has a debt or claim admitted against the company; and
• the creditor did not have notice of the fact that the company was insolvent (this is a different test to a suspicion of insolvency).

The Set Off defence[2], although a defence under the Act, has lost its authority as of December 2021, after the Full Court of the Federal Court in the decision of Gavin Morton As Liquidator Of MJ Woodman Electrical Contractors Pty Ltd (In Liquidation) & Anor v Metal Manufacturers Pty Limited (MJ Woodman) (Morton)[3] found that the defence of set-off is not available to a defendant of a liquidator’s claim for the recovery of an unfair preference.

The case confirmed that creditors could no longer rely on s553C of the Act as a defence to an unfair preference claim. A defence that was already quite difficult to establish, given the need to prove deniability of insolvency under s553C(2) of the Act, has now put more of an emphasis and importance on the running account defence.

Whatever your situation, the team at Constructive Legal Solutions can help you at every stage of your claim. Contact the team via telephone on 1300 972 092 or at info@constructivelegalsolutions.com.au today!

[1] s588FA(3) http://www5.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s588fa.html

[2] s553C of the Act http://classic.austlii.edu.au/cgi-bin/sinodisp/au/legis/cth/consol_act/ca2001172/s553c.html?stem=0&synonyms=0&query=553C

[3] https://jade.io/article/882082