TGIF May 17, 2024 – Not all payments to third parties are unfair

In a recent decision of the Supreme Court of New South Wales (In the matter of Pacific Plumbing Group Pty Limited (in liquidation) (2024) NSWSC 525), Justice Black determined that a payment made by a third party did not constitute an unfair preference because the payment did not diminish the assets available to creditors.

Key takeaways

• When identifying potential recoveries, liquidators should carefully consider whether payments made by third parties constitute unfair preferences.
• The burden is on liquidators to prove that payments made by third parties constitute unfair preferences, even where the liquidator’s claim is not defended.
• The accounting entries recording the transaction concerned as well as the payment terms deducted will not be sufficient on their own. The liquidator must establish that the relevant third party payer came from the company and reduced the assets available for distribution to creditors.

Background

The liquidator has initiated proceedings against several defendants. She sought to recover payments allegedly made by the company to these defendants on the grounds that they were unfair preferences. The liquidator resolved the majority of claims before the start of the procedure. Three demands remained:

• claims against two defendants who both received payments directly from the company’s bank account; And
• a claim against Syfon Systems Pty Ltd (Syfon), who, according to the liquidator, had received payment from a third party on behalf of the company.

None of the accused appeared at the hearing. The judge determined that payments made directly from the company’s bank account constituted unfair preferences. However, the third-party payment to Syfon required a detailed analysis of the evidence, even though the claim was not defended.

Third party payment to Syfon

The liquidator analyzed the books and records of the company and determined that:

• the MYOB records and the company’s general ledger recorded a payment to Syfon on August 3, 2020;
• no corresponding payment was identified in the company’s bank statements; And
• the company’s general ledger recorded transactions between the company, Syfon and an alleged debtor of the company, Mainbrace Constructions (NSW) Pty Ltd (Mainbrace). These transactions were recorded in the company’s books as a credit to a transaction with Syfon, and a debit against Mainbrace, as a “bill payment.”

Subsequently, the liquidator sent a letter of formal notice to Mainbrace. Mainbrace responded by providing a reconciliation referencing an amount paid by Mainbrace on behalf of the company to Syfon.

The time of the transaction

A transaction subject to an unfair preference request is only reversible if it takes place within six months following the day of the relationship. The first step was therefore to think about the timing of the transaction. In this case, the handover date was September 7, 2020, the date on which the company was placed into voluntary administration. The transaction having taken place a month previously, it took place squarely on time.

Unfair Preference Claim Criteria

The judge observed that a transaction constitutes an unfair preference if:

• both the insolvent company and the creditor are parties to the relevant transaction; And
• the transaction results in the creditor receiving more from the company than he or she would have received if the transaction had been canceled (and the creditor was forced to participate in the usual processes, such as filing proof of debt ).

Although the judge noted that it was not unusual for the courts to take into account payments made by third parties to a creditor on behalf of an insolvent company, the liquidator had to establish that:

1. the insolvent company was a party to the transaction. The crucial question was whether there was an agreement between the insolvent company and the third party (express or implied) and whether that agreement involved the third party paying the insolvent company’s creditors; And
2. the corresponding payment has been received from the insolvent company.

Was there an arrangement?

There was no express agreement between the company and Mainbrace that it would pay Syfon on behalf of the company. The judge recognized that, on balance, it was possible to infer the existence of an agreement between the company and Mainbrace. This inference was based on evidence of knowledge of the transaction (based on the accounts), the flow of money between the parties and correspondence from Mainbrace to the liquidator regarding payments.

Has payment been received from the company?

For payment to have been made to the company:

• the payment must have been received with the company’s own money (including money and assets to which it was entitled); And
• the payment by the third party must have reduced the company’s assets that would otherwise be available to creditors.

In this case, the applicable asset was the company’s receivables. The payment made by Mainbrace to Syfon was therefore intended to reduce the debts owed by Mainbrace to the company in order to satisfy the unfair preference regime. In other words, if the debt had not been reduced, this asset would have been available to other creditors.

Based on the available evidence, the judge could not find any debt owed by Mainbrace to the company. Therefore, the judge was not satisfied that the payment made by Mainbrace to Syfon reduced a debt owed by Mainbrace. This was partly because it remained an open question as to whether Mainbrace was actually a creditor of the company (as he claimed). So it was possible that the payment actually increased the company’s debt to Mainbrace. As a result, the liquidator’s application failed.

Comment

This case reminds liquidators that in the absence of clear evidence, they must:

• be reluctant about the specific requirements relating to the establishment of an unfair preference; And
• adequately assess whether it is commercially reasonable to pursue or settle an unfair preference claim based on payment to a third party.

It can be very difficult to assess whether paying a third party constitutes an unfair preference in circumstances where the company’s books and records are incomplete. It is also unclear whether payments to creditors were structured in a way to reduce the risks of liquidators seeking to recover payment as an unfair preference.