TGIF 17 May 2024 - Not all third party payments 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 was not an unfair preference because the payment did not diminish assets available to creditors.

Key Takeaways

• When identifying potential recoveries, liquidators should carefully consider whether payments made by third parties amount to unfair preferences.
  
  
• Liquidators bear the onus of proving that payments made by third parties are unfair preferences, even where the liquidator’s claim is undefended.
  
  
• Book entries recording the relevant transaction together with an inferred arrangement for payment will not alone be sufficient. The liquidator must establish that the relevant third party payment was from the company and diminished the assets available for distribution to creditors.

Background

The liquidator commenced proceedings against several defendants. It was seeking to recover payments allegedly made by the company to those defendants on the basis that the payments were unfair preferences. The liquidator resolved the majority of the claims prior to the commencement of the proceedings. Three claims 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 the liquidator alleged had received a payment from a third party on behalf of the company.

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

Third party payment to Syfon

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

• the company’s MYOB records and general ledger recorded a payment to Syfon on 3 August 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 a purported debtor of the company, Mainbrace Constructions (NSW) Pty Ltd (Mainbrace). Those transactions were recorded in the company’s books as a credit in respect of a transaction with Syfon, and a debit against Mainbrace, as an ‘invoice payment’.

Subsequenlty, the liquidator issued a letter of demand to Mainbrace. Mainbrace responded providing a reconciliation referring to an amount being paid by Mainbrace on behalf of the company to Syfon.

The timing of the transaction

A transaction, the subject of an unfair preference claim, is only reversable if it takes place within six months of the relation-back day. Therefore, the first step was to consider the timing of the transaction. In this case, the relation-back date was 7 September 2020, being the date on which the company was placed into voluntary administration. As the transaction took place one month prior, it fell squarely fell within the timeframe.

Unfair preference claim criteria

The judge observed that a transaction is 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 it would have received if the transaction was set aside (and the creditor were forced to participate in the usual processes, such as lodging a proof of debt).

While the judge noted that it was not unusual for courts to consider third party payments made to a creditor on behalf of an insolvent company, the liquidator needed to establish that:

1. the insolvent company was a party to the transaction. The critical question was whether there was an arrangement between the insolvent company and the third party (express or inferred), and if that arrangement involved the third party paying the insolvent company’s creditors; and
   
   
2. the relevant payment was received from the insolvent company.

Was there an arrangement?

There was no express arrangement between the company and Mainbrace that it would pay Syfon on the company’s behalf. The judge accepted that, on balance, it was possible to infer the existence of an arrangement between the company and Mainbrace. That inference was based on the evidence of knowledge of the transaction (based on the accounts), the flow of money between the parties and the correspondence from Mainbrace to the liquidator in respect of the payments.

Was the payment received from the company?

For the payment to have been made from the company:

• the payment must have been received from 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 assets of the company that would otherwise be available to creditors.

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

On the evidence available, the judge was unable to find any receivable owed by Mainbrace to the company. Accordingly, the judge was not satisfied that the payment made by Mainbrace to Syfon reduced a receivable owed by Mainbrace. In part, that was because there was an open question about whether Mainbrace was actually a creditor of the company (as it contended). It was therefore possible that the payment had actually increased the debt owed by the company to Mainbrace. Accordingly, the liquidator’s claim failed.

Comment

This case reminds liquidators that in the absence of clear cut evidence, they need to:

• be reticent of the precise requirements of establishing an unfair preference; and
  
  
• adequately assess whether it is commercially sensible to pursue or settle an unfair preference claim based on a third party payment.

An assessment of whether a third party payment is an unfair preference can be quite difficult in circumstances where the company’s books and records are incomplete. It is also challenging where creditor payments have been structured in a way to reduce the risks of liquidators seeking to claw back the payment as an unfair preference.