The forgotten front: COVID-19 relief and preference clawbacks

Federal Treasurer Josh Frydenberg announced recently that the Commonwealth Government is considering extending aspects of the ‘regulatory shield’ implemented on 24 March 2020, which provided temporary relief from certain insolvency laws for financially distressed businesses. 

However, the preferences regime was not included in the suite of temporary legislative changes that were passed in the early days of the COVID-19 crisis. This leaves creditors who have continued to trade with companies exposed to potential clawbacks of payments made to them by those companies, which are subsequently wound up when government support is ultimately scaled back. 

What is the temporary regulatory shield?

For companies, the Coronavirus Economic Response Package Omnibus Bill 2020 introduced certain relief measures designed to prevent otherwise profitable and viable businesses facing temporary financial distress from being pushed into insolvency unnecessarily, including:

• a moratorium on a director’s insolvent trading liability; and
  
  
• an increase to the threshold at which creditors can issue a statutory demand on a company (from $2,000 to $20,000) and an increase to the time a company has to respond to a statutory demand (from 21 days to six months). 

Have preferences been forgotten? 

The effect of the (unfair) preferences provisions in the Corporations Act 2001 (Cth) is that a creditor may be forced to return payments received from a company that enters into liquidation. Specifically, unsecured creditors who receive payments from a company in the six month period before it enters into external administration may later be pursued by a liquidator seeking to claw back those payments.

The purpose of the regime is to ensure that all creditors are treated equally, and so if a creditor’s invoice is paid in the six month period before a business collapses because it more vigilantly (or aggressively) pursued its debt, it should not receive any more than a creditor whose invoice remains unpaid. 

The ‘paid’ creditor could normally resist an attempted claw-back from a liquidator by relying on the defence that they had no reasonable grounds for suspecting that the company was insolvent or at risk of being insolvent. This is an objective process and does not require the creditor to have actual knowledge that the company was insolvent at the time of making the payment, simply that they had knowledge of indicators of insolvency. However, in the current economic climate, it will be increasingly difficult for any creditor to rely on that defence as there is an increased likelihood that the indicators of insolvency will be more obvious to creditors. For example, the receipt of JobKeeper payments by a company indicates a significant downturn in the company’s business.

The Government has focused primarily on the immediate short term triggers of insolvency from the company side perspective. But this ignores the creditors of that company who now have an increased exposure to an unfair preference clawback compared with normal trading conditions. Those creditors may themselves be forced into financial distress (or insolvency) when they are required to repay those amounts to a liquidator well after they received the payments. 

To balance this preference risk for trading creditors in this climate, the Government could consider the following options:

• to require the relevant creditor to have actual knowledge that the company it is trading with is insolvent (rather than just an objectively assessed suspicion of insolvency); and/or
  
  
• to allow the creditor to ‘set-off’ any preference claims against the debts owed to them by the company that have been incurred in the six month period. 

What’s next?

The current ‘regulatory shield’ against insolvent trading and the usual statutory demand processes will end on 25 September 2020. This has many sectors concerned about a ‘cliff’ for Australian businesses and an avalanche of insolvencies.

While no date has been set for a decision on whether or not to extend the temporary regulatory measures, businesses will need advance warning and we expect a decision will be made imminently.

If the Government is considering extending the existing regulatory protections, this is an opportunity to adopt a more expansive view of the insolvency triggers and consequences that it may want to guard against in these unprecedented times. Keeping front of mind the position of trading creditors who were ‘forgotten’ in the last suite of legislative protections will also share the risk and burden of this economic downturn more fairly.