Third party payments – have you received an unfair preference?

This week’s TGIF examines a recent decision of the Supreme Court of New South Wales which considered whether payments made by a third party to a company’s creditors could be recovered as unfair preferences.

What happened?

On 2 September 2015, liquidators were appointed to a building and construction company (the Company) and later commenced proceedings against eight defendants for the recovery of payments considered to be unfair preferences.

The defendants did not challenge the liquidators’ evidence as to insolvency. Rather, they contended the payments received were not from the Company and had been paid directly by the principal (Head Contractor) as opposed to the insolvent debtor they had subcontracted with.

Dispute over Works and Union pressure

The Company had been contracted on a project in Pitt Street, Sydney and subcontracted certain interior works to various companies (including each of the defendants).

In late 2012, extensive flood damage meant that the Company was unable to perform further work and it fell into dispute with the Head Contractor. The Company was not paid by the Head Contractor and, as a consequence, neither were the subcontractors.

On 12 March 2013, the Company wrote to the Head Contractor and made a formal request pursuant to its contract that “the subcontractors be paid directly by the Head Contractor on the Company’s behalf”.

Separately, on 14 March 2013, the Head Contractor met with the CFMEU following a request for an urgent conference. Following that meeting, the Head Contractor terminated its contract with the Company and subsequently sent a letter to the CFMEU stating that, amongst other things, it would make direct payment to the subcontractors on behalf of the Company.

The liquidators argued that, although the payments were actually made by the Head Contractor, the Company was also a party to the transaction and the payments were made on its behalf such that the payments were received from the Company.

In doing so, the liquidators placed reliance on, amongst other authorities, the Full Federal Court’s decision in Re Emanuel (No 14) Pty Ltd; Macks v Blacklaw & Shadforth Pty Ltd (1997) 147 ALR 281 (Re Emanuel).

The Decision

The Court rejected the liquidators’ submission and found that, although the payments by the Head Contractor had the effect of discharging the Company’s indebtedness, it did not follow that they were made by or received from the Company.

In reaching this conclusion, his Honour carefully considered Re Emanuel and the relevant provisions of the Act, noting that:

1. a transaction may consist of multiple dealings to extinguish a debt and it is not necessary that the company be a party to every one of them; and

2. whether a payment is made by or received from the company depends upon whether the company has directed the payment be made out of an asset the benefit of which it is entitled.

In his reasoning, his Honour stressed that these were two independent points and the fact that, for example, debtor A authorises a third party’s payment to C does not of itself provide reason for saying that A made the payment.

What is critical is that the creditor (here, the defendant subcontractors) receives the actual benefit of an asset of the company (the Company) at the direction of the company and, but for that direction, the company would have been entitled to the benefit.

In the present case, the Court held that:

• the Head Contractor did not act pursuant to the Company’s request. The payments were made out of the Head Contractor’s assets in response to industrial pressure from the CFMEU; and

• there was no evidence that there were any moneys owing by the Head Contractor to the Company (or property or benefit of which the Company was entitled) out of which any of the payments were made (or could be directed).

The effect of the above arrangement was effectively “neutral” on the Company’s financial position and an order to pay those monies to the liquidators would confer a windfall to which they were not entitled.

Comment

With insolvencies in the building sector on the rise, this decision provides useful guidance to liquidators and creditors alike as to the law with respect to the recovery of payments as unfair preferences in circumstances where the payments sought to be impugned are made by a third party (such as a Head Contractor).

Before such a payment can be avoided, it must be established (in addition to the relevant statutory requirements of the Act) that:

1. the payment was made with the insolvent debtor’s authorisation or ratification; and

2. the monies that were paid represent a benefit or asset to which the debtor was entitled.

This is consistent with the policy for the recovery of unfair preferences, namely that, unsecured creditors should not be prejudiced by the disposition of assets in favour of other creditors shortly before the winding up.