Special Feature: Preferential payments can be reversed - credit managers beware!

electronic-paymentsIt's the stuff of small business horror stories - you keep bugging a customer to pay their long overdue account. You ring them, send them reminder letters, maybe even employ a debt collection agency or initiate legal action. Finally they pay their bill. You're happy and relieved.

Nigel Watson CV1

Nigel Watson is a restructuring
and insolvency lawyer in the
Melbourne office of
Colin Biggers & Paisley

 

 

 

It's the stuff of small business horror stories - you keep bugging a customer to pay their long overdue account. You ring them, send them reminder letters, maybe even employ a debt collection agency or initiate legal action. Finally they pay their bill. You're happy and relieved.

Then, a few months down the track, you hear that the customer has gone into liquidation. You're not surprised. And you breathe a sigh of relief that your invoice got paid before the company's demise.

Then you receive a letter from the company's liquidator demanding repayment of the money paid to you by the customer. Unfortunately, this scenario is not a fantasy.

A recent decision of the High Court has highlighted the fact that the powers of a liquidator to claw back monies may well extend for more than three years after the date of the liquidator's appointment.

electronic-paymentsPreferential payments

The policy of the law is that payments and transactions by a company which is insolvent and which are made within a relevant period prior to commencement of a formal insolvency proceeding, should be set aside and returned to the liquidator for sharing amongst the general body of creditors.

In the language of corporate law, such a payment is a "voidable preference" - "preference" because it shows favouritism to one creditor over others and "voidable" because it can be reversed.

The most common transactions which are challenged are payments made by a company to a creditor during the period of six months prior to commencement of the liquidation. Basically, if the liquidator can prove that the company was insolvent at the time of the payment, the creditor receiving the payment will be ordered to repay it unless the creditor can prove that it received the payment in the ordinary course of business and it did not have any reason to suspect that the company was insolvent at the time.

If a credit manager has been aggressively pursuing payment, has issued letters of demand or commenced court proceedings, it is very difficult for the creditor to defend the liquidator's claim.

Time limit for claims

Back in 1988, a Law Reform Commission Report into insolvency received a number of submissions which complained about inordinate delays on the part of liquidators in commencing proceedings in respect of voidable transactions. The Commission therefore recommended the introduction of the three-year time limit "to place liquidators under more rigorous but, nonetheless, reasonable time limitation for taking action".

The Corporations Lawnowprovides that any claim by a liquidator to recover a preferential payment must be brought within three years of the commencement of the liquidation unless the Court grants the liquidator an extension of time.

There have until now been some conflicting decisions as to the circumstances and manner in which the Courts will allow a liquidator to obtain an extension of time beyond the three year period to issue proceedings.

In a recent decision in Fortress Credit v Fletcher, the High Court accepted that the Courts do have a discretion to extend the three-year period, provided the liquidator could satisfy the Court that an extension is reasonable in the circumstances.

It is probable that in practice, the only circumstances in which a liquidator would gain an extension will be in a complex insolvency administration where investigations have proven difficult.

What can you do?

Prudent and careful credit control to ensure that customers pay strictly in accordance with your normal trading terms is always important and will provide the best defence.

If you can only obtain payment from your debtors outside your normal trading terms, or as a result of proactive collection activities, that payment may well be challenged by a liquidator as a voidable preference. That challenge may not come until three or even more years after your customer is placed into liquidation and at a time which may cause real difficulties with your own cash flow.

If you do receive a demand from a liquidator, do not ignore it. The liquidator will often accept an early compromise resolution, rather than risk incurring the costs of litigation.

 

 

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