Unravelling the unfair preference

10 July 2013

In this issue

Unfair preferences under section 588FA, Corporations Act 2001 (Cth) considered
Whether payments made by a related company of the debtor were payments made by the debtor
Whether payments received by a creditor amounted to unfair preferences in the hands of the creditor

Background

In unfair preference proceedings within the meaning of section 588FA, Corporations Act 2001 (Cth) (the Act), where a liquidator is seeking to recover payments made to a creditor prior to a debtor company’s winding up, two fundamental issues commonly arise for consideration, namely:

Have the alleged preferential payments to the creditor been paid by the debtor or have the payments been made by a third party such that the debtor is not a party to the transaction as required by section 588FA (“the third party payment issue”);
Even if the payments were made by the debtor has the transaction bestowed on the creditor an unfair preference as required by section 588FA (“the preferential effect issue”).

Recently the Full Court of the Federal Court of Australia in Commissioner of Taxation v Kassem and Secatore reviewed these two fundamental issues.

Factual background

The facts are largely uncontroversial. The liquidators of Mortlake Hire Pty Ltd (Mortlake) brought proceedings against the commissioner of taxation under section 588FA of the Act to recover as unfair preferences two payments totalling $70,000 made to the commissioner to reduce Mortlake’s indebtedness.

The payments were made within the relation back period referred to in section 588FE(2) of the Act. However the payments were made to the commissioner by Mortlake using funds provided to it by a related company, Antqip Pty Ltd (Antqip). The liquidators submitted that the payments were made by or on behalf of Mortlake. The commissioner submitted that the payments were made by Antqip using its own funds. As a consequence the commissioner argued that Mortlake was not a party to the payments, being a requirement of section 588FA.

A second substantial issue arose from the decision of the commissioner to allocate the payments in reduction of Mortlake’s indebtedness for the superannuation guarantee charge (SGC), as opposed to the company’s primary tax indebtedness in respect of group tax, goods and services tax, and other related liabilities due to the commissioner.

With respect to this second issue the commissioner contended that under section 556(1)(e) of the Act, indebtedness for the SGC is given priority over other unsecured debts. As a consequence the payments could not constitute unfair preferences because there were no other debts payable by Mortlake with priority equal to or higher than that which applies to the SGC under the Act.

The third party payment issue

In reviewing the question who made the relevant payments to the commissioner, the Full Court accepted the finding of the primary judge that each of the payments was a payment made by Mortlake using moneys borrowed by Mortlake from Antqip. Once it was accepted that the payments were made by Mortlake to the commissioner from borrowed funds the transaction fell squarely within the language of section 588FA.

In arguing against this outcome reference was made by the commissioner to the absence of any loan agreement, company minute or other document recording the existence of any arrangement pursuant to which Antqip advanced funds to Mortlake. The primary judge’s conclusions on this issue were held to be relevant:

“There is nothing remarkable about the absence of such documentation. I am not concerned here with large or sophisticated corporations involving particularly large sums of money……Each of the companies was relatively small and under common ownership.”

Moreover an argument that Antqip was paying Mortlake’s debts free of any repayment obligation would require the court to infer that Antqip was giving away its assets for no consideration, an inference that, in the absence of compelling evidence the Full Court was unwilling to draw.

The preferential effect issue

The commissioner’s submission that it did not receive an unfair preference on receipt of the payments because its SGC claim ranked ahead of other unsecured creditors in the winding up was rejected by the Full Court.

In doing so the Full Court accepted the liquidator’s submission that the priority status of the SGC was irrelevant in determining whether the payments amounted to unfair preferences. The essential question was whether the commissioner received payments out of Mortlake’s assets that were greater than the amount the commissioner would receive in the winding up. In this respect the evidence clearly established that the commissioner had received more than in a winding up. In particular the costs and expenses of the winding up were such that there was little prospect of the commissioner receiving any dividend at all in the winding up.

In view of the benefit received by the commissioner the requirement of unfair preference under section 588FA was satisfied.

Concluding comments

The Full Court of the Federal Court has provided useful commentary on two fundamental aspects of the liquidator’s unfair preference recovery, namely:

The company and the creditor must be parties to the transaction;
The ultimate effect of the transaction must be to provide the creditor with more than the creditor would receive in the winding up.

Recognition by the Full Court of the informal nature of related party advances, particularly where small proprietary companies are involved, will prove useful in future cases. Equally the Full Court’s reflection on the nature of preferential effect has provided an insightful application of existing legal principles in this area.