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Court of Appeal guides the way for creditors looking to navigate the unfair preference regime

By Sam KingstonIsabella Pierri

• 17 August 2020 • 4 min read
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A recent decision of the Victorian Court of Appeal has helped settle the law regarding third party payments. In our recent eAlert Third-party payments and unfair preference claims – effective shield or not?, we considered the inconsistencies in treatment of third party payments by the courts. The Court of Appeal’s latest decision exposes the potential shortfalls of the unfair preference regime in capturing payments made directly by a third party to a creditor of an insolvent company where the insolvent company’s assets are not diminished.

In Cant v Mad Brothers Earthmoving Pty Ltd[1], the Court of Appeal considered whether a payment made by a related party on behalf of the company in liquidation was in fact a payment by the company within the meaning of section 588FA(1) of the Corporations Act 2001 (Cth) (the Act). The Court of Appeal unanimously dismissed the appeal brought by the liquidator of Eliana. [2] In summary, the Court of Appeal made the following findings in relation to the operation of s 588FA(1) of the Act:

  1. a company may be a party to a transaction for the purposes of s 588FA(1)(a) as a result of giving a third party a direction as to the making of a payment to a creditor, or by authorising or ratifying such a payment. However, this does not necessarily mean that the payment is received ‘from the company’;
  2. the words ‘from the company’ in s 588FA(1)(b) have the effect of requiring that the preference be received from the company’s own money, meaning money or assets to which the company is entitled (emphasis added);
  3. it is necessary, in order for a preference to be ‘from the company’ that the receipt of it by the creditor has the effect of diminishing the assets of the company available to creditors; and
  4. a payment by a third party which does not have the effect of diminishing the assets of the company available to creditors is not a payment received ‘from the company’ and is therefore not an unfair preference (emphasis added).

Ultimately, focus must be placed on whether the third party payment is being received from the insolvent company’s own money, including money which the company is entitled to from the third party. That is, whether or not the payment diminishes the assets of the insolvent company including by discharging a claim against the third party. It is clear that a payment by a third party directly to a creditor of the insolvent company will not be a preference solely because the insolvent company directs the third party to make the payment.

The Court of Appeal also suggests that where an insolvent company merely substitutes a debt owing to a creditor with an equivalent debt owing to the third party, then that will not be caught by s 588FA as the ultimate effect of the transaction does not diminish the assets of the insolvent company.

Key takeaway

The Court of Appeal decision provides guidance to creditors of insolvent companies on how to structure a transaction to potentially avoid falling foul of s 588FA of the Act. The third party in this decision was not a party to the settlement deed, but little turns on this as a “transaction” may include composite dealings. In theory careful wording of a settlement agreement between each of a creditor, insolvent company and the third party may allow a third party to safely make payment directly to a creditor if the third party is not indebted to the insolvent company and the transaction does not diminish the assets of the insolvent company. However, the result will be different if those matters are not correct and at the least appropriate clauses such as warranties and indemnities should be included.

Liquidators will need to demonstrate that the assets of the insolvent company have ultimately been diminished by the payment in question. It will not be enough to show that the insolvent company merely ‘authorised’ or ‘directed’ that the payment be made if it cannot also be shown to result in a corresponding decrease in the company’s assets. Ultimately, the Court of Appeal decision makes it clear that the words “from the company” in section 588FA(1)(b) requires the liquidator to show a diminution of assets that would otherwise be available to the creditors.

[1] Cant v Mad Brothers Earthmoving Pty Ltd [2020] VSCA 198.

[2] However, the Court of Appeal did overturn Robson J’s decision about the good faith defence at paragraph 167 of the decision.

Get in touch with our team for more information.

By Sam KingstonIsabella Pierri

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