Court decides Cant can’t recover payment from related company as unfair preference

In the recent decision of Cant v Mad Brothers Earthmoving,[1] the Court of Appeal of the Supreme Court of Victoria (Justices Beach, McLeish and Hargrave) considered whether the liquidator of Eliana Construction and Developing Group (in liquidation) (Eliana) could establish that a payment made to an unsecured creditor of Eliana by one of Eliana’s related companies was an unfair preference.

Background

Eliana incurred a debt to Mad Brothers Earthmoving Pty Ltd (Mad Brothers) in the amount of $236,952.31, which related to earthworks services provided by Mad Brothers. As Eliana failed to pay the debt, Mad Brothers took steps to wind up Eliana in insolvency. However, the winding up proceeding settled after Mad Brothers and Eliana reached an agreement pursuant to which Eliana agreed to pay Mad Brothers $220,000 in full and final settlement of the debt.

The day after the settlement agreement was struck, the $220,000 amount due under the settlement agreement was paid from a loan facility in the name of Rock Development & Investments Pty Ltd (Rock Development) – a related company of Eliana.[2] A month later, Eliana was placed into voluntary administration, and a few weeks after that it was placed into liquidation.

Eliana’s liquidator, Cant, then commenced proceedings against Mad Brothers, alleging that the $220,000 payment made by Rock Development was voidable as an unfair preference given by Eliana to Mad Brothers; thus making Mad Brothers even madder.

Requirements for a transaction to be an “unfair preference”

A payment of an unsecured debt by a company that is later placed into liquidation will generally be voidable (barring applicable defences), and therefore recoverable from the recipient creditor, if the payment was an “unfair preference” and was made within six months prior to the company being placed into liquidation.[3]

Pursuant to section 588FA(1) of the Corporations Act 2001 (Cth) (the Corps Act), a transaction is considered to be an unfair preference given by a company to a creditor if, and only if:

1. the company and the creditor are parties to the transaction (even if someone else is also a party); and
2. the transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor, more than the creditor would receive from the company in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in a winding up of the company.

Was the transaction an unfair preference?

In circumstances where Eliana was a party to the settlement agreement, but did not itself pay the settlement sum (i.e. payment was made by Rock Development), the Court was required to consider two critical questions:

1. Was the $220,000 payment made by Rock Development a “transaction” to which Eliana was a party?
2. Was the payment “from Eliana”?

Was it a “transaction” to which Eliana was a party?

It has long been established that a “transaction” under the Corps Act can be made up of a series of interrelated or composite dealings. Accordingly, the Court held that a “transaction” can extend to “a dealing by which a third party [here, Eliana] authorises or ratifies a person’s [here, Rock Developments] conduct in making the payment. The third party is a party to that transaction.”

As Eliana’s general ledger recorded its debt to Mad Brothers as having been “paid off by Rock“, and Eliana and Rock Development had a common director and shareholder who acted on behalf of both companies in undertaking the transaction, the Court accepted that Eliana authorised and ratified the payment made by Rock Development, and found that Eliana was a party to the transaction.

Was the payment “from the company”?

As the Court noted in its judgment, this question presented much greater difficulty.[4] Even though Eliana was a party to the settlement agreement that triggered the payment to Mad Brothers, the liquidator needed to establish that the payment was “from” Eliana.

In that regard, following a detailed review of the relevant case law and comparable statutory provisions, the Court concluded that the words “from the company” in section 588FA(1) require the preference to be “received from the company’s own money, meaning money or assets to which the company is entitled.“[5] This necessarily requires the payment to have “the effect of diminishing the assets of the company available to creditors“; if a payment by a third party does not have the effect of diminishing the assets of the company available to creditors, it is not a payment received “from the company” and therefore cannot be an unfair preference.

In assessing whether Rock Developments’ payment of the settlement sum had the effect of diminishing Eliana’s assets that would have otherwise been available to its creditors in the liquidation, a critical consideration was whether Rock Development was indebted to Eliana. If Rock Development had been indebted to Eliana, the payment made by Rock Development would have reduced Rock Development’s debt to Eliana and therefore given Mad Brothers the benefit of an asset to which Eliana was entitled.[6] Hence, it would have been a payment “from” Eliana.

However, the evidence in this case fell short of showing that Rock Development was indebted to Eliana at the time of payment. Indeed, Eliana’s general ledger showed that Eliana was indebted to Rock Development, not the other way around. In those circumstances, the Court was not satisfied that the payment made by Rock Development was a payment “from Eliana” and found that Cant could not recover the payment as an unfair preference.

Key takeaways

This decision confirms that, in order to be characterised as an “unfair preference”, a payment must be received from the company’s own money, i.e. money or assets to which the company is entitled, and must have the effect of diminishing the assets that would have otherwise been available to creditors.

When reaching settlement agreements with companies in precarious financial positions, creditors should always bear in mind whether payment is coming from the company’s own money. If payment is being made by a third party, creditors should (to the extent possible) enquire about whether the third party payer owes money to the debtor company.

Authored by:

Guy Edgecombe, Partner
Mitchell Byram, Associate