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Liquidator’s “claw-back” powers
Where a company has been placed into liquidation, the liquidator has statutory powers to recover payments made to creditors and other parties. This often catches many businesses by surprise, as they may be suddenly pressured by a liquidator’s demand, or worse, compelled by Court Order, to refund monies to the liquidator, having, in many cases, done nothing wrong. This articles explores the circumstances in which a liquidator may exercise statutory “claw-back” powers against a person.
You have done the work. You have been paid. Yet, many moons later, you are suddenly being compelled by a liquidator to refund that money to the company (in liquidation) at the threat of suit. Is this legal? What are your obligations? What are your defences? The truth is that you may never know the actual financial health or solvency of a company that you trade with. This means that the risk of a company being placed into liquidation (suddenly, and to your surprise) is more real and common than you might think.
Accordingly, whether you, as a business owner, will be subject to a liquidator’s claw-back demands one day is more a question of “when”, as opposed to “if”, as it is virtually inevitable for a company that you have traded with, at one time or another, to be subsequently placed into liquidation. As a business owner, you should have a firm understanding of this statutory claw-back regime, as you may not always, for the reasons set out below, be legally obliged to refund the money, despite the demand of the liquidator.
What kind of transactions may be "clawed" back by a liquidator?
Subdivision A, Division 2, Part 5.7B of the Corporations Act 2001 (Cth) (the “Corporations Act“), provides that the following transactions may be avoided (i.e. “clawed” back) by a liquidator:
- Unfair preferences
- Uncommercial transactions
- Insolvency transactions
- Unfair loans to a company
- Unreasonable director-related transactions
- Creditor-defeating transactions
The elements giving rise to each transaction is defined by a specific section of the Corporations Act (discussed further below).
However, it is not enough for a liquidator to show that elements constituting the specific type of transaction can be satisfied. For a particular transaction to be voidable by a liquidator, the liquidator must also be able to show that the transaction is an “insolvent transaction”, that it occurred within the relevant timeframe and that there is no statutory defence available to the creditor.
The overarching purpose of this statutory claw-back regime is to prevent certain creditors from being favoured by a company (by receiving payments or a disposition of assets) shortly before the company is placed into liquidation, to the prejudice of other unsecured creditors of the company, who may receive nothing (or very little) as a result of those earlier payments or dispositions.
What is an "unfair preference" transaction?
Section 588FA(1) of the Corporations Act provides that a transaction is an unfair preference given by a company to a creditor of the company if, and only if:
- the company and the creditor are parties to the transaction (even if someone else is also a party); and
- 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;
even if the transaction is entered into, is given effect to, or is required to be given effect to, because of an order of an Australian court or a direction by an agency.
However, an unfair preference (or other type of transaction) will only be voidable if the liquidator can show that the transaction constitutes a “voidable transaction” for the purposes of section 588FE of the Corporations Act.
In what circumstances is an "unfair preference" voidable by a liquidator?
Voidable transactions are set out in section 588FE of the Corporations Act.
An “unfair preference” transaction will be voidable by a liquidator if:
- the transaction is an “insolvent transaction” of the company; and
- it was entered into, or an act was done for the purpose of giving effect to the transaction:
- during the 6 months ending on the “relation‑back day”; or
- after that day but on or before the day when the winding up began.
Therefore, a liquidator can “claw” back a transaction made to a creditor (prior to the winding up of the company) if it can show that:
- the transaction constitutes an “unfair preference”;
- the transaction constitutes an “insolvent transaction”; and
- the transaction took place during the period of 6 months prior to the “relation-back” day.
What is an "insolvent transaction" under the Corporations Act?
Section 588FC of the Corporations Act defines an “insolvent transaction” to be a transaction of a company if, and only if, it is an “unfair preference” given by the company, or an uncommercial transaction of the company, and:
- any of the following happens at a time when the company is insolvent:
- the transaction is entered into; or
- an act is done, or an omission is made, for the purpose of giving effect to the transaction; or
- the company becomes insolvent because of, or because of matters including:
- entering into the transaction; or
- a person doing an act, or making an omission, for the purpose of giving effect to the transaction.
Accordingly, in relation to reversing an unfair preference transaction, a liquidator must be able to show that the company gave an unfair preference payment to a creditor at a time that the company was either:
- insolvent; or
- became insolvent by reason of making the unfair preference payment to the creditor.
When is a company deemed to be "insolvent"?
Section 95A of the Corporations Act states that:
- a person (which includes company) is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable; and
- a person who is not solvent is insolvent.
The word “due” has been held to require the debt to be paid on the date when it first becomes payable. However, it does not mean that a Court cannot take into account a course of dealings between the parties where the debt is not actually payable until a later date. The solvency of a company must therefore be decided as a matter of commercial reality in light of all the circumstances.
Additionally, the fact that the company has borrowed money to pay its debts does not necessarily mean that the company is insolvent (despite the general proposition that a company must use its own money to pay debts to avoid being deemed insolvent). This is because the ability to borrow money may itself be compelling evidence of strong financial standing.
A Court will want to know whether there is a temporary lack of liquidity or an endemic shortage of working capital.
What is the "relation-back" day under the Corporations Act?
Where a company has resolved that it be wound up voluntarily, then, the “relation-back” day, in that case, is the day on which the winding up of the company is taken to have commenced (which is usually the date that a liquidator is formally appointed to take over, and liquidate, the company).
Accordingly, in order for a liquidator to “claw” back an unfair preference transaction, the liquidator must be able to show that:
- the transaction is an “unfair preference”;
- the transaction is an “insolvent transaction”; and
- the transaction took place within 6 months immediately prior to the date the winding up of the company commenced.
Are there any statutory defences available to a creditor?
The liquidator’s attempt at “clawing” back a transaction can be challenged on numerous substantive and technical grounds.
Most commonly, a creditor, on the receiving end of a liquidator’s “claw” back demand, will seek to invoke either of the following statutory defences:
- pursuant to s588FG(1) of the Corporations Act (if the creditor is not a party to the transaction), the defence that “no benefit” was received by the creditor, or if a benefit was received by the creditor, that it was received in “good faith without grounds for suspecting the insolvency of the company”; or
- pursuant to s588FG(2) of the Corporations Act (if the creditor is party to the transaction), the defence that the transaction was entered by the creditor for “valuable consideration” in “good faith without grounds for suspecting the insolvency of the company”.
The creditor bears the onus of establishing the elements of each defence it relies upon.
A creditor, therefore, in defending against a liquidator’s “claw” back demand, may rely on the grounds that either:
- the liquidator has failed to satisfy all relevant statutory elements necessary to give rise to a “voidable transaction”; or
- further or in the alternative, the creditor is entitled to rely on a statutory defence absolving it of any liability to the liquidator for the voidable transaction.
If you need expert legal advice or assistance in relation to responding to, or appealing, a Show Cause Notice or an Enforcement Notice, please contact ADVIILAW today to speak to one of our experienced litigation lawyers.
Contact us on 07 3088 7937 or email us at [email protected].
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