It's an unfortunate situation that those who provide a product or service often find themselves in. They’ve done the work, provided a product, invoiced for the work or product and are therefore entitled to be paid. It can therefore be quite a shock to receive a letter from a liquidator demanding back payment of the money due to an unfair preference.
Madgwicks is pleased to be presenting our eight-part series on unfair preferences as we delve into the practical realities of dealing with an unfair preference. You can find the other articles in this series here.
Liquidators are required to prove various elements to successfully claim transactions are unfair preferences. One element is that the payment(s) must have been made when the company (now in liquidation) was insolvent. Challenging or proving payments were made when a company was solvent rests on a number of different factors outlined as follows.
What is insolvency?
The Corporations Act 2001 (Cth) provides s95A(1):
- A person 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.
- A person who is not solvent is insolvent.
What facts may indicate insolvency?
Matters which may support a finding of insolvency include:
- continuing losses;
- liquidity ratios below one;
- overdue Commonwealth and State taxes;
- a poor relationship with lenders, including any inability to borrow further funds;
- no access to alternative finance;
- inability to raise further equity capital;
- suppliers placing a company on cash or delivery arrangements or otherwise demanding special payments before resuming supply;
- creditors unpaid outside trading terms;
- the issuing of postdated cheques;
- dishonoured cheques;
- special arrangements with selected creditors;
- solicitors’ letters, summonses, judgments or warrants issued against a company;
- payments to creditors of rounded sums not reconcilable to specific invoices; and
- inability to produce timely and accurate financial information to display a company’s trading performance and financial position, and make reliable
What do the courts say about payments and insolvency?
The Courts have held:
- Short term liquidity issues do not necessarily indicate insolvency on their own.
- The Court’s often adapt a “cashflow test” which turns upon the income sources available to the company and the expenditure obligations that it has to meet, although a balance sheet test can provide context for the application of the cashflow test.
- The court may also have regard to the likelihood that the company in question will have funds available to it from sources with which it has no formalised agreement or understanding, including loans from its directors or from third parties.
Challenging a liquidator’s assertion that the company now in liquidation was insolvent at the time of the payments in question is complex and will usually require evidence from an expert. You should always seek expert advice when running this argument in a Court proceeding.