Unfair preference claims against secured creditors – more options for liquidators?

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Take-home points

  • Unfair preferences are liable to be set aside upon application by a liquidator of a company in external administration under sections 588FE of the Corporations Act 2001.
  • Section 588FA of the Corporations Act 2001 defines an unfair preference as a transaction that that is entered into between a company and creditor and “results in a creditor receiving from the company (in respect of an unsecured debt the company owes the creditor) more than the creditor would have received if the transaction were set aside and to be proved in the winding up”.
  • Section 588FA(2) further provides that “a secured debt may be taken to be an unsecured to the extent it is not reflected in the value of the security.”
  • In Matthews v The Tapp Inn Pty Ltd [2015] SADC 108 the Court adopted a test that for the purpose of assessing the value of security pursuant to section 588FA(2), the date of the assessment is the date of the winding up of the company that granted the security.
  • The reasoning adopted by the Court means that if at the date of the winding up of the company the assets of the company which are the subject of the security are less than the quantum of the secured debt the short fall is treated as an unsecured debt. This potentially widens the scope for liquidators to examine if certain secured debts may be challenged and increase the pool of available assets to be distributed to creditors. This may extend to the scope of liquidators’ coercive powers such as examinations to obtain documents in support of claims.
  • There has been scarce consideration of section 588FA(2) of the Act by superior courts. Matthews provides some guidance to liquidators that the mere fact that a creditor has obtained security does not mean that they are immune from an action for unfair preference. The decision may be cited as a persuasive precedent, though liquidators should proceed carefully to bolster their case if they intend to pursue secured creditors for unfair preference claims.

A decision by the District Court of South Australia may provide liquidators with a wider scope to pursue unfair preference claims against secured creditors.

Pursuant to sections 588FE of the Corporations Act 2001 (the Act) certain classes of transactions (including insolvent trading transactions, uncommercial transactions, unfair preferences, and unreasonable director related transactions) are considered voidable by a liquidator seeking to recover assets.

Under section 588FA of the Act, an unfair preference occurs when:

  • A transaction is entered into between the company and one of its creditors;
  • The transaction resulted in the creditor receiving more from the company than it would have received if it proved for the debt in the liquidation; and
  • The transaction was entered into during the period of six (6) months ending on the relation-back day.

One of the rationales for giving liquidators the power to seek to have unfair preferences voided is to discourage creditors from dismembering debtor companies through the giving of security, thereby reducing the pool of assets available to pay creditors and unfairly favour certain creditors.

Interpreting when a secured debt is considered secured (particular in the context of a purported over future assets) is critical to determining if the secured debt is “reflected in the value of the security” and if an unfair preference action has good prospects of success.

Background facts

In Matthews v The Tapp Inn Pty Ltd the defendant sold a hotel to Pub Tap Investments. The sale was financed in part by a bank and in part by the defendant and secured by debentures to each party respectively. The banks debenture took priority as it was first in time. Both debentures created a fix and floating charge over the present and future assets of the company (or in the language of the Personal Properties Securities Agreement 2009 (Cth), a general security agreement over a non-circulating asset and circulating assets.

Under the terms of sale, Pub Tap was required to make periodic payments to the Defendant. Between 30 June 2008 and 27 April 2010, Pub Tap made 24 payments, of which $76,678.46 was made within the six months of 16 June 2010 (the relation back day).

On 16 June 2010, Pub Tap was placed in administration and subsequently liquidation. The liquidator sought to claim the payments made in the six months leading up to the relation back day as an unfair preference, claiming that they were payments discharging an unsecured debt by virtue of section 588FA(2) of the Act.

Arguments made to the Court

The liquidator argued that the payments were to discharge an unsecured debt by virtue of section 588FA(2) of the Act and the value of the security (the debentures) should be assessed at the date of the winding up of the company (being at that stage, nil).

The defendant argued that the correct date to assess the value of its security should be the date it was created, when the amount secured was less than the value of the security, and therefore wholly secured the debt and not preferential.

Courts’ decision

Judge Chivell was asked to decide when the time for assessing the value of security was (either the date the security was created, the date when the payments were made, or the date of the winding up or some other date) prior to the trial of the principal dispute between the liquidator and defendant.

His Honour held that, in accordance with settled principles of statutory interpretation, the date of assessing the value of the security is the date of the winding up of the company that granted the security. In practical terms, section 588FA(2) was to be interpreted as meaning “the debt will be deemed to be unsecured to the extent of so much of it (if any) constitutes a shortfall between the value of security and the debt.”

The reasoning adopted by her Honour meant that there are no assets at the date of the winding up on which the security can operate, then the security is valueless to the creditor and the debt is unsecured.

As a result, the payments made by Pub Tap were considered an “unfair preference” and constituted insolvent transactions and voidable under section 588FE of the Act.

Commentary

The approach adopted by the Court in Matthews means that in the context of liquidation proceedings, the effective value of a security may be assessed as minimal or zero when taking into account factors including whether the assets realised by the liquidators being of insufficient value to discharge a security because the assets were only enough to discharge a prior security only and were largely dissipated prior to the winding up.

Furthermore, certain payments (namely, those which were made in repayment of a secured debt) may potentially open to attack as unfair preferences if it can be established that at the date of commencement of the winding up, the assets of the company which are subject to a security are worth less than the quantum of the secured debt.

Any shortfall between the value of the security and quantum of the secured debt may be considered an unsecured debt which can be assessed against payments made to determine if an unfair preference has been given which would prejudice other unsecured creditors.

We note that the decision in Matthews is one of an inferior court which does not bind superior courts. While there are few cases regarding section 588FA(2), it remains to be seen whether or not the decision will lead to an increase in unfair preference claims against secured creditors. In the right factual circumstances, the Matthews decision may be cited in support of the proposition that certain transactions are unfair preferences.

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