Due to COVID-19, the Federal Government implemented several measures to assist companies’ longevity and sustainability of its business.  Many commentators have suggested that those measures have kept many insolvent companies afloat, but are likely to go into liquidation once these measures cease.  As a wave of liquidations is forecasted by many in the insolvency industry, this article serves as a timely reminder to Creditors of the Good Faith Defence to Unfair Preference Claims.

Generally, a Creditor will face a demand from a Liquidator seeking to claw back an unfair preference payment pursuant to section 588FA(1) of the Corporations Act (the Act) made, where the Creditor has received payment from the Company, in the six (6) months leading to Liquidator’s appointment to the Company. A Creditor may deploy the Good Faith Defence in response to the Liquidator’s Unfair Preference claim, if it can satisfy the requirements of s. 588FG (2) of the Act.

The Legal Principles

The Creditor bears the onus of proving each element of the Good Faith Defence.

In order for a Creditor to rely on the Good Faith Defence they are required to prove that:

  1. they entered into the transaction in good faith;
  2. at the time when the person became such a party:
    1. had no reasonable grounds for suspecting insolvency;
    2. a reasonable person would not have suspected insolvency; and
  3. valuable consideration was provided.

As valuable consideration is often an uncontentious element of the defence we have not referred to it in this article.

Good Faith

The first element is that the Creditor must establish that it became a party to the transaction in good faith, without the benefit of a presumption in its favour. The Good Faith component is a subjective test. The term Good Faith is to be given its natural meaning; that is to act with propriety or honesty.  In order for the Creditor to establish that it subjectively entered the transaction in good faith, it is necessary to prove that the motive which actuated them to do so was honest and proper.

Reasonable Grounds

For this element, the Creditor must show an absence of grounds on which it, or a reasonable person in its position, ought to have suspected insolvency.  The test is to be applied in consideration of all the commercial circumstances at the time of the transaction so as to determine whether in that context, factors exist indicating insolvency of the debtor company.

The Courts have recognised that a Creditor has a substantial task to overcome, namely, the factual circumstances of the case appreciated by the Creditor at the time were insufficient to induce a suspicion of insolvency.

When Good Faith is Enough Faith

The Supreme Court of New South Wales Judgment of Heavy Plant Leasing Pty Ltd (in Liq) [2018] NSWSC 707 gives guidance for Creditors seeking to rely on the Good Faith Defence. In this matter, the Court was dealing with a Creditor who supplied construction materials to a debtor company, payment of which being 30 days after receipt of the goods. The debtor company did not make the payments as they fell due, for a variety of reasons, and the Creditor exerted a certain amount of pressure to have all its debts paid as and when they fell due and payable. The Creditor received payment from the debtor, which was then challenged as an unfair preference.

In considering the Creditors Good Faith Defence, and what would amount to a suspicion of insolvency, the Court set out that what is required is more than a mere idle wondering of a fact, but rather a positive feeling of actual apprehension or mistrust. The Court stated that the amount of pressure exerted by the Creditor for the payment of debts, resistance to pay by a debtor, late payment by a debtor, or the resort to conventional debt recovery procedures, are not of themselves reasonable grounds to suspect insolvency. The Creditor in this matter succeeded in opposing any reasonable suspicions of insolvency.

As a side note, recently in August 2020, the Victorian Court of Appeal in Cant v Mad Brothers Earthmoving Pty Ltd [2020] VSA 198 dealt with a claim for a third-party preference payment.  Here the Court found that for there to be an unfair preference, the payment must have been received from the Company, or resulted in a reduction in the Company’s assets otherwise available to the Company’s creditors in liquidation. In this matter, as the payment was received from a third party and not the Company, and the Company assets were not reduced by the transaction, the Court found there could not be an unfair preference.

For further information or should you require any assistance, please contact John Fairgray (Partner) jfairgray@bbwlaw.com.au, Luis Ormazabal (Senior Associate) lormazabal@bbwlaw.com.au or Andi Warda (Solicitor) awarda@bbwlaw.com.au.