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When is a Company Insolvent?

26/05/2019 By // by Wayne Davis

A company is insolvent if it is unable to pay its debts as and when they become due and payable.

A company’s insolvency is calculated upon:

The cash flow test; and then
The balance sheet test.

There is a difference between company insolvency and temporary illiquidity.

This article will look at when a company is insolvent and the distinction between insolvency and the temporary lack of liquidity.

When is a Company Insolvent? This depends on a large number of factors. It is vital that a director gets qualified legal advice before they cause the company to trade while insolvent!

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What is Insolvency?

Section 95A of the Corporations Act 2001 (CTH) (“Corporations Act“) says:

(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.
(2) A person who is not solvent is insolvent.

Classically this is known as the “cash flow test”. Does a company have enough cash on hand to pay debts as and when they become due and payable?

This raises some further questions, namely:

What does “debt” mean?
What does “due and payable” mean?

These will be discussed in more detail below.

As well as the cash flow test, the Courts have also adopted the “balance sheet test” which says that temporary lack of liquidity may not be indicative of insolvency.

A company is insolvent under the balance sheet test if the total liabilities are more than the total value of the assets of the company.

This again raises an important question, namely:

How does a Court value the total assets?

When is a Company Insolvent?

It is very difficult in some circumstances to establish when a company is insolvent.

The Courts have stated that primarily pursuant to 95A of the Corporations Act, the cash flow test is the first and primary test in establishing insolvency.

However, the balance sheet test can be used as a secondary test to show the Court that the temporary lack of liquidity is indicative of that and does not prove insolvency.

This article will explain the above in more detail below.

The Cash Flow Test

As mentioned above, section 95A of the Corporations Act says:

(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.
(2) A person who is not solvent is insolvent.

This essentially says that a company that is unable to pay the company’s debts as and when they become due and payable is insolvent.

So, in order to understand this definition, a person must understand what a debt is, what the ability to pay means, and what due and payable means.

We will discuss these in more detail below.

What does “debt” mean?

In the absence of a definition of debt in the Corporations Act, we have to look at the common definition of the word, and the case law to determine how they have defined debt.

Debt is defined in the Oxford English Dictionary to mean:

A sum of money that is owed or due

In Re WorkCover Queensland [1998] QSC 32, Muir J said:

A debt is a sum payable in respect of a liquidated money demand recoverable by action. Stroud’s Judicial Dictionary, 2nd ed., p.471 and see Geo Thompson (Australia) Pty Ltd v. Vittadello [1978] VicRp 20; (1978) 33 FLR 465 at 481.

In Hawkins v Bank of China (1992) 26 NSWLR 562, Gleeson C.J. said:

Dictionaries define debt as a liability or obligation to pay or render something.

In Rothwells Limited v. Nommack (No. 100) Pty Limited 2 Qd R 85 Mc Pherson J said:

That the word ‘indebted’ … was used in the context of a debt being a liquidated sum of money presently due owing and payable by a person called the debtor to another person called the creditor.

So, generally a debt is a sum of money, or an obligation to pay, owed by one person to another person.

By far the most common form of debt in insolvency law is the non-payment of invoices for goods provided or services rendered. This is consistent with the definitions above.

However, it is worth knowing the definitions (as obvious as it appears) for the less common debts which may occur. So, what does being able to pay the debts mean?

What does “due and payable” mean?

Once again, with lack of meaning in the Corporations Act, we can look at extrinsic materials and cases to understand what due means and payable means.

The Oxford English Dictionary defines due to mean:

(of a payment) required at a certain time, or an obligatory payment; a fee.

The Oxford English Dictionary defines payable to mean:

(of money) required to be paid; due.

There is some difference between monies that are “due” and monies which are “payable”. For example, monies owed under contract pursuant to an invoice with a date for payment in fourteen (14) days are payable, but not yet due. The monies would not be due until the fourteenth day.

In Metropolitan Brick Company v Hayward and Anor [1938] SAStRp 57 Napier J said:

[t]here is a sense in which money can be “due” although not yet “payable”, but the converse cannot be true.

In Main Camp v Australian Rural [2002] NSWSC 219 Barrett J said:

A statement that a sum is “due and payable” thus connotes not only that it is “owed” (so that the debtor is “indebted”) but also that the time for payment has arrived and the obligation to pay is an unqualified and unfettered obligation requiring immediate performance.

So, for a debt to be due and payable, it must be both due, that is there must be an obligation to pay the debt, and it must be payable, that is any time stipulation (14 days) has to have come and gone.

In Sutherland & Anor as joint liquidators of Australian Coal Technology v Hanson Construction Materials Pty Ltd [2009] NSWSC 232 Barrett J said:

It has been authoritatively determined that s 95A calls attention principally to the cash flow test of insolvency with subsidiary relevance afforded to the balance sheet test.

We will now look at the balance sheet test for insolvency.

The Balance Sheet Test

The ability of the company to pay its debts has been given a lot of consideration by the Courts.

Most importantly, in Sandell v Porter (1966) 115 CLR 666 Barwick C.J. (with whom McTiernan and Windeyer JJ agreed said:

[t]he debtor’s own moneys are not limited to his cash resources immediately available. They extend to moneys which he can procure by realisation by sale or by mortgage or pledge of his assets within a relatively short time – relative to the nature and amount of the debts and to the circumstances, including the nature of the business, of the debtor.

The High Court then went on to say:

The conclusion of insolvency ought to be clear from a consideration of the debtor’s financial position in its entirety and generally speaking ought not to be drawn simply from evidence of a temporary lack of liquidity.

So, because the test is an objective test taking into consideration of the debtor’s financial position as a whole, being able to pay company debts is not limited to cash resources immediately available.

If the company is “able” to realise assets, or borrow cash in a relatively short time, then this might constitute being “able” to pay its debts when they become due and payable.

Temporary Lack of Liquidity

In order for a Court to make a determination of insolvency pursuant to section 95A of the Corporations Act, it will need to debtor’s financial position in its entirety and generally speaking ought not to be drawn simply from evidence of a temporary lack of liquidity.

After all, it is possible for a company to have a temporary lack of liquidity because of its own debtors, and once paid, will be able to pay its creditors.

In Sutherland & Anor as joint liquidators of Australian Coal Technology v Hanson Construction Materials Pty Ltd [2009] NSWSC 232 Barrett J said:

The emphasis must be upon the extent of cash and other liquid assets compared with the quantum of debts due and payable and to become due and payable in the immediate future. Insufficiency of cash or liquid resources to pay those debts is indicative of insolvency. The insufficiency becomes determinative if it is shown that it is more than a temporary lack of liquidity. In essence, there is a question whether the inability to pay is purely temporary.

If a company is experiencing a temporary lack of liquidity, then the Courts must determine objectively whether the value of its assets is more than its liabilities, remembering the commercial realities of the company.

In Southern Cross Interiors Pty Ltd and Anor v Deputy Commissioner of Taxation and Ors. [2001] NSWSC 621 Palmer J said:

Commercial realities will be relevant in considering what resources are available to the company to meet its liabilities as they fall due, whether resources other than cash are realisable by sale or borrowing upon security, and when such realisations are achievable.

The commercial reality of valuation causes problems when trying to assess the value of a company’s assets.

When is a Company Insolvent?

So, as you can tell, only in the most cut-and-dry cases such as a $2 company with no assets and a number of debts, can insolvency be easily ascertained.

The Court will first make an assessment using the cash flow test and then make a subsidiary determination as to whether the company is experiencing temporary illiquidity or are in fact insolvent.

In Southern Cross Interiors Pty Ltd and Anor v Deputy Commissioner of Taxation and Ors. [2001] NSWSC 621 when deciding the solvency or insolvency of a company, Palmer J considered all of the authority cases on this point and said:

In my opinion, the following propositions may now be drawn from the authorities:

i)          whether or not a company is insolvent for the purposes of CA ss.95A, 459B, 588FC or 588G(1)(b) is a question of fact to be ascertained from a consideration of the company’s financial position taken as a whole;
ii)         in considering the company’s financial position as a whole, the Court must have regard to commercial realities. Commercial realities will be relevant in considering what resources are available to the company to meet its liabilities as they fall due, whether resources other than cash are realisable by sale or borrowing upon security, and when such realisations are achievable;
iii)        in assessing whether a company’s position as a whole reveals surmountable temporary illiquidity or insurmountable endemic illiquidity resulting in insolvency, it is proper to have regard to the commercial reality that, in normal circumstances, creditors will not always insist on payment strictly in accordance with their terms of trade but that does not result in the company thereby having a cash or credit resource which can be taken into account in determining solvency;
iv)        the commercial reality that creditors will normally allow some latitude in time for payment of their debts does not, in itself, warrant a conclusion that the debts are not payable at the times contractually stipulated and have become debts payable only upon demand: Antico;
v)         in assessing solvency, the Court acts upon the basis that a contract debt is payable at the time stipulated for payment in the contract unless there is evidence, proving to the Court’s satisfaction, that:
•           there has been an express or implied agreement between the company and the creditor for an extension of the time stipulated for payment; or
•           there is a course of conduct between the company and the creditor sufficient to give rise to an estoppel preventing the creditor from relying upon the stipulated time for payment; or
•           there has been a well-established and recognised course of conduct in the industry in which the company operates, or as between the company and its creditors as a body, whereby debts are payable at a time other than that stipulated in the creditors’ terms of trade or are payable only on demand:
vi)        it is for the party asserting that a company’s contract debts are not payable at the times contractually stipulated to make good that assertion by satisfactory evidence.
There are a number of cases which have outlined what Courts have determined to be indicia or features of determining when a company is insolvent.

Common Features of Insolvency

There are a number of types of conduct which may suggest that the company is insolvent.

In Pearce v Gulmohar Pty Ltd [2017] FCA 660 Rangiah J said:

In ASIC v Plymin (No 1) [2003] VSC 123; (2003) 46 ACSR 126 at [386], the Court identified a number of common, albeit not essential, features in insolvency situations. That judgment has been referred to with approval in many subsequent decisions, including Bluestone Property Services Pty Ltd (in liq) v First Equilibrium Pty Ltd [2013] FCA 876 at [42]; Smith v Bone at [24] and McLellan v Carroll [2009] FCA 1415; (2009) 76 ACSR 67 at [106]. The features are:
1. Continuing losses.
2. Liquidity ratios below 1.
3. Overdue Commonwealth and State taxes.
4. Poor relationship with present Bank, including inability to borrow further funds.
5. No access to alternative finance.
6. Inability to raise further equity capital.
7. Suppliers placing [company] on COD, or otherwise demanding special payments before resuming supply.
8. Creditors unpaid outside trading terms.
9. Issuing of post-dated cheques.
10. Dishonoured cheques.
11. Special arrangements with selected creditors.
12. Solicitors’ letters, summons[es], judgments or warrants issued against the company.
13. Payments to creditors of rounded sums which are not reconcilable to specific invoices.
14. Inability to produce timely and accurate financial information to display the company’s trading performance and financial position and make reliable forecasts.

Rangiah J then went on to say:

Importantly, this is a guide, not a checklist. It is merely a list of factors, the presence of one or more of which may indicate insolvency. Likewise, not all factors need be present.

In Lewis (as liquidator of Doran Constructions Pty Ltd (in liq) & v Doran & Ors [2005] NSWCA 243 Giles JA Hodgson JA McColl JA said quoting Palmer J:

As at 1 November 1994 there were present none of the usual indicia of insolvency;
1. A history of dishonouring cheques;
2. Suppliers delivering goods only on a COD basis;
3. The company issuing post-dated or ‘rounded sum’ cheques;
4. The company special arrangements with its creditors;
5. The company was unable to produce timely, audited accounts;
6. Unpaid group tax, payroll tax, workers compensation or superannuation;
7. The company had received demands from bankers to reduce overdraft limits and has a bad relationship with its bankers;
8. The company had received statutory demands, solicitors’ letters requiring payment of debts or legal proceedings for the payment of trade debts.

Further, in the ASIC guide – Insolvency: A guide for Directors they outline the warning signs of insolvency, namely:

Absence of a business plan;
An expectation that the ‘next’ big job/sale/contract will save the company;
Board disputes and director resignations, or loss of management personnel;
Change of bank, lender or increased monitoring/involvement by financier;
Creditors unpaid outside usual terms;
Inability to raise funds from shareholders;
Incomplete financial records or disorganised internal accounting procedures;
Increased level of complaints or queries raised with suppliers;
Increasing debt (liabilities greater than assets);
Issuing post-dated cheques or dishonouring cheques;
Lack of cash-flow forecasts and other budgets;
Ongoing losses;
Overdraft limit reached or defaults on loan or interest payments;
Overdue taxes and superannuation liabilities;
Payments to creditors of rounded sums that are not reconcilable to specific invoices;
Poor cash flow;
Problems obtaining finance;
Problems selling stock or collecting debts;
Solicitors’ letters, demands, summonses, judgements or warrants issued against your company;
Special arrangements with selected creditors;
Suppliers placing your company on cash-on-delivery (COD) terms; and
Unrecoverable loans to associated parties.

Is my Company Insolvent?

In determining if your company is insolvent, firstly you must look at the cash flow test and section 95A of the Corporations Act. Can the company pay its debts as and when they become due and payable?

If not, looking at the indicia above, is it a temporary lack of liquidity or is it an insurmountable endemic illiquidity resulting in insolvency?

For advice and assistance on company insolvency contact an insolvency lawyer as soon as possible.

When is a Company Insolvent? This depends on a large number of factors. It is vital that a director gets qualified legal advice before they cause the company to trade while insolvent!

GET A FREE FEE ESTIMATE TODAY

OR CALL: 1300 545 133 AND SPEAK TO OUR LAWYERS

What are Insolvent Transactions?

22/04/2019 By // by Wayne Davis

Insolvent transactions are one of the elements the liquidator will need to prove if there is an unfair preference claim or an uncommercial transaction claim.

The elements of insolvent transactions are:

There must be a transaction of a company;
The transaction is an unfair preference or an uncommercial transaction;
The transaction is entered into; or an act has given effect to the transaction, when the company is insolvent; or
The company becomes insolvent because the transaction is entered into; or an act giving effect to the transaction has been made.

If a liquidator is unable to prove that the transactions which form an unfair preference or an uncommercial transaction claim are insolvent transactions, then its claim will fail.

This article explains insolvent voidable transactions in more detail.

If you have been contacted by a liquidator in relation insolvent transactions claims, you should contact an insolvency lawyer as soon as possible to attempt to defend the liquidator’s demand for money

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What are Voidable Insolvent Transactions?

A voidable transaction in company insolvency is a transaction entered into by the company and a third-party which can be avoided and recovered by the liquidator of the company in liquidation.

Voidable transactions can include:

588FA – Unfair preferences;
588FB – Uncommercial transactions;
588FC – Insolvent transactions;
588FD – Unfair loans to a company; and
588FDA – Unreasonable director-related transactions.

Section 588FE of the Corporations Act outlines the criteria for a transaction able to be avoided by the liquidator.

There must be an insolvent transaction; and
The transaction was made, or an act was done for the purpose of giving effect to it:
During the 6 months ending on the relation-back day; or
It is also an uncommercial transaction – 2 years ending on the relation-back day; or
It is also a related entity of the company – 4 years ending on the relation-back day; or
The company became a party to the transaction for the purpose of defeating, delaying, or interfering with, the rights of any or all of its creditors – 10 years ending on the relation-back day.

Then, each of the voidable transactions have their own specific requirements.

If you fall into the category outlined above, then this transaction could be a voidable transaction. But what is an insolvent transaction?

Insolvent Transactions

Section 588FC of the Corporations Act says:

A transaction of a company is an insolvent transaction of the company if, and only if, it is an unfair preference given by the company, or an uncommercial transaction of the company, and:
(a) any of the following happens at a time when the company is insolvent:
(i) the transaction is entered into; or
(ii) an act is done, or an omission is made, for the purpose of giving effect to the transaction; or
(b) the company becomes insolvent because of, or because of matters including:
(i) entering into the transaction; or
(ii) a person doing an act, or making an omission, for the purpose of giving effect to the transaction.

So, as outlined above, the elements of insolvent transactions are:

There must be a transaction of a company;
The transaction is an unfair preference or an uncommercial transaction;
The transaction is entered into; or an act has given effect to the transaction, when the company is insolvent; or
The company becomes insolvent because the transaction is entered into; or an act giving effect to the transaction has been made.

To assess if the transaction was an insolvent transaction, section 588FC of the Corporations Act asks a number of questions, namely:

What is a transaction?
What is a transaction of a company?
Is the transaction an unfair preference or an uncommercial transaction?
When does a person do an act, or an omission, for the purpose of giving effect to the transaction?
When is the company insolvent?

This article will explain these in more detail below.

What is a Transaction?

A transaction for this section of the Corporations Act includes:

A conveyance, transfer or other disposition of property;
A guarantee;
A loan;
A payment made;
A release or waiver;
A security interest granted in property; and
An obligation incurred;

A transaction can also include a transaction that has been completed or given effect to, or that has terminated.

Section 9 of the Corporations Act outlines these transactions, but also expressly states that they are by way of example (but without limitation). So, it is therefore likely that a transaction not on this list may also be ruled to be a transaction.

Section 1371 of the Corporations Act defines the word “made” to mean:

“made” includes issued, given or published

So, what can be a transaction is very broad, and not limited to what is included in the Corporations Act.

But what is a transaction of a company?

What are Insolvent Transactions of a Company?

The Court has distinguished a transaction “of a company” from a transaction “of the company”.

In Kalls Enterprises Pty Ltd (In Liquidation) & Ors v Baloglow & Anor [2007] NSWCA 191 Giles JA said:

… the words “of the company” add something. As well as being a transaction to which the company is party … the transaction must warrant the description of a transaction of the company.

Ipp J agreeing with Giles JA said:

… the question whether a transaction is a transaction of a company depends on the nature and extent of involvement of the company in the transaction. A transaction may be “of” more than one company or party. The mere fact that a company is a party to a contract or contracts that form part of the transaction does not necessarily make the transaction “of” that company. Whether a company is so bound up in the transaction that it is a transaction “of” the company is a question of judgment dependent on fact and degree.

Then Basten JA agreeing with Giles JA went on to say:

A transaction “of” a particular company can be said to involve something more than the concept of a company being “party to” a transaction. It involves a different perspective. A sale may involve three companies, a vendor, a purchaser and a financier. Each is “party to” the transaction, but in order to characterise the transaction for the purposes of Pt 5.7B, one needs to identify “of” which company it is a transaction, so as to assess benefits for, detriments to, insolvency of and winding up of, that company.

Therefore, it may be possible that a transaction of the company may not be a transaction of a company.

This distinction may, if successfully argued, could enable a party to the transaction (or transactions) to defeat the liquidator’s claim.

A great discussion on these points can be found in McCann, in the matter of Walton Construction (Qld) Pty Ltd (In Liq) v QHT Investments Pty Ltd [2018] FCA 1986.

The transaction of a company must also be an unfair preference or an uncommercial transaction.

Are the Insolvent Transactions also Unfair Preferences?

Section 588FA of the Corporations Act gives the liquidator the power to avoid certain preference payments made by the company to an unsecured creditor of the company.

An unfair preference occurs when:

There is a transaction between the company and an unsecured creditor; and
The transaction occurred while the company was insolvent; and
The transaction results in the creditor receiving more than the creditor would receive from the company if the creditor were to prove for the debt in a winding up of the company.
If this happens, then a liquidator may be entitled to recover those funds from the creditor.

There are a number of defences and exceptions to the above.

Read our article – Unfair Preference Claims and how to Defeat Them

Are the Insolvent Transactions also Uncommercial Transactions?

Section 588FB of the Corporations Act gives the liquidator the power to avoid certain uncommercial transactions made by the company to another party.

A transaction of a company is an uncommercial transaction when:

There is a transaction of a company; and
There is a transaction with another party (or parties); and
A reasonable person in the company’s circumstances would not have entered into the transaction having regard to;
The benefits and detriments to the company and the other party (or parties).

There are a number of defences and exceptions to uncommercial transactions claims.

Read our article – Uncommercial Transactions Claims and how to Defeat Them

What is Giving Effect to the Transaction?

As well as entering into the transaction, an insolvent transaction also includes an act done, or an omission made, for the purpose of giving effect to the transaction. But what does giving effect to the transaction mean?

In Re Legend International Holdings Inc (in liq) [2018] VSC 789 the Supreme Court of Victoria discussed the few authorities on this point.

In Demondrille Nominees Pty Ltd v Kevin R Shirlaw and Cornelis Holdings Pty Ltd (in liquidation); Kevin R Shirlaw v Cornelis Holdings Pty Ltd (in liquidation) and Demondrille Nominees Pty Ltd [1997] FCA 1220 (“Demondrille”) the relevant transaction was an agreement for sale of real property.

Cornelis Holdings Pty Ltd was a property development company and entered into a contract to sell a property to Demondrille.

The contract stated that a deposit of $120,000 had been paid. This amount had not been paid but was accounting for a debt owing to Demondrille from a company related to Cornelis.

After Cornelis became insolvent, the parties entered into a deed of recession rescinding the sale contract upon repayment of $120,000 to Demondrille.

In their judgment Foster, Lindgren and Madgwick JJ said:

… the acts of Cornelis and Demondrille in entering into the deed in fact ‘gave effect’ … to the ‘transaction’ constituted by the agreement, because it gave effect to the ‘credit’ in favour of Demondrille which the agreement created.

In Lewis (as liquidator of Doran Constructions Pty Ltd (in liq) & v Doran & Ors [2005] NSWCA 243 the Court considered if a resolution of a board of directors and journal entries, relating to debt restructuring agreements between a number of related companies, gave effect to a transaction.

In the judgment of Giles JA, with Hodgson JA and McColl JA agreeing, he said:

I consider it sufficient that posting the journal entries was doing what had been agreed should be done, maybe sufficient even if the resolution(s) had not stipulated the method of payment. Attaching legal significance, in the present context, to an act done for the purpose of giving effect to a transaction seems to have been intended to catch an agreement entry into which was an uncommercial transaction if the company was insolvent when the agreement was performed.

In International Cat Manufacturing Pty Ltd (in liq) & Anor v Rodrick & Ors [2013] QSC 91 the Court considered whether payments made while the company was insolvent, gave effect to a charge created while the company was not insolvent.

In his judgment Philip McMurdo J said:

… the payment must have had a purpose of giving effect to the creation of the charge. None of these payments was made in order that the creation of the charge would have its legal effect. Rather each payment was made simply for the purpose of reducing the debt to Nu-Log. By contrast, the registration of a charge could be considered an act done for the purpose of making effective the creation of the charge.

In Cashflow Finance v WestpacCOD Factors v Cashflow FinanceStar v Kylon P/LCOD Factors v Walters [1999] NSWSC 671 the Court considered whether certain payments made by cheque were for the purpose of giving effect to previous transactions.

In the judgment, Einstein J said:

At the time that Mr Walters caused each of the cheques pursuant to which the WUPs were made to be drawn on Cashflow’s bank account, and paid to CODFA (or Burkett), and banked into the account of CODFA (or Burkett), an act was done (by Mr Walters) for the purpose of giving effect to the transactions. I accept that at each of those times, Cashflow was insolvent. I accept that this establishes each of them as an insolvent transaction within section 588FC(a)(ii) … Cashflow became insolvent because of (or because of matters including) a person (Mr Walters) doing an act for the purpose of giving effect to the transaction. I accept that at each time Walters did such an act, Cashflow was insolvent. I accept that this establishes each of the WUPs as an insolvent transaction within section 588FC(b)(ii).

In Diana Denise Newman as liquidator of Riverview Heights Pty Ltd (In Liq) v Coropean Pty Ltd [2002] WASC 79 the Court considered whether payments made by a related entity forming part of a continuing business relationship means that there was an act done for the purpose of giving effect to a transaction.

In the judgment Master Sanderson said:

I am satisfied that the payments made to the respondent by the Company were part of a continuing business relationship under s 588FA. That means there was only one transaction under s 588FA(1), but the fact that as part of this one transaction there were payments made during the four years ending on the relation-back day means that there was an act done for the purpose of giving effect to the transaction during that four-year period.

In looking at the above cases, they seem to have a similar theme – whether there is an act done, or an omission made (after the date of insolvency), for the purpose of giving effect to transaction (prior to the date of insolvency) is in-itself a transaction.

An easy to understand example might be when a solvent company gives a security interest, the company becomes insolvent when the secured party causes the security interest to crystallise.

But what are the time-frames for an insolvent transaction?

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When is the Company Insolvent?

A transaction is voidable if the company is deemed to be insolvent. There are different requirements for when a company is deemed to be insolvent depending on the circumstances of the transaction.

These time-frames are outlined at section 588FE of the Corporations Act.

Unfair Preference Claims

An unfair preference claim is normally voidable (if not a related entity) for six (6) months.

Section 588FE(2) says:

The transaction is voidable if:
(a) it is an insolvent transaction of the company; and
(b) it was entered into, or an act was done for the purpose of giving effect to it:
(i) during the 6 months ending on the relation-back day; or
(ii) after that day but on or before the day when the winding up began.

Uncommercial Transaction Claims

An uncommercial transaction is usually voidable (if not a related entity) for two (2) years.

Section 588FE(3) says:

The transaction is voidable if:
(a) it is an insolvent transaction, and also an uncommercial transaction, of the company; and
(b) it was entered into, or an act was done for the purpose of giving effect to it, during the 2 years ending on the relation-back day.

Related Entity of the Company

If a party to the transaction is a related entity, the transaction is voidable for four (4) years.

Section 588FE(4) says:

The transaction is voidable if:
(a) it is an insolvent transaction of the company; and
(b) a related entity of the company is a party to it; and
(c) it was entered into, or an act was done for the purpose of giving effect to it, during the 4 years ending on the relation-back day.

Attempting to Defeat Creditors

If the transaction was done for the purpose of defeating, delaying, or interfering with the rights of any or all of its creditors, then the transaction is voidable for ten (10) years.

Section 588FE(5) says:

The transaction is voidable if:
(a) it is an insolvent transaction of the company; and
(b) the company became a party to the transaction for the purpose, or for purposes including the purpose, of defeating, delaying, or interfering with, the rights of any or all of its creditors on a winding up of the company; and
(c) the transaction was entered into, or an act done was for the purpose of giving effect to the transaction, during the 10 years ending on the relation-back day.

Unfair Loans

An unfair loan is voidable at any time. Section 588FE(6) says:

The transaction is voidable if it is an unfair loan to the company made at any time on or before the day when the winding up began.

Unreasonable Director-Related Transaction

An unreasonable director-related transaction, the transaction is voidable for four (4) years.

Section 588(6A) says:

The transaction is voidable if:
(a) it is an unreasonable director-related transaction of the company; and
(b) it was entered into, or an act was done for the purposes of giving effect to it:
(i) during the 4 years ending on the relation-back day; or
(ii) after that day but on or before the day when the winding up began.

Company Under Administration

If the company was under administration prior to the liquidation, then the relation back day commences:

When the company made the special resolution that it be wound up voluntarily; or
When the Court made the order that the company be wound up.

Deed of Company Arrangement

If the company was subject to a deed of company arrangement prior to the liquidation, then the relation back day commences:

When the company made the special resolution that it be wound up voluntarily; or
When the Court made the order that the company be wound up.

This does not apply if the transaction, or the act done for the purpose of giving effect to it, was not entered into, or done, on behalf of the company by, or under the authority of:

The administrator of the deed; or
The administrator of the company.

Relation Back Day – Insolvent Transactions

The date for calculating the above relies on when the relation-back day is said to have been.

For example, for an order winding up the company in liquidation, the relation-back day is the date of filing the application in the Court.

There are a number of other possible scenarios at section 91 of the Corporations Act.

It is very important that this date is calculated correctly.

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Uncommercial Transactions Claims and how to Defeat Them

20/04/2019 By // by Wayne Davis

Uncommercial transactions claims are one of the types of voidable transactions in company insolvency and are outlined at section 588FB of the Corporations Act 2001 (CTH) (“the Corporations Act”).

A transaction of a company is an uncommercial transaction when:

There is a transaction of a company; and
There is a transaction with another party (or parties); and
A reasonable person in the company’s circumstances would not have entered into the transaction having regard to;
The benefits and detriments to the company and the other party (or parties).

There are a number of defences and exceptions to uncommercial transactions claims which may mean that a third-party does not have to repay their hard-earned dollars to the liquidator.

This article explains in detail uncommercial transactions claims under the voidable transaction regime in the Corporations Act and details the possible defences and exceptions to uncommercial transactions claims.

If you have been contacted by a liquidator in relation to uncommercial transactions claims, you should contact an insolvency lawyer as soon as possible to attempt to defend the liquidator’s demand for money

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What are Voidable Transactions?

A voidable transaction in company insolvency is a transaction entered into by the company and a third-party which can be avoided and recovered by the liquidator of the company in liquidation.

Voidable transactions can include:

588FA – Unfair preferences;
588FB – Uncommercial transactions;
588FC – Insolvent transactions;
588FD – Unfair loans to a company; and
588FDA – Unreasonable director-related transactions.

Section 588FE of the Corporations Act outlines the criteria for a transaction able to be avoided by the liquidator.

There must be an insolvent transaction; and
The transaction was made, or an act was done for the purpose of giving effect to it:
1. During the 6 months ending on the relation-back day; or
2. It is also an uncommercial transaction – 2 years ending on the relation-back day; or
3. It is also a related entity of the company – 4 years ending on the relation-back day; or
4. The company became a party to the transaction for the purpose of defeating, delaying, or interfering with, the rights of any or all of its creditors – 10 years ending on the relation-back day.

Then, each of the voidable transactions have their own specific requirements.

Section 9 of the Corporations Act defines a what transaction is.

Section 91 of the Corporations Act has a table which outlines the date of the relation-back day.

Section 95A of the of the Corporations Act defines what solvent and insolvent mean.

Section 588FC of the Corporations Act defines what an insolvent transaction means.

If you fall into the category outlined above, then this transaction could be a voidable transaction.

This article will focus on uncommercial transaction claims.

What is an Uncommercial Transaction?

Section 588FB of the Corporations Act says:

(1) A transaction of a company is an uncommercial transaction of the company if, and only if, it may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction, having regard to:
(a) the benefits (if any) to the company of entering into the transaction; and
(b) the detriment to the company of entering into the transaction; and
(c) the respective benefits to other parties to the transaction of entering into it; and
(d) any other relevant matter.
(2) A transaction may be an uncommercial transaction of a company because of subsection (1):
(a) whether or not a creditor of the company is a party to the transaction; and
(b) even if the transaction 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.

So, as outlined above, an uncommercial transaction is:

A transaction of a company; and
A transaction with another party (or parties); and
A reasonable person in the company’s circumstances would not have entered into the transaction; having regard to
The benefits and detriments to the company and the other party (or parties).

This raises some further interesting points, namely:

What is a transaction of a company; and
What does uncommercial mean; and
How have the Courts decided the objective test of whether a reasonable person in the company’s circumstances would not have entered into the transaction; and
What are the benefits and detriments to the parties to the transaction.

What is a Transaction of a Company?

The Court has distinguished a transaction “of a company” from a transaction “of the company”.

In Kalls Enterprises Pty Ltd (In Liquidation) & Ors v Baloglow & Anor [2007] NSWCA 191 Ipp J agreeing with Giles JA said:

… the question whether a transaction is a transaction of a company depends on the nature and extent of involvement of the company in the transaction. A transaction may be “of” more than one company or party. The mere fact that a company is a party to a contract or contracts that form part of the transaction does not necessarily make the transaction “of” that company. Whether a company is so bound up in the transaction that it is a transaction “of” the company is a question of judgment dependent on fact and degree.

Then Basten JA agreeing with Giles JA went on to say:

A transaction “of” a particular company can be said to involve something more than the concept of a company being “party to” a transaction. It involves a different perspective. A sale may involve three companies, a vendor, a purchaser and a financier. Each is “party to” the transaction, but in order to characterise the transaction for the purposes of Pt 5.7B, one needs to identify “of” which company it is a transaction, so as to assess benefits for, detriments to, insolvency of and winding up of, that company.

Therefore, it may be possible that a transaction of the company may not be a transaction of a company.

This determination will rely on the facts of each particular case.

This distinction may, if successfully argued, could enable a party to the transaction (or transactions) to defeat the liquidator’s claim.

A great discussion on these points can be found in McCann, in the matter of Walton Construction (Qld) Pty Ltd (In Liq) v QHT Investments Pty Ltd [2018] FCA 1986.

What does Uncommercial Mean?

A good starting-point, is that 588FB of the Corporations Act is used to recover undervalued transactions, or transactions where no consideration has been paid.

However, the Courts have found that both undervalued transactions have not been uncommercial, and that payment of full consideration have been uncommercial.

The Explanatory Memorandum for the Corporate Law Reform Bill 1992 (Cth) said that the uncommercial transactions provision was to prevent companies:

disposing of assets or other resources through transactions which resulted in the recipient receiving a gift or obtaining a bargain of such magnitude that it could not be explained by normal commercial practice.

In Liquidators’ Avoidance of Uncommercial Transactions (1996) 70 ALJ 390 Professor Keay said:

While not dealing exclusively with undervalue, undervalue is at the heart of the section, that is, if the company received less than what is reasonable from the transaction the liquidator may attack it.

The elements of an uncommercial transaction have been outlined in case law as essentially:

The wording of the legislation – the benefits to the company; and the detriment to the company; and the respective benefits to other parties; and any other relevant matter – are to be determined on an objective basis; and
The objective determination must include the actual knowledge of the controller of the debtor company; and
The recipient received a gift or obtained a bargain of such magnitude that it could not be explained by normal commercial practice; and/or
The consideration lacks commercial quality.

For more on this see Capital Finance Australia Limited v Tolcher [2007] FCAFC 185.

Whether a reasonable person would not have entered into the transaction?

Obviously, section 588FB of the Corporations Act posits an objective test.

A transaction of a company is an uncommercial transaction of the company if, and only if, it may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction.

The Courts have determined that the reasonable assessment is based on:

The totality of the company’s circumstances at the time of the transaction; and
What knowledge the director or directors of the company ought to have known; and
The purpose of the transaction at the time of the transaction; and
The business relationship of the parties at the time of the transaction.

In Cussen & Ors v Sultan & Ors [2009] NSWSC 1114 Nicholas J said:

… the court will look at the totality of the business relationship between the parties, and to what the parties under their relationship intended to effect, and how their intention was effected, in part or in whole, by the impugned transaction.

So, with this objective approach, the section also requires consideration of the benefits and detriments to the parties to the transaction.

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What are the benefits and detriments to the parties to the transaction?

The main consideration in 588FB of the Corporations Act is the benefits and detriments of the company and the benefits for other parties to the uncommercial transaction.

What is a Benefit?

For an uncommercial transaction, section 9 of the Corporations Act says:

“benefit” means any benefit, whether by way of payment of cash or otherwise.

The dictionary defines benefit to mean:

an advantage or profit gained from something; or receive an advantage or profit; or bring advantage to.

So following the definitions above, a benefit pursuant to 588FB of the Corporations Act will be an advantage or profit whether by way of payment of cash or otherwise.

What is a Detriment?

Unlike benefit, detriment is not defined in the Corporations Act.

The dictionary defines detriment to mean:

the state of being harmed or damaged; or a cause of harm or damage.

So, a detriment pursuant to 588FB of the Corporations Act will be commercial harm or damage, or harm or damage that can be assessed on a commercial basis.

Does the Liquidator have an uncommercial transaction claim?

If the elements above are reasonably arguable by a liquidator, then the liquidator may have an uncommercial transaction claim against the other party or parties.

If so, then the transaction must have occurred within strict timeframes.

Timeframes for Uncommercial Transactions Claims

The timeframes for uncommercial transactions are:

Two (2) years – for an uncommercial transaction claim; or
Four (4) years – if the uncommercial transaction included a related party; or
Ten (10) years – if it was made defeat, delay, or interfere with, the rights of creditors.

The transaction is an uncommercial transaction of the company and it was entered into, or an act was done for the purpose of giving effect to it, during the 2 years ending on the relation-back day.

Alternatively, if the other party is also a related entity of the company, then the insolvent uncommercial transaction was entered into, or an act was done for the purpose of giving effect to it during the 4 years ending on the relation-back day.

Lastly, if the company became a party to the transaction for the purpose of defeating, delaying, or interfering with, the rights of any or all of its creditors then the insolvent transaction was entered into, or an act was done for the purpose of giving effect to it during the 10 years ending on the relation-back day.

These timeframes raise some interesting questions, namely:

What is the relation-back day?
What is a related entity?

What is the Relation Back Day?

Section 91 of the Corporations Act includes a table which says the relation-back day is either:

The date of the filing of the winding up application; or
The date the company resolves that it be wound up voluntarily; or
The date that the deed of company arrangement was executed.

Most commonly, the date of the winding up application.

What is a Related Entity in uncommercial Transactions Claims?

A related entity is defined at section 9 of the Corporations Act and includes (but not limited to):

A body corporate that is related to the first-mentioned body; and/or
A director or member of the body or of a related body corporate; and/or
A relative of a spouse of such a director or member; and/or
A relative of such a director or member.

Examples of an Uncommercial Transactions Claim in Liquidation

Some examples of uncommercial transaction claims in liquidation include claims for:

The transfer of property of an insolvent company, for undervalued consideration or no consideration, to a related party of the insolvent company; and/or
Payments made by a company to a related entity satisfying the related entities liabilities;
The forgiveness of debts by a company for no commercial reason; and/or
Extravagant upfront payments for services provided by another party being of such a magnitude rendering payments inexplicable in normal commercial practice; and/or
The granting of security thereby turning an unsecured loan into a secured loan with no further consideration or commercial advantage; and/or
The undervalue transfer of shares of a corporate trustee limiting the trustees right of indemnity against trust assets.

The liquidator’s job is to realise as many assets, and recover as much money, as it can to pay company creditors.

This is understandable from an unpaid creditor’s perspective.

However, if you are the party (or the director of the party) to which the uncommercial transaction claim is directed then it may not seem very fair at all.

However, there are a number of defences and exceptions to uncommercial transaction claims.

Defences to Uncommercial Transactions Claims

There are defences to uncommercial transaction claims. They include:

The person received no benefit because of the transaction; or
The party entered into the transaction in good faith; and
At the time of entering into the transaction a reasonable creditor did not know, or ought not to suspect that the company was insolvent.

Section 588FG of the Corporations Act prescribes transaction which are not voidable as against certain persons.

If the claim is made against a person other than a party to the transaction, then it is a defence under 588FG(1) if:

The person received no benefit because of the transaction; or
If there was a benefit the person received the benefit in good faith; and
At the time when the person received the benefit the person had no reasonable grounds for suspecting that the company was insolvent at that time or would become insolvent; and
A reasonable person in the person’s circumstances would have had no such grounds for so suspecting.

If the claim is made against a creditor if the transaction is not an unfair loan to the company, or an unreasonable director-related transaction of the company, then it is a defence under 588FG(2) if:

The person became a party to the transaction in good faith; and
At the time when the person became such a party the person had no reasonable grounds for suspecting that the company was insolvent at that time or would become insolvent; and
A reasonable person in the person’s circumstances would have had no such grounds for so suspecting; and
The person has provided valuable consideration under the transaction or has changed his, her or its position in reliance on the transaction.

Probably the most important of the above is proving that a creditor did not know, or ought to have known, that the company in liquidation was insolvent at the time of the transaction.

However, as well as the defences 588FG of the Corporations Act, the liquidator must ensure that the elements of the uncommercial transaction are made out.

Elements of an Uncommercial Transactions

As outlined above, for a claim to be an uncommercial transaction claim, the liquidator must prove the elements of the uncommercial transaction. These include:

There is a transaction of a company; and
There is a transaction with another party (or parties); and
A reasonable person in the company’s circumstances would not have entered into the transaction having regard to;
The benefits and detriments to the company and the other party (or parties).

If we can sufficiently argue that one or more of these elements cannot be made out, then the liquidator’s claim should fail.

For example, we can attempt to argue that:

There was no transaction as defined by the act; and/or
The transaction was not a transaction of a company; and/or
You were not a party to the transaction; and/or
It is reasonable that the company would have entered into the transaction; and/or
The balance of benefits and detriments to the company and the other party (or parties) swings in favour of the person whom the claim is made.

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Unfair Preference Claims and how to Defeat Them

07/04/2019 By // by Wayne Davis

Unfair preference claims are one of the types of voidable transactions in company insolvency and is outlined at section 588FA of the Corporations Act 2001 (CTH) (“the Corporations Act”).

An unfair preference occurs when:

There is a transaction between the company and an unsecured creditor; and
The transaction occurred while the company was insolvent; and
The transaction results in the creditor receiving more than the creditor would receive from the company if the creditor were to prove for the debt in a winding up of the company.

If this happens, then a liquidator may be entitled to recover those funds from the creditor.

There are a number of defences and exceptions to the above which may mean that a creditor does not have to repay hard-earned monies to the liquidator.

This article explains in detail unfair preference claims under the voidable transaction regime and details the possible defences and exceptions to unfair preference claims.

If you have been contacted by a liquidator in relation to unfair preference claims you should contact an insolvency lawyer as soon as possible to attempt to defend the liquidator’s demand for money

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What are Voidable Transactions?

A voidable transaction in company insolvency is a transaction entered into by the company and a third-party which can be avoided and recovered by the liquidator of the company in liquidation.

Voidable transactions can include:

588FA – Unfair preferences;
588FB – Uncommercial transactions;
588FC – Insolvent transactions;
588FD – Unfair loans to a company; and
588FDA – Unreasonable director-related transactions.

Section 588FE of the Corporations Act outlines the criteria for a transaction able to be avoided by the liquidator.

There must be a transaction; and
The transaction must be an insolvent transaction; and
It was entered into, or an act was done for the purpose of giving effect to it:
1. During the 6 months ending on the relation-back day; or
2. It is also an uncommercial transaction – 2 years ending on the relation-back day; or
3. It is also a related entity of the company – 4 years ending on the relation-back day; or
4. The company became a party to the transaction for the purpose of defeating, delaying, or interfering with, the rights of any or all of its creditors – 10 years ending on the relation-back day.

Then, each of the voidable transactions have their own specific requirements.

What is a Transaction?

Section 9 of the Corporations Act defines a transaction to mean:

“transaction” … means a transaction to which the body is a party, for example (but without limitation):
(a) a conveyance, transfer or other disposition by the body of property of the body; and
(b) a security interest granted by the body in its property (including a security interest in the body’s PPSA retention of title property); and
(c) a guarantee given by the body; and
(d) a payment made by the body; and
(e) an obligation incurred by the body; and
(f) a release or waiver by the body; and
(g) a loan to the body;
and includes such a transaction that has been completed or given effect to, or that has terminated.

Obviously, this is just a list of examples and section 9 explicitly does not limit the scope of what a transaction can be.

What is an Insolvent Transaction?

Section 95A of the of the Corporations Act defines solvent and insolvent to mean:

(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.
(2) A person who is not solvent is insolvent.

This essentially means that a company that is unable to pay its debts as and when they become due and payable is insolvent.

Care should be taken however to distinguish a temporary lack of liquidity with insolvency. In Sandell v Porter (1966) 115 CLR 666 the High Court said:

The conclusion of insolvency ought to be clear from a consideration of the debtor’s financial position in its entirety and generally speaking ought not to be drawn simply from evidence of a temporary lack of liquidity.

Section 9 of the Corporations Act says:

“insolvent transaction” has the meaning given by section 588FC.

Section 588FC of the Corporations Act says:

A transaction of a company is an insolvent transaction of the company if, and only if, it is an unfair preference given by the company, or an uncommercial transaction of the company, and:
(a) any of the following happens at a time when the company is insolvent:
(i) the transaction is entered into; or
(ii) an act is done, or an omission is made, for the purpose of giving effect to the transaction; or
(b) the company becomes insolvent because of, or because of matters including:
(i) entering into the transaction; or
(ii) a person doing an act, or making an omission, for the purpose of giving effect to the transaction.

So, an insolvent transaction is a transaction entered into, or an act is done giving effect to a transaction, at a time when a company is unable to pay its debts as and when they become due and payable.

Or the company becomes unable to pay its debts as and when they become due and payable because the transaction was entered into, or because of the act being done giving effect to a transaction.

So that is a voidable transaction. This article will focus on Unfair Preference Claims.

What are Unfair Preference Claims?

An unfair preference means that because one (1) creditor has been paid more than if it had to prove its debt in the liquidation, while other creditors have not been paid, that creditor will be preferred.

Section 588FA(1) of the Corporations Act 2001 (CTH) says:

(1) A transaction is an unfair preference given by a company to a creditor of the company if, and only if:
(a) the company and the creditor are parties to the transaction (even if someone else is also a party); and
(b) 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.

As previously outlined above, an unfair preference occurs when:

There is a transaction between the company and an unsecured creditor; and
The transaction occurred while the company was insolvent; and
The transaction results in the creditor receiving more than the creditor would receive from the company if the creditor were to prove for the debt in a winding up of the company.

In Ashala Model Agency Pty Ltd (in liq) & Anor v Featherstone & Anor [2016] QSC 121 Jackson J said at [139]:

… an unfair preference turns on the result or effect of the transaction in relation to an unsecured debt owed to the creditor, by comparing what the creditor received from the company with what the creditor would have received on a winding up (in a pari passu distribution of the available assets to the unsecured creditors in accordance with the statutory priorities).

Timeframes for Unfair Preference Claims

The liquidator must prove that the insolvent transaction was entered into, or an act was done for the purpose of giving effect to it during the 6 months ending on the relation-back day.

Alternatively, if the preferred entity is also a related entity of the company, then the insolvent transaction was entered into, or an act was done for the purpose of giving effect to it during the 4 years ending on the relation-back day.

This raises some further questions, namely:

What is the relation-back day? and
What is a related entity?

What is the Relation Back Day?

The relation-back day is the day that either the winding up application was filed; or the day on which one of the other days outlined at 513B of the Corporations Act or 513C of the Corporations Act.

Section 9 of the Corporations Act says:

“relation-back day” has the meaning given by section 91.

Section 91 of the Corporations Act has a table which basically says the relation-back day is (depending on the circumstances):

The date of the filing of the winding up application; or
The date the company resolves that it be wound up voluntarily; or
The date that the deed of company arrangement was executed.

So, if a creditor applies to a Court for an order winding up the debtor company on 20 June, and the company is subsequently wound-up, then the relation-back day is 20 June.

This means that for a transaction from an unrelated entity to be a voidable transaction, it must have occurred six (6) months prior to 20 June.

This means that for a transaction from a related entity to be a voidable transaction, it must have occurred two (2) years prior to 20 June.

What is a Related Entity?

A related entity is defined at section 9 of the Corporations Act. The most common include:

A director or member of the body or of a related body corporate; and/or
A relative of such a director or member; and/or
A relative of a spouse of such a director or member; and/or
A body corporate that is related to the first-mentioned body.

So, a transaction to a related entity could include a transaction from the company to a director, a wife of a director, or a related company of the company in liquidation.

Example of an Unfair Preference in Liquidation

A typical example of an unfair preference in liquidation is:

A building contractor engages 3 subcontractors to conduct work;
The contractor pays one of the subcontractors, but not the other two;
The contractor goes into liquidation two (2) months later;
The two unpaid contractors become unsecured creditors in the liquidation;
The money paid to the single subcontractor may be an unfair preference and recoverable by the liquidator.

The idea is to recover as much as possible into the fund to pay all creditors of the company in liquidation. This is understandable, but not nice for small subcontractors who need the money.

However, there are a number of defences and exceptions to unfair preference claims.

Defences to Unfair Preference Claims

There are defences to unfair preference claims. They include:

The party entered into the transaction in good faith; and
At the time of entering into the transaction a reasonable creditor did not know, or ought not to suspect that the company was insolvent.

Section 588FG of the Corporations Act prescribes transaction which are not voidable as against certain persons. As against a creditor, 588FG(2) says:

(2) A court is not to make under section 588FF an order materially prejudicing a right or interest of a person if the transaction is not an unfair loan to the company, or an unreasonable director-related transaction of the company, and it is proved that:
(a) the person became a party to the transaction in good faith; and
(b) at the time when the person became such a party:
(i) the person had no reasonable grounds for suspecting that the company was insolvent at that time or would become insolvent as mentioned in paragraph 588FC(b); and
(ii) a reasonable person in the person’s circumstances would have had no such grounds for so suspecting; and
(c) the person has provided valuable consideration under the transaction or has changed his, her or its position in reliance on the transaction.

The most important of the above is proving that a creditor did not know, or ought to have known, that the company in liquidation was insolvent at the time of the transaction.

The Suspicion of Insolvency

Obviously, the wording of 588FG(2) posits an objective test.

The use of the words “a reasonable person in the person’s circumstances” means that it is not simply what the creditor knew, but what a reasonable creditor in the creditor’s position would or should have known.

By way of example, a creditor can rely on the following to make a case to show that a reasonable creditor in their situation had no way of knowing if the company in liquidation was insolvent at the time of the transaction:

Age of the debts are not unreasonable;
The creditor and the company had a good payment history;
History of late payments followed by payments;
Industry specific reasons (such as irregular payments being normal);
No demands made by the creditor of its solicitors;
No evidence of continued or persistent demands for payment;
Phone calls are being returned by the company, and communication was reasonable; and
Statements that the company were just having short-term liquidity issues.

This is by no means an exhaustive list, but it illustrates ways in which a creditor can persuade a liquidator or a Court that it not only had no knowledge of insolvency but didn’t reasonably suspect insolvency, thereby defending the unfair preference claim.

However, as well as these defences, there are a number of exceptions to unfair preference claims.

Exceptions to Unfair Preference Claims

Obviously, as the liquidator needs to prove that the party to the transaction meets the threshold matters relating to an unfair preference claim. So, if it cannot then it may not be a valid claim.

The threshold issues include:

There was a transaction;
That transaction was an insolvent transaction;
Within the timeframe outlined above – 6 months, 2 years, or 10 years;
Between the company and a creditor; and
The creditor was an unsecured creditor.

If a creditor can successfully argue these points, then the liquidator may not have an unfair preference claim.

Secured Creditor vs Unsecured Creditor

If a creditor is a secured creditor then the voidable transaction regime may not apply.

A security can include:

Bailment;
A charge or mortgage;
Goods provided on consignment;
Retention of title; and/or
Perfected security on the PPSR.

If you offer goods and/or services on trade credit, then it is advisable for a number of reasons to take security over the trade debtor’s property.

A properly worded credit agreement can not only assist with recovering bad debts, continuing or proceeding with legal action against a company in liquidation, but it may also defeat a claim for unfair preference.

It can also be a partial defence if the company and the creditor had a running account.

The Running Account “Partial Defence”

A single transaction may not be a preference if it forms a running account between the company in liquidation and the creditor.

Section 588FA(3) of the Corporations Act says:

(3) Where:
(a) a transaction is, for commercial purposes, an integral part of a continuing business relationship (for example, a running account) between a company and a creditor of the company (including such a relationship to which other persons are parties); and
(b) in the course of the relationship, the level of the company’s net indebtedness to the creditor is increased and reduced from time to time as the result of a series of transactions forming part of the relationship; then:
(c) subsection (1) applies in relation to all the transactions forming part of the relationship as if they together constituted a single transaction; and
(d) the transaction referred to in paragraph (a) may only be taken to be an unfair preference given by the company to the creditor if, because of subsection (1) as applying because of paragraph (c) of this subsection, the single transaction referred to in the last-mentioned paragraph is taken to be such an unfair preference.

What this means for a creditor who has a running account with the company in liquidation is that it may allow for a partial or complete reduction in the unfair preference claim.

The transactions in the running account form one transaction and the preference is calculated on the net position.

The running account reduction is calculated in the following way:

The liquidator will create a six (6) month running balance;
The most amount owed at one time during that period is Peak Indebtedness (PI);
The amount owed at the time of the relation-back day is Current Indebtedness (CI);
The net difference between the two is the unfair preference amount (PC).

So, PI – CI = PC.

If PI is greater than CI then there is an unfair preference claim.

If PI is less than CI then there is not an unfair preference claim.

For example:

XYZ Contractors had a running account with A1 Earthmoving;
PI during the six (6) months prior to the relation-back day was $135,496.00;
The CI on the relation-back day was $104,633.00;
$135,496.00 – $104,633.00 = PC;
PC = $30,863.00

What is NOT an Unfair Preference?

The following a potentially transactions which an unfair preference claim may not apply:

There is a genuine pre-payment to a person who is not a creditor of the company; or
A purchase from a supplier on a cash on delivery basis as it may not give rise to a debtor/creditor relationship; or
Payment to a creditor that is a secured creditor of the company in liquidation; or
A right of set-off unless knowledge of insolvency is proved; or
A transaction where the company receives equivalent value to any payment.

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Subcontractors’ Charge – Construction Debt Recovery

09/03/2019 By // by Wayne Davis

A subcontractors’ charge under the old Subcontractors’ Charges Act 1974 (Qld) has been repealed and replaced with Building Industry Fairness (Security of Payment) Act 2017 (Qld) (“BIFA”).

The provisions of the repealed legislation have been amended and incorporated into BIFA.

A subcontractors’ charge under the old Subcontractors’ Charges Act are dealt with in Chapter 4 of BIFA.

This article will deal with making a subcontractors’ charge under BIFA in more detail below.

Very strict time limits apply to the different stages of BIFA. Ensure that you do not miss out on claiming your subcontractors’ charge by contacting our building and construction lawyers today

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Subcontractors’ Charge

If you are a subcontractor, owed money by a debtor contractor, then you may be able to serve a Notice of Claim on the person obliged to pay the money under the contract (superior contractor by whom money is claimed as payable). This is a subcontractors’ charge.

By serving this notice correctly, a subcontractor becomes a secured creditor of the debtor contractor, and in the event of insolvency may have a priority claim or be allowed to commence or continue with legal proceedings.

You will also need to serve a copy of the notice to the debtor contractor.

If eligible, and completed correctly, it is the superior contractor’s responsibility to pay to the subcontractor, the money owed to it by the debtor contractor.

This article will outline if you are eligible, explain the process, and provide useful information and links to guild you through the subcontractors’ charges chapter of BIFA.

Parties Involved in the Subcontractors’ Charge

BIFA provides definitions for the following:

Subcontractor – Section 6(3) of BIFA says:

If the party to a contract, who is required to carry out work under the contract, subcontracts all or part of the work – the resulting subcontract is a subcontract for the contract; and the person required to carry out the work under the subcontract is a “subcontractor” for the contract; and the work required to be carried out under the subcontract is the “subcontracted work” for the contract.

Contractor – Section 104 of BIFA says:

“contractor” for a contract, means the party to the contract who is required to carry out work under the contract.

Person – Section 104 of BIFA says:

“person” includes an unincorporated association.

Qualified Person – Section 147 of BIFA defines a qualified person to be:

an architect registered under the Architects Act 2002; or
a registered professional engineer under the Professional Engineers Act 2002; or
a person licensed under the Queensland Building and Construction Commission Act 1991 to carry out or supervise work of the type to which the claim relates; or
a quantity surveyor who is a member of the Australian Institute of Quantity Surveyors; or
a person having expert knowledge of the work to which the claim relates and who is accepted in a particular case as a qualified person by the contractor and subcontractor.

Once you have correctly identified the parties to the Notice of Claim then you are able to give the relevant parties your Notice of Claim.

The next eligibility criteria is to establish if the work conducted or goods are services provided are meet the requirements under BIFA.

The Meaning of Work

Section 105 of BIFA says “Work” for a contract:

means labour, whether skilled or unskilled, carried out by a person in connection with:
1. the construction, decoration, alteration or repair of a building or other structure; or
2. the development or working of a mine, quarry, sandpit, drain, embankment or other excavation in or on land; or
3. the placement, fixation or erection of materials, plant or machinery used or intended to be used for a purpose mentioned in subparagraph (i) or (ii); or
4. the alteration or improvement of a thing; or
5. the demolition, removal or relocation of a building or other structure;
and includes:
1. the supply of materials used by a subcontractor in connection with other work the subject of a contract; or
2. the manufacture or fabrication, wherever it happens, of project-specific components for a contract; or
3. the supply of labour for a contract, other than labour that is only administrative in nature.

So, if the debt relates to “Work” as defined in BIFA, and the subcontractor knows the relevant parties to the contract and the subcontract, then the subcontractor can issue a Notice of Claim.

What is a Subcontractors’ Charge?

Section 207 of BIFA says:

“subcontractors’ charge” means a charge within the meaning of section 3 of the repealed Act (Subcontractors’ Charges Act 1974 (Qld)).

Section 3 of the Subcontractors’ Charges Act 1974 (Qld) defined “Charge” as:

“charge” means a charge under this Act.

A charge pursuant to this Act is a security interest on monies owed to a subcontractor by a contractor, from monies payable to the contractor by the person obliged to pay the money under the contract.

The BIFA allows the payment of monies owed to a contractor, to essentially “leapfrog” the contractor, and be paid directly to the subcontractor.

To do so, the subcontractor must issue a Notice of Claim on the person obliged to pay the money under the contract.

Notice of Claim

If eligible, as discussed above, then a subcontractor must serve a Notice of Claim on the person obliged to pay the money under the contract. This is an approved form – FORM S122 – which you can download from the QBCC website.

Section 122 of BIFA says:

The notice of claim must be made in the approved form and:
State the amount of the claim; and
Include details of the work done by the subcontractor, certified as prescribed by a qualified person; and
Include the other information prescribed by regulation.

The Form S122 has the following headings:

Details of Claimant of Subcontractor Subcontract;
Details of Superior Contractor by Whom Money is Claimed as Payable;
Details of Contract;
Certification by Qualified Person; and
Witness Certification.

It is very important to get these details correct. Failure to do so may mean that the form is defective, and the subcontractor may lose their secured interest. We strongly suggest engaging a solicitor to complete this Notice of Claim.

Strict Time Limits for Notice of Claim

Section 122 of BIFA says that:

(4) The notice of claim may be given even if the work is not completed, or payment of the money relating to the charge is not yet due.
(5) However, if the work has been completed, the notice of claim must be given within 3 months after practical completion for the work.
(8) If the notice of claim relates only to a retention amount for the contract, the notice (a) may be given at any time while work under the contract is being performed; and (b) must be given within 3 months after the expiration of the defects liability period for the contract.

This means:

Any time that the works are still being completed; or
After completion – for money owed under a contract – within three (3) months after the completion of works; or
After completion – for retention money – within three (3) months of the expiration of the maintenance period.

Copy of Notice of Claim to Contractor

After giving a copy of the notice of claim to a person obliged to pay money to a contractor under a contract, the subcontractor must give a copy of the notice to the contractor.

Section 123 of BIFA says:

The subcontractor must (a) give the contractor a copy of the notice of claim; and (b) advise the contractor of the name and address of the person given the notice of claim. If the subcontractor does not comply … the notice is of no effect and the subcontractor’s charge does not attach.

So, the contractor must have a copy of the notice of claim and be given the name and address of the person given the notice of claim.

Failure to do so means that the charge does not attach, and the subcontractor loses its security interest.

We strongly suggest engaging a solicitor to complete this.

Very strict time limits apply to the different stages of BIFA. Ensure that you do not miss out on claiming your subcontractors’ charge by contacting our building and construction lawyers today

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Ok, so you have done all of that, now what happens?

Person Must Retain Money

Once served with the notice of claim, the person obliged to pay money to a contractor under a contract must retain the money payable to the contractor.

Section 126(2) of BIFA says:

(2) The person must retain a sufficient part of the money that is or is to become payable by the person under the contract to satisfy the claim until the court in which the claim is heard makes an order about to whom, and in what way, the money is to be paid.

If the person fails to retain the money and pays it to the contractor, then the person becomes liable for that amount of the claim. Section 126(3) of BIFA says:

(3) If the person fails to retain the money as required under subsection (2), the person is personally liable to pay to the subcontractor the amount of the claim, not exceeding the amount that the person is required to retain under subsection (2).

As well as the person having to retain the money, the contractor has to respond to the notice of claim. Failure to do so will incur a maximum of 20 penalty units.

Contractor given copy of Notice of Claim must Respond

The contractor must respond to the notice of claim within 10 business days.

Section 128(2) of BIFA says:

(2) The contractor must give both of the following persons a written response to the claim within 10 business days after the contractor is given the copy of the notice of claim, unless the contractor has a reasonable excuse (a) the person given the notice of claim; (b) the subcontractor.

The response to the claim must be made in the approved form and:

Accept liability to pay the amount claimed; or
Accept liability to pay an amount stated in the response, but otherwise dispute the claim; or
Dispute the claim.

The approved form for the contractor’s response is Form S128 – Response to a Notice of Claim.

The details the contractor must include:

Details of claimant subcontractor (person who gave the notice of claim);
Details of superior contractor (by whom money is claimed as payable);
Details of contractor;
Details of the work done by the claimant subcontractor;
Declaration including if the contractor:
Accepts liability to pay the amount claimed; or
Accepts liability to pay an amount stated; or
Disputes the claim.
States amount for which liability is accepted

If the Debtor Accepts Liability to Pay an Amount Claimed

If the contractor accepts the liability for the amount claimed, then the person must pay that amount to the subcontractor.

Sections 129(2) of BIFA says:

If, in the response to the claim, the contractor accepts liability to pay the amount claimed, the person given the notice of claim must pay the subcontractor the amount the person is required to retain.

If the contractor accepts liability to Pay a stated amount in the contractor’s notice, but otherwise disputes the balance of the claim, then the person must pay to the subcontractor the amount stated in the response to the notice of claim and retain the balance (the unsatisfied amount).

Sections 129(3) of BIFA says:

If, in the response to the claim, the contractor accepts liability to pay an amount stated in the response but otherwise disputes the claim, the person given the notice of claim must pay the subcontractor the amount the person is required to retain, up to the amount stated in the response.

If the Contractor Disputes the Claim or Does Nothing

If the contractor disputes the claim, then the subcontractor must commence proceedings in relation to the charge, recover the amount claimed from the person, as a debt owing to the subcontractor, in any court of competent jurisdiction.

Section 136 of BIFA says:

A proceeding for a subcontractor’s charge must (a) be started within (i) if the claim is for the retention amount only – 4 months after the balance of the retention amount is payable; and (ii) otherwise—1 month after notice of the claim is given under section 122 to the person by whom the money is payable; and (b) be brought by way of action.

If the subcontractor does not commence proceedings in the required time to prove the debt, then the charge is deemed to be extinguished unless the subcontractor duly commences a proceeding under section 136 to enforce it.

Debtor Contractor in Liquidation

If the contractor goes into liquidation, then a subcontractor who gave a notice of claim to the person prior to the commencement of the liquidation, and has elevated themselves to the status of a secured creditor, can take advantage of section 471C Corporations Act 2001 (CTH) which says:

Nothing in section 471B affects a secured creditor’s right to realise or otherwise deal with the security interest.

In MSI (Holdings) Pty Ltd v Mainstreet International Group Ltd [2013] QCA 27 the Queensland Court of Appeal said:

Section 471C is concerned with the right of a secured creditor with respect to a security interest. The expression “secured creditor” is defined by s 51E of the Corporations Act to mean: a creditor of the corporation, if the debt owing to the creditor is secured by a security interest.
The expression “security interest” is defined in s51A to have a meaning which includes a charge. According to the definition in the Dictionary in s 9 of the Corporations Act, the word “charge” means: a charge created in any way and includes a mortgage …
Plainly, the charge … was a security interest as defined. Just as plainly, at the time of commencement of the District Court proceeding … there was a debt owed by MSI … which was secured by the charge.
In my view, the commencement and continuation of the District Court proceeding is apt to be characterised as a realisation of [a] security interest for the purposes of s 471C.

As you can see, a subcontractor’s charge may have some substantial benefits for a creditor.

We strongly advise that you seek suitably qualified legal advice in relation to a subcontractor’s charge as soon as possible to secure the money owed to you by a contractor.

Very strict time limits apply to the different stages of BIFA. Ensure that you do not miss out on claiming your subcontractors’ charge by contacting our building and construction lawyers today

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OR CALL: 1300 545 133 FOR A PHONE CONSULTATION

What is Insolvency?

When is a Company Insolvent?

The Cash Flow Test

What does “debt” mean?

What does “due and payable” mean?

The Balance Sheet Test

Temporary Lack of Liquidity

When is a Company Insolvent?

Common Features of Insolvency

Is my Company Insolvent?

What are Voidable Insolvent Transactions?

Insolvent Transactions

What is a Transaction?

What are Insolvent Transactions of a Company?

Are the Insolvent Transactions also Unfair Preferences?

Are the Insolvent Transactions also Uncommercial Transactions?

What is Giving Effect to the Transaction?

When is the Company Insolvent?

Unfair Preference Claims

Uncommercial Transaction Claims

Related Entity of the Company

Attempting to Defeat Creditors

Unfair Loans

Unreasonable Director-Related Transaction

Company Under Administration

Deed of Company Arrangement

Relation Back Day – Insolvent Transactions

What are Voidable Transactions?

What is an Uncommercial Transaction?

What is a Transaction of a Company?

What does Uncommercial Mean?

Whether a reasonable person would not have entered into the transaction?

What are the benefits and detriments to the parties to the transaction?

What is a Benefit?

What is a Detriment?

Does the Liquidator have an uncommercial transaction claim?

Timeframes for Uncommercial Transactions Claims

What is the Relation Back Day?

What is a Related Entity in uncommercial Transactions Claims?

Examples of an Uncommercial Transactions Claim in Liquidation

Defences to Uncommercial Transactions Claims

Elements of an Uncommercial Transactions

What are Voidable Transactions?

What is a Transaction?

What is an Insolvent Transaction?

What are Unfair Preference Claims?

Timeframes for Unfair Preference Claims

What is the Relation Back Day?

What is a Related Entity?

Example of an Unfair Preference in Liquidation

Defences to Unfair Preference Claims

The Suspicion of Insolvency

Exceptions to Unfair Preference Claims

Secured Creditor vs Unsecured Creditor

The Running Account “Partial Defence”

What is NOT an Unfair Preference?

Subcontractors’ Charge

Parties Involved in the Subcontractors’ Charge

The Meaning of Work

What is a Subcontractors’ Charge?

Notice of Claim

Strict Time Limits for Notice of Claim

Copy of Notice of Claim to Contractor

Person Must Retain Money

Contractor given copy of Notice of Claim must Respond

If the Debtor Accepts Liability to Pay an Amount Claimed

If the Contractor Disputes the Claim or Does Nothing

Debtor Contractor in Liquidation

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