Third party payments as unfair preferences

Articles Written by Ben Renfrey (Partner)

Commissioner of Taxation v Kassem and Secatore as liquidators of Mortlake Hire Pty Ltd (in liq) [2012] FCAFC 124 (31 August 2012)

The Full Court of the Federal Court has recently confirmed that third party payments made at the direction of the insolvent debtor are 'transactions' for the purposes of the unfair preference provisions.

Third party payments made in the relation back period will be voidable against a liquidator appointed to the debtor unless:

  1. the third party payment is a gift or some other "white knight" arrangement whereby the debt created in favour of the third party is subordinated to the other debts of the insolvent debtor; or
  2. the recipient of the third party payment can make out the grounds of a defence in section 588FG of the Corporations Act 2001 (Cth).

Review

An unfair preference is commonly thought of as a transaction between an insolvent company (A) and its unsecured creditor (B) which results in B receiving more (on account of its unsecured debt) than B would be entitled to receive as a dividend in the winding up of A. That is, the parties to the unfair preference transaction are the insolvent company (A) and its unsecured creditor (B), with the payment being made directly by A to B.

Creditors commonly attempt to reduce the risk of payments (received on account of unsecured debts) being clawed back as unfair preferences by demanding payment from a third party (C) rather than A (the insolvent debtor) on the understanding that payment from C breaks the nexus of the "transaction" (between A and B) required for an unfair preference.

Following the 1997 decision in Re Emanuel (No 14) Pty Ltd1, it became clear that payment by a third party (C) of an unsecured debt due by A to B could be classified as an unfair preference in certain circumstances; namely where C's payment to B had the effect of satisfying a separate debt due by C to A. This is because C's payment reduced the assets available in the winding up of A, because the debt due by C to A was satisfied in the process of C's payment to B (at A's direction).

The decision in Re Emanuel (No 14) did not cause particular concern because unsecured creditors could reduce the risk of receiving an unfair preference by seeking assurances from the third party (and / or the debtor) that payment by the third party to the unsecured creditor did not satisfy the conditions in Re Emanuel (No 14)2. However, the Full Federal Court recently found in Commissioner of Taxation v Kassem and Secatore3 (Kassem) that a third party payment could be characterised as part of a "transaction" between an insolvent company and its unsecured creditor (and thus an unfair preference) in broader circumstances than in Emanuel (No 14).

The Full Court found in Kassem that a payment by a third party (Antqip Pty Ltd (Antqip)) at the direction of an insolvent company (Mortlake Hire Pty Ltd (Mortlake)) to Mortlake's unsecured creditor (the Commissioner of Taxation (Commissioner)) was in reality nothing more than a "transaction" between Mortlake and the Commissioner for the purposes of the unfair preference provisions of the Corporations Act.

There was no evidence before the Court that Antqip (the payer) owed any debt to Mortlake (the insolvent debtor) that was satisfied or reduced by Antqip's payment to the Commissioner (i.e. the criteria for an unfair preference where third party payments are involved arising from Emanuel (No 14) were not satisfied). Rather, Antqip's payment to the Commissioner simply resulted in the creation of a new debt, from Mortlake to Antqip.

The Full Court found that Mortlake's direction to Antqip to pay Mortlake's debt to the Commissioner was no different than if Mortlake had directed its bank to pay the Commissioner using funds available from Mortlake's overdraft account. The Court stated that, "this was a clear example of a lender paying moneys advanced to a creditor of the borrower in accordance with the borrower's directions."4 In effect, the impugned payments were made directly from A to B (using funds borrowed from C). 

Taking the Full Court's decision in Kassem at face value, unsecured creditors will not gain any protection from potential unfair preference claims by demanding payment on account of their unsecured debts from third parties unless the third party pays A's debt to B by way of a gift or other "white knight" arrangement under which any rights created in favour of the third party are subordinated to the debtor's other unsecured creditors.

Any payment by a third party to A's creditor which gives rise to a debt due by A to the third party is likely to be viewed as a payment direct from A to B for the purposes of the unfair preference provisions, and therefore voidable against A's liquidator.


1 Re Emanuel (No 14) Pty Ltd: Macks v Blacklaw & Shadforth Pty Ltd (1997) 147 ALR 281
2 namely the satisfaction or reduction of a debt due by the third party to the insolvent debtor
3 Commissioner of Taxation v Kassem and Secatore [2012] FCAFC 124 (31 August 2012)
4 Kassem, above, at [40]

 

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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