A case for unfair preferences—don't rely on third party payments to insolvent company creditors27 July 2018
The NSW Court of Appeal recently held that payments made by a third party to an insolvent company’s creditors may not necessarily be unfair preferences within the meaning of s 588FA of the Corporations Act 2001 (Cth) (Act).
In Hosking v Extend N Build Pty Ltd  NSWCA 149, Built Pty Ltd (Built) entered into a contract with a subcontractor, Evolvebuilt Contracting Pty Ltd (Evolve). Evolve then retained secondary subcontractors to undertake the work. When Evolve failed to pay the secondary subcontractors, the subcontractors ceased work. On the same day the subcontractors ceased work, the Construction, Forestry, Mining and Engineering Union (CFMEU) wrote to Built and requested it make the payments Evolve failed to make. Also on the same day, relying on a provision on its contract with Built, Evolve also provided a written request to Built to pay the secondary subcontractors. The evidence did not show which request came first.
Built subsequently terminated the contract with Evolve, then made arrangements with the CFMEU outlining the payment arrangements to pay five of the secondary subcontractors. One of the secondary subcontractors, Kennico Interiors Pty Ltd (Kennico) did not receive any payments from Built under this arrangement. However, Evolve paid Kennico on its own accord.
Evolve eventually entered into liquidation and the liquidators commenced proceedings in the Supreme Court of New South Wales to recover the payments from the five secondary subcontractors and Kennico as unfair preferences.
At first instance, Brereton J found that:
- Evolve was insolvent at the relevant times
- payments made by Built to the five secondary subcontractors (with the exception of Kennico) were not unfair preferences, and
- payments made by Evolve to Kennico were unfair preferences but Kennico was entitled to rely on the “good faith” defence in s 588FG(2) of the Act.
Court of Appeal decision
The issues before the Court of Appeal were whether:
- the payments made by Built to the five other secondary subcontractors were unfair preferences, and
- Kennico was entitled to rely on the defence in s 588FG(2) of the Act, that it was a party to transaction in “good faith” and had no reasonable grounds to suspect that Evolve was insolvent.
The liquidators argued that the primary judge erred when his Honour found that the payments made by Built were made in accordance with CFMEU’s request and not in accordance with Evolve’s request. The liquidators also argued the primary judge was incorrect in finding that the payments were not made from an asset that benefitted Evolve. According to the liquidators, the request from Evolve to pay its secondary subcontractors was part of a “chain of causation” that caused the payments to be made.
At the time the payments were made, there was no money owing from Built to Evolve. However the liquidators contended that Built was paying for work that it would otherwise have to pay Evolve to do.
The Court of Appeal unanimously dismissed the liquidators’ appeal and held that the payments to the five subcontractors were not unfair preferences. The Court stated that a “transaction” where an unfair preference claim is made may be a series of interrelated dealings and that a debtor company and creditor did not need to be a party to each part. However, the Court did not rely upon a “chain of causation” to connect a debtor company to the payments and found that Evolve was not a party to the transactions where Built arranged to pay the secondary subcontractors.
At the time Built made the payments, it was not under any contractual obligations to Evolve to pay the secondary subcontractors. Furthermore, the Court held that Evolve was not a party to the arrangements between Built and the CFMEU. As a result, the Court did not find it necessary to consider whether the payments made by Built to the secondary subcontractors were received “from” Evolve for the purposes of s 588FA(1)(b) of the Act.
The Court overturned the primary judge’s decision that Kennico could rely on the “good faith” defence. Correspondence between Kennico and Evolve suggested that Kennico knew Evolve could not pay all of its subcontractors and that Kennico knew payments had been arranged by CFMEU. In the circumstances, the Court held that Kennico would have had a “positive apprehension of fear” that Evolve would not be able to pay all its debts at the time Evolve paid Kennico.
Where liquidators are seeking to claw back unfair preference payments it is important to consider whether:
- the payments were made with the authority of the insolvent company, and
- the payments by a third party to an insolvent company’s creditors gives rise to a “restitutionary” claim—i.e. whether the third party can then make a claim against the insolvent company for the payment.
In this case, while the Court found that payments made by a third party were not made at the direction or with the authority of the insolvent company, this decision illustrates that if payment was made with the insolvent company’s authority and that payment gives rise to a “restitutionary” claim, courts may be inclined to find that these third party payments to an insolvent company’s creditors are unfair preferences.