Three’s a crowd: Can third party payments give rise to an unfair preference?

The question of when and how a third party payment can give rise to an unfair preference was considered in the recent case of Cant v Mad Brothers Earthmoving Pty Ltd [2020] VSCA 198 (Cant v Mad Brothers).

Typically, in seeking to establish an unfair preference under section 588FA of the Corporations Act¹ (Act), a liquidator will need to prove that the creditor receiving the impugned payment:

• was a party to a transaction with the insolvent company; and
• received from the company more than they would have received if the payment were set aside and the creditor had to prove for the debt in the winding up.

There are cases dealing with when a third party payment on behalf of an insolvent company can give rise to an unfair preference within the meaning of section 588FA, but the area has been subject to uncertainty.

Background

The relevant facts are as follows:

• Eliana Construction and Developing Group Pty Ltd (In Liquidation) (Eliana) owed $220,000 (Debt) to Mad Brothers Earthmoving Pty Ltd (Mad Brothers).
• Shortly before Eliana went into liquidation, a third party company, Rock Development & Investments Pty Ltd (Rock) paid the Debt to Mad Brothers on behalf of Eliana. 
• Eliana and Rock were related companies with the same sole director.

The liquidator of Eliana sought to recover payment of the Debt from Mad Brothers as an alleged unfair preference payment.

The liquidator was successful before an associate judge at first instance.²  This was overturned on appeal by Justice Robson in the trial division, with Justice Robson finding that “in the facts of this particular case, there was no unfair preference given by Eliana to Mad Brothers as a creditor of Eliana”.³

The liquidator then appealed the matter to the Victorian Court of Appeal.

The Appeal

The liquidator of Eliana argued that the fact that Eliana and Rock had the same sole director led to the inference that Eliana had authorised or directed Rock to pay the Debt to Mad Brothers, and that this satisfied the requirement that Eliana be a party to the transaction with Mad Brothers.

The liquidator also argued that Eliana was a creditor of Rock, that the payment by Rock appeared to have reduced Rock’s debt to Eliana, and that this satisfied the requirement that Mad Brothers received the payment from Eliana.

The respondents argued that there was no agreement between Rock and Eliana, Eliana was not a party to the payment transaction, and the payment was not ‘from’ Eliana.

In relation to section 588FA(1) of the Act, the Victorian Court of Appeal held⁴ in its very detailed judgment that:

• an insolvent company can be party to a transaction between a creditor and a third party if it authorises or ratifies the payment by the third party;
• however, even if the insolvent company does authorise or ratify the third party payment, this does not necessarily mean that payment is received “from the company”;
• there is substantial case law on third party payments and unfair preferences and whether third party payments can be found to be “from” the insolvent company;
• the wording “from the company” requires that the preference received is “from the company’s own money, meaning money or assets to which the company is entitled”;
• for a preference to be ‘from the company’, it must also have the effect of “diminishing the assets of the company available to creditors”; and
• a payment that does not the diminish the assets of the company is not a payment from the company and therefore cannot be considered an unfair preference.

In assessing the matter, the Court of Appeal was satisfied that there was sufficient evidence to show that Eliana had authorised and ratified the payment by Rock (by the actions of the joint sole director) and was a party to the payment transaction.

However, the Court of Appeal found that the liquidator had not established that Eliana was a creditor of Rock.  As a result, the Court of Appeal found that the liquidator had not and could not establish that the payment by Rock had reduced or diminished the assets of Eliana.

All of the grounds of appeal relating to this issue were dismissed.

Lavan Comment

The judgement in Cant v Mad Brothers provides valuable guidance as to when and how a third party payment can give rise to an unfair preference.

Liquidators will need to be alert when considering third party payments to creditors during the relevant period to assess whether any terms or arrangements relating to that payment could be said to have reduced the available assets of the insolvent company.