Unfair Preference Claims after Badenoch and Morton: Where the Law Stands
If your business received payments from a customer that went into liquidation 6 months later, you may open the mail one day to find a demand from that company’s liquidator asking for the money back – that’s an unfair preference claim. In 2023, two High Court decisions on unfair preference claims changed the terrain for both sides, and every credit manager and director should understand the current position.
Section 588FA of the Corporations Act 2001 (Cth) (“Act”) provides that an unfair preference is a payment or transfer made by an insolvent company to an unsecured creditor that puts that creditor in a better position than it would occupy in the winding up. Under sections 588FE and 588FF of the Act, a liquidator can recover that advantage for the benefit of creditors as a whole. This article explains the elements, the relation-back period, the effect of Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2 (“Badenoch”) and Metal Manufactures Pty Ltd v Morton [2023] HCA 1 (“Morton”) and the defences that still work.
A liquidator must establish several elements before a payment is recoverable. Each one is a genuine hurdle, and the defence usually lives in the detail of one of them.
First, there must be a transaction between the company and a creditor, typically a payment of a debt, but it can include a transfer of property or the grant of security. Second, the creditor must be unsecured, at least to the extent of the preference. Third, the creditor must receive more than it would have received as a creditor in the winding up. That comparison is the heart of the concept: if the company would pay 30 cents in the dollar in liquidation, a creditor paid in full received a 70-cent advantage.
The transaction must also be an “insolvent transaction” under section 588FC (meaning the company was insolvent when the payment was made or became insolvent because of it) and it must fall within the relevant relation-back period. Proving insolvency at the relevant time is often the liquidator’s heaviest burden, and the point most worth testing.
For a creditor, this means a payment that felt entirely routine at the time, an invoice settled in the ordinary course, can be recoverable months later if the company was in fact insolvent when it paid you.
The relation-back period depends on the relationship between the company and the creditor.
For unrelated creditors (ordinary suppliers and trade creditors), the period is six months ending on the relation-back day. The relation-back day is usually the date the winding up is taken to have begun, which for a company that went from voluntary administration into liquidation is the date administration started. For related parties, such as directors and their associated entities, the period extends to four years. Where a transaction was entered into for the purpose of defeating creditors, it can reach back ten years.
Most trade creditors are therefore exposed to a six-month look-back. Related-party creditors face far longer exposure, which is why intercompany payments deserve particular scrutiny before a group company fails.
Many commercial relationships are not one-off payments but a continuing account: goods supplied, invoices issued, payments made, more goods supplied. Section 588FA(3) recognises this. Where transactions form part of a “continuing business relationship”, they are treated as a single transaction, and only the net effect across the whole relationship can be a preference.
The practical question was always: where do you start measuring? For years, liquidators relied on the “peak indebtedness rule”, which let them pick the point of highest debt within the relation-back period as the starting balance, maximising the preference. In Badenoch, the High Court abolished that rule. The court held that section 588FA(3) requires the whole of the continuing business relationship (within the relevant period) to be assessed from beginning to end. A liquidator cannot cherry-pick the peak.
The effect is significant. For a creditor who kept trading and kept supplying, the net reduction in the debt across the relationship is frequently modest, and it is only that net figure that is exposed. Badenoch materially reduced preference exposure for genuine trade suppliers who maintained a running account. We examine the decision in detail in our note on the abolition of the peak indebtedness rule.
For a supplier, the lesson is to keep supplying rather than simply taking payments and walking away. A creditor who provides new value in exchange for payments is far better protected than one who merely reduces an old debt.
Creditors used to argue that if the company still owed them money for other unpaid invoices, they could set that debt off against the liquidator’s preference claim under section 553C of the Act, reducing or extinguishing their liability.
In Morton, decided the same sitting as Badenoch, the High Court closed that door. We explain the set-off position further in our article on set-off as a defence to an unfair preference claim. It held that statutory set-off is not available against an unfair preference claim, because the required mutuality is missing: the liquidator’s right to recover a preference is a statutory right that did not exist before liquidation and is exercised for the benefit of all creditors, not a debt owed to the company in the same right.
The two decisions cut in opposite directions. Badenoch helped creditors by shrinking the size of preference claims; Morton hurt them by removing a defence. Taken together, they mean a creditor can no longer rely on being owed money to neutralise a claim: the defence must now be built on the elements themselves or on section 588FG.
Even after Morton, creditors are not defenceless. The principal statutory defence is the good faith defence in section 588FG(2). A creditor will defeat the claim to the extent that it can show it became a party to the transaction in good faith, meaning that:
The suspicion element is where most of these claims are won and lost. Warning signs (repeated dishonoured payments, requests for payment plans, round-sum payments, long-overdue invoices) can defeat the defence because they put a reasonable creditor on notice. Clean, contemporaneous records of an ordinary trading relationship support it.
Beyond section 588FG, a creditor should always test the liquidator’s proof of insolvency at the transaction date, the correct identification of the relation-back day, whether the relationship was in truth a continuing business relationship (bringing in the running account), and whether the creditor was in fact unsecured. A well-run defence attacks the elements before it reaches the statutory defence.
What is an unfair preference claim?
An unfair preference is a payment or transfer a company makes to an unsecured creditor before liquidation that leaves that creditor better off than it would have been in the winding up. A liquidator can apply to the court to recover the amount if it is voidable under section 588FA, 588FE and 588FF of the Act.
How far back can a liquidator claw back payments?
For unrelated creditors, the relation-back period is six months ending on the relation-back day. For related-party creditors it extends to four years, and for transactions entered into to defeat creditors, up to ten years.
What is the running account defence?
Where a creditor and the company traded on a continuing basis, all transactions in that relationship are treated as a single transaction under section 588FA(3). Only the net reduction in the company’s indebtedness across the whole relationship can be a preference, not the individual payments. Since Badenoch, the liquidator must measure from the start of the relationship, not from the point of peak debt.
Can I set off what the company still owes me against a preference claim?
No. In Morton the High Court held that statutory set-off under section 553C is not available against a liquidator’s unfair preference claim, because the necessary mutuality is absent.
What is the best defence to an unfair preference claim?
The main defence is the good faith defence in section 588FG(2): the creditor received the payment in good faith, had no reasonable grounds to suspect insolvency, a reasonable person in its position would not have suspected insolvency, and it provided valuable consideration.
If your business has received a demand from a liquidator, or you are a director concerned about payments made before administration, Chamberlains’ Insolvency & Restructuring team can assess your exposure and defences. Contact us on 1300 676 823 to discuss your options.