To put it colloquially, in the bankruptcy context, preference payments are payments made by a bankrupt debtor in favour of an unsecured creditor at the expense of other ordinary creditors of a bankrupt estate. The payment received by the creditor must be more than that creditor would have received if the debtor had been declared bankrupt and they had proved for their debt along with all the other creditors in the estate without receipt of the payment. Preference payments to creditors are voidable against a Trustee in Bankruptcy if they are within the period stipulated by section 122(1)(b) of the Bankruptcy Act.
This law has been developed to try to ensure that all creditors are treated equally by not allowing debtors to ‘pick favourites’. Once a Trustee in Bankruptcy can establish that an unsecured creditor has been paid in preference to others, they can seek to void that transaction and recover the proceeds or other assets for the benefit of all unsecured creditors.
Features of a preference claim
The following elements must be established by the Trustee to recover a preference:
- a transfer of assets must have occurred (this is usually money but can be property);
- the transfer was from the bankrupt to the creditor on the creditor’s instructions or their demand;
- the transfer occurred when the bankrupt was insolvent;
- the transfer was made within the time period stipulated in section 122(1)(b) before the bankruptcy;
- the transfer has to have been for more than the creditor would have received if the payment was not made, the debtor had been declared bankrupt and the creditors had proved for their debt in the ordinary course (this gives an unfair advantage over the other creditors); and
- the creditor receiving the transfer suspected or should have suspected that the debtor was insolvent at the time.
Unsecured vs. Secured creditors
Only unsecured creditors can receive a preference under this regime. Secured creditors have a security over some asset of the debtor and give this up on payment of the debt in full. However, if the value of the security does not cover the full amount of the debt, a transfer of the difference between the security and the full amount may be preferential.
There is a statutory defence that may be available to creditors. The three elements that need to be established are:
- that the transfer was in the ordinary course of business;
- that the creditor acted in good faith in the transaction; and
- the creditor gave at least fair market value consideration for the assets transferred.
If you are concerned about a trustee claiming a preference payment against you or your company, contact our Dispute Resolution, Insolvency & Reconstruction Team on
P 02 6215 9100 or E email@example.com OR firstname.lastname@example.org