Paid by Instalments

Receiving Payment by Instalments from a Company in Financial Difficulty

If a company owes your business money and asks to pay the outstanding account by instalments, accepting the proposal may appear preferable to receiving nothing.

However, if the debtor company later enters liquidation, payments received before the liquidation may potentially be investigated by the liquidator as unfair preference payments.

This does not mean that every instalment payment received from a company experiencing financial difficulty must be repaid. Whether a payment is recoverable depends upon the circumstances and the requirements of the Corporations Act 2001 (Cth).

What is an Unfair Preference Payment?

An unfair preference can arise where an insolvent company pays an unsecured creditor and, as a result of the transaction, that creditor receives more in respect of the debt than it would have received if the transaction were set aside and the creditor had to prove for the debt in the liquidation.

A liquidator may investigate payments made before liquidation and, where the statutory requirements are satisfied, seek to recover payments for the benefit of creditors generally.

The Six-Month Period

For an ordinary liquidation, unfair preference claims commonly involve transactions occurring during the six months ending on the relevant relation-back day, together with transactions occurring after that day and before the winding up began.

The calculation of the relevant period can depend upon how and when the external administration and liquidation commenced.

Special rules can also apply under the simplified liquidation process. For unrelated creditors, ASIC explains that an unfair preference is generally only recoverable where the payment, or series of payments, was made during the three months before the liquidation is taken to have begun (or afterwards before the liquidator was appointed) and the total received during that period exceeds $30,000. See ASIC’s current guidance for creditors in liquidation.

Does Paying by Instalments Mean a Company is Insolvent?

No. A request to pay a debt by instalments does not automatically establish that a company is insolvent.

However, persistent inability to pay debts when they fall due, repeated requests for extensions, broken payment promises and other evidence of financial distress may become relevant when considering whether there were reasonable grounds to suspect insolvency.

Creditors should therefore take requests for extended payment arrangements seriously, particularly where the debtor has previously failed to comply with agreed payment terms.

Defending an Unfair Preference Claim

The Corporations Act provides defences that may be available to a creditor facing an unfair preference claim.

Depending upon the circumstances, relevant matters can include whether the creditor:

• became a party to the transaction in good faith;
• had no reasonable grounds for suspecting that the company was insolvent or would become insolvent;
• was in circumstances where a reasonable person would have had no reasonable grounds for such a suspicion; and
• provided valuable consideration or changed their position in reliance upon the transaction.

The availability of a defence depends upon the evidence and circumstances of the particular case.

What Should a Creditor Do When Instalments Are Requested?

If a company that normally pays its accounts on time suddenly requests an instalment arrangement, it may be appropriate to obtain further information about the reason for the request.

Depending upon the size of the debt and circumstances, a creditor may consider obtaining information about the company’s financial position and keeping careful records of communications, payment proposals and representations made by the debtor.

A statement from a director or financial information may form part of the available evidence, but obtaining such information does not guarantee protection against a future unfair preference claim.

Warning Signs of Financial Difficulty

Potential warning signs can include repeated late payments, dishonoured payments, requests for increasingly extended terms, broken payment arrangements, inability to meet debts when due or information suggesting significant financial difficulties.

The significance of any particular warning sign depends upon the surrounding circumstances.

If You Receive a Demand from a Liquidator

Receiving a demand from a liquidator does not necessarily mean that the amount claimed must immediately be repaid.

The circumstances of the payments, the company’s financial position at the relevant times and any available statutory defence should be considered.

A creditor should obtain legal advice before admitting liability or repaying an amount demanded by a liquidator.

Debt Recovery and Commercial Disputes

Early advice can be particularly important where a business customer is experiencing financial difficulty or proposes an instalment arrangement for a substantial outstanding account.

Russell Kelly & Associates can advise businesses concerning debt recovery, commercial disputes and claims arising from corporate insolvency.

Learn more about our Commercial Litigation services.

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This information is general in nature. Unfair preference claims and available defences depend upon the particular circumstances and the applicable provisions of the Corporations Act 2001 (Cth). Legal advice should be obtained before responding to a liquidator’s demand.