Defences available to creditors
On 25 April 2025, ASIC released its annual insolvency statistics, confirming a significant increase in the level of corporate insolvency in Australia. Relevantly, the creditors of struggling companies who elect to pursue a creditors’ voluntary winding up process have increased by 28% from 2024 and 40% from 2023. ASIC has reported that accommodation and food services, construction and scientific and technical services are the most affected industries.
Part 5.7B of the Corporations Act 2001 (Cth) (Act) establishes the regime under which a liquidator of an insolvent company may seek court orders to effect the avoidance of certain transactions the company has entered into prior to its winding up.
When an insolvent company has entered the winding-up process, an insolvent transaction by the company may be an unfair preference and voidable if it occurred during the relation back period, which is the period:
- within the 6 months preceding the date the winding up application was filed; or
- after the date the winding up application was filed; or
- after the commencement of administration and ending when the company is wound up; or
- the company was subject to a deed of company arrangement and ending when the company is wound up,
(together Relation-back period).
A liquidator will assess the following elements in determining whether a transaction is voidable:
- the nature of the transaction;
- when the transaction was entered into or given effect to; and
- whether a defence can be made out.
If a creditor is unable to refute that the transaction the subject of the preference claim is voidable, the liquidator may recover the claimed amount for the benefit of all the creditors of the company.
Unfair preference transactions
Section 588FA(1) of the Act sets out the basis for unfair preference transactions. Relevantly, a transaction is an unfair preference given by a company to the creditor of the company if:
- the company and the creditor are parties to the transaction (even if someone else is also a party); and
- the transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor, more than the creditor would receive from the company in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in a winding up of the company.
Defences to a preference claim
Transactions entered during a Relation-back period are not always voidable. There are two primary defences available to creditors in responding to a demand for the repayment of preference amounts from liquidators:
- a good faith defence; or
- a running account defence.
Good faith defence
Under section 588FG(2), for a creditor to succeed with a “good faith” defence, they must prove that they became a party to the transaction in good faith and, at the time they became a party to the transaction:
- the creditor had no reasonable grounds for suspecting that the company was insolvent at that time or would become insolvent and a reasonable person in the creditor’s circumstances would have had no such grounds for so suspecting; and
- the creditor has provided valuable consideration for the transaction or has changed their position in reliance on the transaction.
Relevant factors to be considered in determining whether a reasonable person in the creditor’s position would have suspected the company’s insolvency may include, but are not limited to:
- the company’s prior ability to pay the creditor as its debts become due;
- the continued capacity of the company to trade and the fact that it was doing so; or
- the reasonable knowledge and business qualifications of a creditor in its industry.
Running account
Section 558FA(3) of the Act confirms that, where:
- a transaction is, for commercial purposes, an integral part of a continuing business relationship (for example, a running account) between a company and a creditor of the company (including such a relationship to which other persons are parties); and
- in the course of the relationship, the level of the company’s net indebtedness to the creditor is increased and reduced from time to time as the result of a series of transactions forming part of the relationship,
then
- the unfair preference applies in relation to all the transactions forming part of the relationship as if they together constituted a single transaction; and
- the transaction may only be taken to be an unfair preference given by the company to the creditor if, because the unfair preference threshold applies in relation to all transactions forming part of the relationship, the single transaction referred to in the last‑mentioned paragraph is taken to be such an unfair preference.
For a creditor to be successful in a running account defence, it must establish that:
- the alleged voidable transactions cannot be separated from the entire transaction;
- there is a common business purpose which connects each individual payment; and
- the conduct before and after each payment was such that services were expected to be provided in respect of that payment.
Key takeaways
If a creditor receives a demand for repayment of a preference amount, it may be entitled to reduce or eliminate the amount claimed if it can establish a relevant defence.
Please contact Partner Peter Motti, Special Counsel Sarah Ewing or Solicitor Emily Cooper for more information.
