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Paying creditors pre-liquidation

What’s a preference and what will a liquidator do?

A difficult area of the Corporations Act is in regard to Unfair Preferences. The general philosophy of the law is that where possible, creditors should be treated evenly or “parri passu”. So as a general principle the law says that if a creditor received a preference, priority or advantage over other creditors within the six months prior to the liquidation then a liquidator has the power to recover that preference. If the liquidator successfully recovers money that was a preference, those funds go into the liquidator’s general bank account and the funds are redistributed to creditors in accordance with their statutory priority – so that will be to employees first then evenly to all ordinary creditors.

But there are some tricks and traps for directors. Firstly, there is nothing actually illegal in paying any creditor. However, the payment of one creditor over another can lead to unnecessary legal actions.

In particular, directors have a natural tendency to ensure payments are directed to creditors where the director has provided a personal guarantee or perhaps to relatives. What the law says about that is that in either of those situations a liquidator can seek to recover the funds from the director personally.

There are a number of timeframes that are too complicated to explain in detail here, however, payments to unrelated creditors are recoverable at least within a six-month period prior to the liquidation. A liquidator may seek to recover payments made to related parties within a two and four year timeframe based on various other criteria, but in brief, those payments may be recoverable if they are designed to defeat creditors or if they were “uncommercial” or were made to related parties.

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