Michael.1
Insolvency and related law and policy, and more

Michael Murray is an Australian author and commentator on corporate and personal insolvency law and related issues, in Australia and internationally. He has a strong law and policy background, is independent of any connections, and his views are his own. He gives no legal advice. 

Why do we have preference recoveries in insolvency?

In finding that the ‘peak indebtedness rule’ did not in fact exist, the Full Federal Court[1] in Badenoch v Bryant has also questioned the central aspect of its purported purpose that

“if the continuing business relationship commenced at the beginning of the running account (some years prior to 2012), questions may arise as to whether Badenoch “received” anything in relation to an unsecured debt at all. Expressed another way, if the single transaction is that evidenced by the whole of the running account, Badenoch appears to have supplied more than it has received, such that there could be no unfair preference”.

As the Court concluded, “whether that is the intended operation of the Act is a question that may be deferred to a case where the outcome depends upon it”.

A review of preference law?

That is but one significant question that would arise for those proposing a root and branch review of insolvency law.  Preference law tries to counter that aspect of voidable transactions involving unfairness between creditors; the other aspect being voidable transfers involving unfairness between the debtor and the creditors.[2]  Understanding that distinction is important to determining the rationale for different types of voidable transactions.

Preference law has several justifications, which seem good in theory, but which often don’t stand up under scrutiny or in practice, and some of which are naïve in behavioural terms.

One purported value of preference law in ‘deterring a race to the court-house’ of competing creditors has long been questioned. It sounds good in theory but would a creditor being offered payment refuse the money because some time down the track the debtor might go into insolvency, and a liquidator might make a claim and so contingently on? As one Court said,

“there is nothing compelling a creditor somehow to remain pure by shunning a payment in respect of which there exists some theoretical future possibility of its proving to be preferential. A normally motivated creditor would be inclined to accept such a payment conscious of any risk of disgorgement, and with fingers crossed to the extent indicated by the circumstances”.[3]

The aim of preference law to ensure equity between creditors is problematic.  The law can disadvantage creditors who take proper steps to mitigate their risks and who might otherwise seek to support a debtor through a difficult trading time, putting them on relevant notice of the debtor’s insolvency.[4] And while the idea that creditors who have used their power or influence to extract a payment from a struggling debtor should repay that money to benefit all has some sense of collective justice about it, much of the benefit of preference recovery is not known. There is no data, except what the industry holds and knows, including the extent to which preference claims are made and paid without court proceedings.

How much do creditors benefit?

One indicator from AFSA statistics is that, overall, receipts by bankruptcy trustees from action taken to set aside voidable transactions are generally under 5% of total moneys received.

I have suggested that with any voidable transaction recovery, there be a public accounting of how much in fact goes to creditors.  The reality may be that in some or many cases no moneys flow to creditors,[5] rather to the trustee’s or liquidator’s remuneration and expenses.

That does not, under insolvency law principles, negate the purpose of the action[6] but it puts the rationale of equity between creditors in perspective.

And that equity is arguably lessened given that the creditor that initially recouped its debt unfairly and then having repaid it, is still then entitled to prove for the full amount of its debt: s 122(5) BA, s 588FI CA.  Thus there is no disincentive for a creditor to refuse payment by a debtor, and no real deterrent. The idea of penalising a creditor for having accepted a preference is not realistic nor sound in theory.[7]

As I wrote before – A policy question with insolvency preferences | Murrays Legal Commentary – a purpose met by a preference recovery is often more to have the insolvency laws enforced and to thereby promote the principle of fairness, such as it is, and to recoup the trustee or liquidator’s unmet remuneration, than to provide any real dividend return to creditors. The costs of the process are one main reason and a reason why Keay recommended that there be an automatic right of recovery of preferences paid within a set time period, the alternative, abolition, being too inconsistent with the collective principles of insolvency.

We need more information

The point is we don’t know much about how preference law works.  If preferences are used to pay remuneration, then this suggests some fundamental dysfunction with other aspects of the system necessitating a readjustment of insolvency’s aims and the mechanisms to achieve them.  If preference law does in fact benefit all creditors, financially, and with some sense of justice delivered, that is good but those who can provide the data to show this should do so.  Either way, the lack of transparency may hide a flawed system although some, like the peak indebtedness rule, may be said to have been in plain sight, with apparent “weight of authority and sufficient pedigree” simply ensuring its existence.[8]

Quality thinking[9] is required for any root and branch law reform review. The gathering and release of data by the profession to show whether preference laws in fact benefit creditors would assist.

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[1] Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (in liq) (receivers and managers appointed) (No 2) [2021] FCAFC 111.

[2] Avoidance Provisions in Insolvency Law, LBC Information Services, 1997, Andrew Keay, Chapter 2.

[3] Nationwide v Franklins [2001] NSWSC 1120; Keay’s Insolvency, 10th ed, at [5.125-5.130].

[4] Submission of AICM to Treasury on the Corporations Amendment (Corporate Insolvency Reforms) Bill 2020, 12 October 2020.

[5] “… AICM members report that they are yet to see an unfair preference claim paid to a liquidator result in a benefit to creditors”: AICM submission.

[6] Even if preference proceedings are pursued to seek to recover the liquidators’ costs or litigation funding, that is a proper purpose, if otherwise “liquidators could not recover their remuneration or litigation funders could not recover the funding which they provided”: In the matter of Cardinal Group Pty Limited (in liquidation) [2015] NSWSC 1761 at [34].

[7] Keay’s Avoidance Provisions, pp 356ff.

[8] Badenoch v Bryant citing the NZCA in Timberworld v Levin.

[9] Some of the issues only lightly touched upon here are well addressed in thoughtful detail in Unfair Preferences as an Instrument of Restoration, (2021) 29 Insolv LJ 4, by Nikita Angelakis.

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