Most readers will be aware of the concept of preferential payments and the right of liquidators and bankruptcy trustees to recover money from creditors. They may do so when creditors receive a payment (or transfer of an asset) that gives them more than they would have received if the payment had not been made and they had proved for a dividend in the estate.
Most of the time debtors or directors do not intentionally make preferential payments just to advantage the creditor. They do so to try to maintain the business’s operations by getting continuing supply or to satisfy creditors that have commence collection actions.
The major difference between payments made by companies in liquidations and by real people that end up bankrupt, is that the people were already personally liable for the debts that are paid. There is no intention to avoid personal liability, and recovery of these payments will not make any difference them, it will only adjust the amount of distribution within the estate.
The position is more complicated for directors of companies. They are not personally liable for the debts that are paid, but may be made liable in some circumstances if those payments are recovered by the liquidator. If the winding up is inevitable, some directors will try to manipulate the circumstances to avoid that liability.
There are two main instances where a director is exposed: from payments to the ATO being recovered (section 588FGA), and from payments to creditors guaranteed by the director being preferential (section 588FH). If a payment made to the ATO is recovered as a preference; or if a payment to a guaranteed creditor is preferential – whether or not it is recovered from that creditor – the director may be liable to either the ATO, the liquidator or the creditor under the guarantee. The director will not want these payments being classified as preferential, and one way that they can avoid this is to manipulate the timing of the winding up.
Preferential or void payments to related parties must have occurred within a 4 year period before the winding up. Manipulation of that time period would be extremely difficult without significant and ongoing litigation. Preferential payments to unrelated parties must be made “during the 6 months ending on the relation-back day; or after that day but on or before the day when the winding up began.”
The relation-back day is the day when the liquidation is deemed to have commenced. It is usually the date of the filing of the winding up application (court appointments) or the members’ or directors’ resolutions appointing the liquidator or administrator (voluntary liquidations).
The directors’ and members’ resolutions are made at these parties’ discretion, so delaying the decision to appoint someone until payments fall outside the six month period is easy. It is not so easy if the company is being would up by a creditor in the courts, but the director may not have to do much to delay the process.
A procedure must be followed to wind up a company in court, and this takes time. Instructions must be given to solicitors, documents are prepared, filed and served for judgments and the statutory demands, and all related statutory time periods must expire. Even an uncontested winding up will take some months. The company may delay this process by filing a simple defence or raising a dispute or offset against the debt. It is not difficult to envisage a period of six months expiring before the application to wind up the company is eventually filed.
It is not uncommon that the business of a company is closed or sold during this delaying process, if for no other reason to avoid incurring further debts that may go unpaid and avoiding an insolvent trading claim. By the time a liquidator is appointed, the assets have gone and payments to the ATO, guaranteed creditors and other creditors that would otherwise be recoverable, and could lead to a distribution to all creditors, are out of time.
How do you limit the ability for directors to manipulate this timing factor? One option is to make the relation-back day the earlier of the currently defined date or the date of the cessation of trading by the company, or the sale of the business or its main body of assets, whichever is earlier.
This early trigger – which may be limited to where recoveries are sought under section 588FH or from the ATO – will allow liquidators to look further back into the payments history and possibly allow further recoveries against parties that would otherwise be out of reach.