588FH Related Party Preferences
What is a 588FH preference?
Section 588FH of the Corporations Act allows liquidators to recover money from an entity related to the company in liquidation, when a creditor of the company has received a preferential payment, and where the effect of that payment to the creditor was to release the related entity from an obligation to the creditor. That is, the liquidator will be able to recover money from a related guarantor of a debt, when the primary debt was paid by a preferential payment.
The most common example is where a company owes money to a creditor and the director has provided a personal guarantee to that creditor. The director has the company pay that creditor in preference to other creditors to save being made liable under the guarantee.
Can the liquidator take both actions?
Yes. The liquidator may take: (1) an action for the original preferential payment (section 588FA); and (2) an action against the related guarantor (section 588FH) at the same time. They do not have to chose between them and there is no rule on which claim must be taken or decided first. The amount of the second claim awarded will be dependent upon the amount of the first claim awarded, so that the maximum combined amount that the liquidator can recover from both parties is the amount of the initial payment.
What is the purpose of this section?
The preference provisions of the Corporations Act are designed to ensure that all creditors receive a fair distribution of the company's assets, i.e. that no creditor is preferred above others. Provisions like section 588FH give the liquidator more power to level the playing field between creditors.
What parties are involved?
The three essential parties are:
1. the company in liquidation that made the preferential payment;
2. the third party creditor that received the preferential payment; and
3. the related entity that had their obligation to the creditor released.
What is a related entity?
A related entity is defined in the Corporations Act. Usually the related entity is the director or a relative or spouse of the director or member, but other close links like companies with common directors and shareholders can create the necessary relationship.
What factors are necessary for a 588FH recovery?
1. There must have been a preferential transaction to a creditor of the company, that would otherwise be recoverable against the creditor (without consideration of the statutory defences).
2. The company must have been insolvent when the preferential transaction occurred.
3. The related entity must have had some obligation to the third party creditor in relation to the debt that was paid.
Does the company need to have been insolvent?
Yes. The transaction to the creditor must be a recoverable preference, therefore must have occurred when the company was insolvent, or the company must have become insolvent because of the transaction. If not, the creditor would not have received preferential treatment, and the money will not be recoverable from the related party.
What obligation needs to be released?
The obligation from the related party to the creditor commonly arises from a personal guarantee, but it can be any obligation or other form of security or enforceable arrangement. Payment of the creditor's debt must reduce or release that obligation. The amount of the reduction in the obligation is the amount of the recovery claim.
Can the related entity rely on the statutory defences for preferences?
No. The Corporations Act provides statutory defences that can be used by creditors against claims for recovery of preferential payments under section 588FA. These are set out in section 588FG.
When considering a section 588FH claim, the liquidator only needs to prove that the transaction is preferential to the creditor, regardless of the defences. The related entity does not have the benefit of the creditor using the defences to defend the original claim. So the creditor may not have the return any monies due to access to the defences, but the related party still may have to do so.
What rights do the parties have after a recovery?
The creditor can lodge a proof of debt for in the liquidation for any amount they refund to the liquidator, and may be able to claim under the guarantee against the related party. The related entity has the right to lodge a proof of debt for the amount that they refund.
What time limits apply?
Section 588FF provides that claims made under the preference provisions have to be made within 3 years after the relation back day, as defined in the Act. Interestingly, this does not appear to apply to claims under section 588FH. They appear to be able to be taken at any time during the liquidation, even if the original preferential payment can no longer be made due to expiry of the time limit.
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Last Updated: 4.2.2008