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. This can occur when a creditor of the company has received a preferential payment from the company, and where the effect of paying that preferential payment to the creditor was to release the related entity from an obligation to the creditor.
The most common example is where a company owes money to a creditor and the director has personal guaranteed that creditor. The director has the company pay that creditor in preference to other creditors to save being made personally liable under the guarantee. The liquidator will be able to claim the money back directly from the director/guarantor.
Can the liquidator make claims against both the creditor and the guarantor?
Yes. The liquidator may claim both:
(1) the original preferential payment to the creditor (section 588FA); and
(2) against the related guarantor (section 588FH).
They do not have to choose between them and there is no rule on which claim must be taken or decided first. The amount of the second claim awarded - regardless of who it is against - will be dependent upon any amount received from the other party. The maximum amount that the liquidator can recover from both parties together is the amount of the initial payment.
What is the purpose of section 588FH?
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. Section 588FH gives the liquidator power to recover money from related parties to make any distribution fairer.
What parties are involved in the transaction?
The three essential parties are:
1. the company in liquidation that made the preferential payment to the creditor;
2. the third party creditor that received the preferential payment from the company; and
3. the related party that had their obligation (their guarantee) to the creditor released.
What is a related entity?
A related entity is defined in the Corporations Act. Usually the related entity is a director or shareholder, a relative or spouse of the director or member, and some entities with other close links like other companies with common directors and shareholders.
Does the company have to have been insolvent at the time of the payment?
Yes. The transaction to the third party creditor must be a recoverable preference, therefore must have occurred when the company was insolvent. If not, the creditor would not have received preferential treatment and the money will not be recoverable from either the creditor or 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 that may be available to the creditor. The related entity does not have the benefit of using the defences. It may transpire that the creditor may be able defend the claim and avoid having to return money, but the related party who does not have access to the defences may still be liable to the liquidator.
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 original 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.
The Act does not seem to contemplate that the right to take the action against the related party lapses with the right to take the claim against the creditor.
For more detailed information:
Insolvency Resource Page: Related Party Preferences
Disclaimer
The enclosed information is of necessity a brief
overview and it is not intended that readers should rely
wholly on the information contained herein. No warranty
express or implied is given in respect of the information
provided and accordingly no responsibility is taken by
Worrells or any member of the firm for any loss resulting
from any error or omission contained within this
fact sheet.
Back to Fact Sheets
Last Updated: 9.2.2010