Preference Payments to Construction Creditors in Australia

What it is

A preference payment is a payment by an insolvent company to one of its unsecured creditors in the lead-up to liquidation that puts that creditor in a better position than the rest. The classic example in construction: a head contractor is sliding into insolvency, a long-overdue subbie threatens to walk off site or wind up the company, the head contractor pays the subbie in full, and three months later the head contractor enters liquidation. The other unsecured creditors get cents in the dollar. The paid subbie got 100 cents.

The Corporations Act 2001 lets a liquidator claw that payment back. The mechanism is the voidable transactions regime in sections 588FA to 588FH. A successful preference claim turns the paid creditor into an unsecured creditor in the liquidation, the money goes back into the estate and is shared equally among all unsecured creditors per the pari passu principle.

For builders, this matters both ways. As a creditor receiving money from a struggling counterparty, a clean payment today can become a clawback demand tomorrow. As a counterparty paying out of an insolvent business, the directors may face follow-on claims for insolvent trading and breach of duty.

The statutory test for an unfair preference

Section 588FA defines an unfair preference. A transaction is an unfair preference if the company and the creditor are parties to the transaction, the creditor is owed an unsecured debt, and the transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor, more than it would receive from the company in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in the winding up.

The test is comparative. The liquidator asks: what did this creditor actually get from the payment, and what would the creditor have received as an unsecured proof in the wind-up? If the difference favours the paid creditor, the payment is an unfair preference. Most cash payments to unsecured trade creditors of an insolvent builder will fail this test if the company would have paid only cents in the dollar in liquidation.

Insolvent transactions and voidable transactions

Section 588FC builds on 588FA. An unfair preference is an insolvent transaction if it was entered into when the company was insolvent, or it caused the company to become insolvent. Insolvency is the inability to pay debts as and when they fall due (section 95A of the Corporations Act).

Section 588FE then categorises which insolvent transactions are voidable. The category relevant to most construction preferences is in subsection 588FE(2): an insolvent transaction is voidable if it was an unfair preference and was entered into 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 generally the day the winding-up application was filed or, for voluntary liquidations after administration, the day the administration began. So a payment made within roughly six months of a wind-up filing is squarely inside the clawback window for an ordinary unsecured creditor.

Related entities and longer reach-back periods

The six-month period is for unrelated creditors. If the creditor is a related entity (a director, a director's family member, a related body corporate), the reach-back stretches to four years under section 588FE(4). For uncommercial transactions, the reach-back can extend to two years. For transactions involving an intention to defeat creditors, the reach-back extends to ten years under section 588FE(5).

In construction, related-entity preferences turn up when a struggling builder pays a related company (a sister entity, a director's spouse's company) instead of unrelated subbies. Those payments stay clawable for four years, not six months.

How a liquidator pursues a preference

The liquidator's path is set out in section 588FF. The liquidator applies to the court for an order setting aside the transaction or ordering the recipient to pay the amount back to the company. Time limits apply: the application must be filed within three years of the relation-back day or within 12 months of the liquidator's appointment, whichever is later.

In practice, liquidators write demand letters first, identifying the impugned payments and demanding repayment. Many preference claims settle without litigation because the math is against the recipient creditor. A creditor that fights and loses pays the principal plus interest and may pay the liquidator's costs.

The relation-back day

The relation-back day is the anchor for the clawback window. Section 91 of the Corporations Act defines it. For a winding-up by court order on an application, it is the date the application was filed. For a creditors' voluntary winding-up that follows a voluntary administration, it is the day administration began. For a winding-up that follows a deed of company arrangement that is terminated, the rules track back to the original administration.

Builders watching a counterparty for warning signs should think in terms of the relation-back day. Once an administrator is appointed or a wind-up application is filed, the clock has already been running for six months. Payments received in that window are exposed.

Director liability flowing from preference

A preference payment is not just a creditor problem. If the directors knew or should have known the company was insolvent, the payment can trigger an insolvent trading claim under section 588G. Directors can be personally liable for debts incurred while the company traded insolvent, and the preference payments are often part of the proof of insolvency. The Corporations Act gives liquidators a strong toolkit for unwinding the last months of a builder collapse.

What the warning signs look like

Construction creditors should treat a few patterns as preference warning signs from a paying head contractor: round-number payments after long disputes, lump-sum catch-ups on aged invoices, payments funnelled through a related entity rather than the head contractor itself, and payments made under threat of a winding-up petition. None of these are decisive on their own. Together, they are the picture a liquidator will paint in court to argue the transaction was an insolvent unfair preference.

The defences (running account, good faith, no-knowledge under section 588FG) are covered in the companion entry on unfair preferences.