Unfair Preferences in Construction: How to Defend a Clawback

What it is

An unfair preference under section 588FA of the Corporations Act 2001 is an unsecured payment that puts one creditor ahead of the others before the company collapses. The liquidator can claw it back. The companion entry on preference payments explains the test and the relation-back period. This entry is about defending a clawback once the demand letter lands on a builder's desk.

In construction, the typical scenario is a subcontractor or supplier that got paid by a builder shortly before the builder went under. The liquidator now wants the money back. The defendant has three main lines of defence: dispute the elements of section 588FA, run the running account defence in section 588FA(3), or run the good faith defence in section 588FG. Each has a different shape and each can be a complete answer.

Disputing the elements

The first move is to test whether the liquidator can prove each element of section 588FA. The transaction has to be between the company and a creditor, the creditor has to be owed an unsecured debt, and the payment has to result in the creditor receiving more than it would have in the wind-up.

Each element creates daylight. If the payment was for a secured debt (for example a supplier with a registered PPSA security interest over the goods supplied and retained), it is not an unfair preference because secured creditors do not give preference. If the creditor is owed nothing (the payment was a refund, a deposit return or a payment under a separate contract that does not give rise to a debt), there is no creditor relationship for that transaction. If the dividend in the actual liquidation would be 100 cents in the dollar (rare but possible where the estate has surplus assets), no preference arose.

Trust money is the most useful element-defence for construction. Money received from a project trust account in Queensland or a retention trust account in NSW is the subcontractor's money as trust beneficiary, not payment of an unsecured debt by the builder. Trust money is not part of the company's general estate so the section 588FA test does not bite.

The running account defence

The running account defence is in section 588FA(3). Where a transaction is, for commercial purposes, an integral part of a continuing business relationship between the company and the creditor (for example a running account), the court treats all the transactions in that relationship as a single transaction. The preference test is then applied to the net effect of all the dealings, not to each payment in isolation.

The principle behind the doctrine is that ongoing trade should be encouraged. A supplier who keeps supplying a struggling builder and receives staggered payments in return is providing fresh value with each delivery. If the running account is in net deficit by the end of the period (the supplier ended up owed more than it received), the preference reduces to that net amount, or sometimes to zero.

The math the courts apply is the peak indebtedness rule and now (after the High Court's 2023 decision in Bryant v Badenoch Integrated Logging) the focus on the net position over the relevant period. The detail of how to compute the running account net position matters; a few thousand dollars of fresh supply can offset a payment of equivalent size.

For a supplier or subbie defending a clawback, the running account argument depends on:

Continuous trading

The relationship must be ongoing, not a single closing-out payment. A subbie that took a lump-sum payment to clear a frozen account and then never invoiced again is in a weaker position than one that kept supplying labour or materials after the payment.

Mutual intention

The court looks at whether both parties treated dealings as a running account. Invoicing patterns, payment patterns and statements of account help prove it.

Net deficit at the relevant date

The defence shines where, by the end of the running account period, the supplier had supplied more value than it received. Document the deliveries and unpaid invoices that kept accumulating after the impugned payment.

The good faith defence

Section 588FG provides a defence where the creditor became a party to the transaction in good faith, had no reasonable grounds for suspecting that the company was insolvent at that time and provided valuable consideration under the transaction.

All three limbs have to be made out. Good faith means honest absence of awareness of the insolvency. No reasonable grounds for suspicion means the creditor did not know and could not reasonably have suspected the company was insolvent. Valuable consideration means money or money's worth was given, which for an ordinary trade creditor is usually easy to show (work performed, materials delivered).

The middle limb is the battleground. Reasonable grounds for suspicion are tested objectively against what a reasonable person in the creditor's position would have suspected from the available facts. Construction creditors typically come unstuck where the evidence shows late payments stretching out, broken payment promises, partial payments after demands, disputes over invoicing, or knowledge of disputes between the head contractor and its principal. Each of those tends to put a reasonable contractor on notice.

The High Court tightened the law on this defence in Metal Manufactures Pty Ltd v Morton (2023), confirming that creditors cannot use section 553C set-off as a shield against a section 588FA preference claim. The good faith defence remains, but the set-off route has been closed.

Evidence that helps

A creditor defending a preference claim should pull together its supply records, invoicing history, payment history, statements of account, correspondence about payment terms and any documentation about the credit relationship. The aim is to show one of:

A running account in continuous operation with fresh supply tracking the impugned payment;

A creditor that had no reasonable basis to suspect insolvency at the time of the payment;

A payment that was, by its nature, not a preference (secured, trust money, fresh-value transaction).

Practical posture

Most preference claims settle. The maths and the law are usually on the liquidator's side once the initial elements are made out, and a creditor that fights and loses pays interest plus liquidator's costs. Settlement at a discount (often 60 to 80 cents in the dollar of the demand) is common. A creditor with a strong running account defence or strong evidence of no knowledge of insolvency can settle lower, sometimes much lower.

The first step on receiving a preference demand is to stop talking to the liquidator on the substance, get the supply and payment records together and take legal advice. Section 588FA and section 588FG are technical provisions and the running account analysis is now sensitive to High Court reasoning. Going into a negotiation without that work done is how a defendable claim becomes an early payout.