Wither the fruits of preference claims?

Cook v Italiano Family Fruit Company Pty Ltd. (In Liq), 6/12/10, Melbourne, FCA

Do preference recoveries by a liquidator belong to unsecured creditors, or do they fall under a bank’s charge over present and future property?

Under s561, statutory priorities should only be paid out of floating charge realisations ‘so far as the property of the company .for payment of creditors other than secured creditors is insufficient to meet payment of’ priority claims.  So if the liquidator makes payments effectively ‘at the expense of the bank’, can the bank’s priority be preserved out of later recoveries?

In the recent Italiano  case, the liquidators made an interim distribution to employee and other priority creditors out of realisations of company assets which fell within a bank’s floating charge. They did not inform the bank, but took it that the bank would assume this was normal practice, as indeed it is. 

The liquidators also successfully pursued preference claims against two creditors. Although these only resulted in awards a year later, of some $50 000,  the case provided a test case for the liquidators, though somewhat surprisingly, the bank did not take part in the proceedings. The question was the destiny of the $50 000.

The Court said that the liquidators should have waited until the full realisation position was determined, because only then were they able to ascertain whether there was a deficiency of assets which would justify payment of employee entitlements out of floating charge realisations.
Finkelstein J stated that “s561 only mandates payment of priority claims out of floating charge assets when it is clear that the liquidation will not realise free assets sufficient to meet those claims ..In some windings up, it may become obvious at an early stage that there will be a deficiency..In other windings up, it may take much longer.” 

Furthermore, Finkelstein J went on to categorise the liquidator’s conduct in making interim payment to employees as a ‘breach of trust,’ because floating charge assets are held on trust for the bank unless there is a clear insufficiency of free assets to meet  priority claims. After reviewing  cases on subrogation and breach of trust, ,Finkelstein J concluded that that there was scope for the bank to claim a right of subrogation notwithstanding the Corporations Act:

“Equity would permit the charge to be subrogated to the extent that floating charge assets have been used to pay priority claims which otherwise could have been paid out of the company’s free assets.”

Of course, if the bank had  advanced funds for the specific purpose of paying employee entitlements, it would have achieved statutory subrogation under s560, but obviously in this case, the bank was not even informed or consulted.

Since the case of Re Yagerphone Ltd. (1932) it had always been thought, at least in England, that the fruits of a successful preference claim should go to unsecured creditors. Australian case law, especially after the 1993 amendments, has not taken an identical course. Part of the justification for the English approach was that only a liquidator can pursue a preference claim, and therefore, since it would not have been available to the company itself, its fruits should not be caught by a charge over the company’s property. (In England, this has led to further complications in relation to assignment of the causes of action, and as to whether expenses of an unsuccessful preference action, can be paid out of the assets of the company, and it has been necessary for Parliament to clarify that they generally can, by amendment to Regulations).

Finkelstein J   reviewed case law in the UK and Australia, and concluded that the position had diverged between the two. Whilst in the UK the position set out in Re Yagerphone had been confirmed in a series of cases such as Re Oasis Merchandising and Lewis v CIR, the High Court of Australia had broadly confirmed the approach in re Yagerphone, in Kratzmann, but this had led to some unintended consequences, including the issue of the liquidator’s expenses of pursuing such claims. The UK approach as broadly endorsed in Kratzmann had not been followed in Australia (see Movitor Pty Ltd. (1996)) mainly since under s588M and 588W, Corporations Act 2001, the liquidator recovers the money ‘as a debt due to the company’. Other cases in Australia since 1992 were conflicting, but tended to suggest  the statutory approach was different here. Thus, he concluded that the preference recoveries fell under the bank’s charge, as property of the company.

Having thus reviewed the muddied waters of the Australian authorities, Finkelstein J turned to the policy arguments either way. He thenconcluded that either the High Court should reconsider Kratzmann,  or Parliament should resolve the matter one way or the other, after careful consideration of the true role of the avoidance provisions and the competing interests in them.


Until the High Court or Parliament clarify the position, liquidators act at their peril in making distributions before all realisations are ascertained. Given that preference claims may take years to pursue, this is bad news for employees, and may also affect GEERS payments. The alternative is for liquidators to involve the bank and seek advances from it under s560, or enter into ‘early payment arrangements’ as suggested by the judge (though the former are probably on a firmer legal basis than the latter).
In our view, we think that the original philosophy of Yagerphone rests on fairness and is justified on that basis notwithstanding the scope of all embracing bank security- unsecured creditors get very little back, therefore preference recoveries should go to them, not the bank under its charge. This is further supported by the philosophy behind unfair preferences, which is aimed at preserving a level playing field between unsecured creditors in the lead-up to liquidation.

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