C&A Friedlander Attorneys

Here is the scenario, you render services for company X, company X receives the service and makes payment. Happy days, the business has some money in the bank and now you can move on to the next job. A few months go by and you receive an email which advises you that company X was provisionally liquidated and according to their records a payment was made to you by company X. You are further advised that at the time of making the payment, company X’s liabilities exceeded its assets and the payment made by company x, to you, was made with either the intention to prefer you over its other creditors, or it has had the effect of preferring you above the other creditors. As a result, the payment made to you amounts to an undue preference, alternatively a voidable preference as defined in the Insolvency Act and you are required to return that which was paid to you.

Frustrated and angry you think to yourself how can this be? I rendered services and was accordingly paid therefore. On what basis would I be required to repay money which has been paid to me?

The answer to the question above lies within section 29(1) of the Insolvency Act (“the Act”) and is rooted in fairness. Much like standing in a queue or receiving a number and waiting for your order, the Act wants to ensure that as far as reasonably possible, each and every creditor of the liquidated company (“the company”) is in a position to share equally and proportionately in the proceeds of the liquidation.

Section 29(1) of the Act states that, “every disposition of his property made by a debtor not more than six months before the sequestration of his estate . . . which has had the effect of preferring one of his creditors above another, may be set aside by the Court if immediately after the making of such disposition the liabilities of the debtor exceeded the value of his assets, unless the person in whose favour the disposition was made proves that the disposition was made in the ordinary course of business and that it was not intended thereby to prefer one creditor above another.”

What is interesting to note is that section 29(1) has two parts to it, the first part provides the liquidator with the necessary power to claw back the amount paid or disposition made, while the second part provides you with a defense to the first part.

So, let us start with the first part, the portion which is not underlined.

This section provides that all amounts that the company has paid to creditors in the six months preceding insolvency proceedings can be clawed back by the appointed Liquidator. Once clawed back, the Liquidator will pay the clawed back amount into the insolvent estate for the benefit of the entire body of creditors.

The rationale behind this is to prevent a situation where a company, knowing that liquidation proceedings are imminent, uses the remaining funds to pay creditors with whom; it has a personal or long standing relationship with; it derives some benefit from the payment or because the recipient, suspecting that insolvency proceedings were imminent, was more aggressive than others in its demand for payment.

It would accordingly be unfair and completely contradict the essence of the Act if a company could pick and choose which creditors it would like to pay and thereafter liquidate itself leaving the remaining creditors with whatever scraps remain. Thus, if a payment has been made and this has resulted in someone jumping the queue, the Liquidator is afforded the necessary powers to recover these payments for the benefit of the entire pool of creditors.

Section 29(1) accordingly aims to protect the entire pool of creditors, however, as stated above, within the second part of Section 29(1) is the defence to the scenario set out above.

In order for you to make use of this defence, you will be required to show that the payment made by the company during the six month claw back period is consistent with how payments were made prior to the period, that the payment in question is payment of a debt incurred by the company in the ordinary course of business or financial affairs of the company and that the payment was not made with the intention of preferring one creditor over the other. 

While it may appear to be straight forward, this is often not the case. This has resulted in the courts applying a test in order to determine whether the payment was made in the ordinary course of business or not. The test is an objective test, which looks at an honest and solvent businessman and asks the question as to whether the solvent and honest businessman would have in the ordinary course of business acted in a similar manner or would the businessman have thought the transaction extraordinary. 

In conclusion, section 29(1) of the Act both takes and gives, in that it provides the Liquidator with the power to act retrospectively and claw back payments or dispositions made which shouldn’t have been made, while affording those who have received payments in the ordinary course of business a defence in the event the Liquidator comes knocking. 

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE).