Alex is Sprintlaw’s co-founder and principal lawyer. Alex previously worked at a top-tier firm as a lawyer specialising in technology and media contracts, and founded a digital agency which he sold in 2015.
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If you trade on credit or you’re managing cashflow in a tough period, the phrase “preferential payments” (sometimes called “preference payments”) can be worrying. It usually comes up when a company goes into liquidation and a liquidator asks a supplier to return money the company paid them in the months before the collapse.
As a small business, you could be on either side of this: paying your own creditors while under financial pressure, or receiving a demand from a liquidator to hand back funds you were legitimately paid for your goods or services.
In this guide, we unpack what a preferential payment is under Australian law, common scenarios for small businesses, the main defences, and practical steps to reduce your risk. We’ll also cover how to respond if a liquidator sends you a demand.
What Is A Preferential Payment?
Under the Corporations Act, a “preferential payment” is broadly a payment or transaction a company makes to a creditor before it goes into liquidation that unfairly puts that creditor in a better position than the company’s other unsecured creditors. In plain English: if your company pays one unsecured creditor in the lead-up to liquidation so they end up getting more than everyone else, a liquidator may be able to claw that payment back and redistribute it across all unsecured creditors.Key ingredients liquidators look for
- Payment to a creditor: There was a transaction in favour of a creditor (often a cash payment, but it can include set-offs, transfers of assets, or granting security).
- Timing: The transaction happened in a “relation-back period” (commonly the 6 months before liquidation for unrelated creditors; longer in some related-party cases).
- Insolvency: The company was insolvent at the time, or became insolvent because of the transaction.
- Preferential effect: The creditor received more than they would have received in a winding up if the transaction had not occurred.
When Might Preference Payments Arise For Small Businesses?
Preference claims can affect you whether you’re the company under stress or a supplier who got paid right before a customer went under.Common scenarios (from both sides)
- Catch-up payment after pressure: A customer has fallen behind, you’ve chased hard, and they make a big lump-sum payment just before they appoint liquidators. That lump sum may be alleged to be a preference.
- Switching to cash-on-delivery: As a supplier, you move a risky customer to COD. Payments matching new deliveries are less likely to be preferential than payments reducing old debt, but liquidators still scrutinise the overall trading pattern.
- Granting late security: A lender or supplier gets a charge or retention-of-title clause documented and registered late. A security granted in the relation-back period that secures old debt can be vulnerable.
- Director juggling creditors: Your own company is under strain and you pay the “loudest” creditors (for example, ones threatening legal action) while leaving others unpaid. Those payments may be at risk if the company later liquidates.
Are There Defences To Preference Claims?
Yes. Even if the elements above are present, several statutory and factual defences may apply. The most common ones used by small businesses include:Good faith (without suspicion) defence
If you can show you received the payment in good faith, gave value, and had no reasonable grounds to suspect the payer was insolvent (and a reasonable person in your shoes wouldn’t have suspected it), the liquidator’s claim may fail. Evidence that you were trading normally, not applying atypical pressure, and not aware of red flags can help.Running account (continuing business relationship)
Where payments and supplies form part of a continuing business relationship (for example, you continued supplying goods while receiving payments), the law may look at the net effect over the period rather than each payment in isolation. If overall the account didn’t improve your position (or only improved marginally), the recoverable preference might be reduced.Contemporaneous exchange
If a payment was in exchange for goods or services supplied at the same time (or near the same time), it’s less likely to be seen as unfairly preferring you over other creditors. Think genuine COD transactions where each payment aligns to new supply.Secured creditor position
Secured creditors are generally in a stronger position. If you held valid, properly perfected security, payments to you may not have a preferential effect in the same way they do for unsecured creditors. This is one reason why suppliers often adopt a security model for trade credit. A robust credit toolkit can make a real difference in practice. For example, using a General Security Agreement, registering your interest on the PPSR, and embedding security language in your Terms of Trade helps you move out of the “unsecured” category and reduce preference risk.Practical Steps To Reduce Preference Risk (Before There’s A Problem)
The best time to manage preference risk is long before a liquidator gets involved. These steps are practical and achievable for most small businesses.1) Trade on documented, secured terms
- Adopt written terms: Clear, signed credit terms set out pricing, payment timing, defaults, interest, and remedies. They also support consistent credit control.
- Build in security: Where appropriate, include retention-of-title and security clauses and support them with a separate General Security Agreement.
- Perfect your security: Register your security interests promptly. If you’re new to PPSR, consider help to register a security interest correctly and on time.
- Use credit applications: A signed credit application that incorporates your credit terms gives you an upfront dataset for due diligence and better enforcement options later.
2) Align payments to supply where possible
COD or payment-on-delivery reduces the chance that a payment will be characterised as reducing old debt. Where risk increases, consider shifting to shorter terms or staged payments that correspond to new supply milestones.3) Standardise credit control (and record it)
Inconsistent or unusually aggressive collection activity can be used to argue you suspected insolvency. Standardising reminders, statements and escalation steps helps show you acted in the ordinary course - and your file notes and emails will be your best evidence if a defence is needed.4) Consider additional credit support for higher-risk accounts
- Personal or corporate guarantees: These can provide an alternative recovery path if the company customer fails. Understand the risks and obligations that come with personal guarantees.
- Bank guarantees or security deposits: For larger exposures, an bank guarantee can provide independent security that sits outside day-to-day cashflow.
5) Keep an eye on your own solvency
If it’s your business under stress, think carefully before selectively paying old debts. Directors also have ongoing responsibilities around solvency. Regular board reviews and appropriate reporting (including any required solvency resolution) can help you identify issues earlier and manage them lawfully.How Should You Respond To A Preferential Payment Demand?
If a liquidator writes to you asserting a preference and demanding repayment, don’t panic - but don’t ignore it either. There are structured steps you can take.Step 1: Gather your records
Collect invoices, statements, contracts, delivery dockets, email correspondence, payment receipts, and any notes of calls. Build a timeline of supply and payment. This will be essential for assessing defences like running account, good faith, or contemporaneous exchange.Step 2: Compare supply vs payments (net effect)
Chart the rolling balance of the account over the relation-back period. If your overall position didn’t materially improve (for example, you continued to supply more than you were paid), a running account analysis may reduce the claim significantly.Step 3: Check your security position
Confirm whether you held any perfected security and when it was perfected. If you had a valid, timely PPSR registration supporting a security interest, that can change the analysis.Step 4: Assess knowledge and red flags
Review what you knew at the time. Were there clear signs of insolvency, or were you trading on a normal basis? Standard reminders and reasonable payment plans aren’t necessarily signs that you suspected insolvency.Step 5: Seek advice and consider resolution options
Preference disputes often resolve commercially once the facts are laid out. Depending on your position, options might include defending the claim, negotiating a reduced settlement, or documenting a compromise using a Deed of Release and Settlement. If your terms include carefully drafted set-off clauses, these can still be useful in broader commercial negotiations (noting that set-off rules against liquidators are technical and fact-specific). It’s sensible to get tailored advice before relying on them in a preference context.FAQs: Short Answers To Common Small Business Questions
Do payments under payment plans automatically become preferences?
No. Payment plans are common and can be consistent with ordinary trading. The real question is whether, in context, the payments had a preferential effect and whether you had reasonable grounds to suspect insolvency. The pattern of supply and payment matters.Will switching a troubled account to COD help?
Often, yes. Payments for contemporaneous supply (like genuine COD) are less likely to be preferential than lump sums that reduce old debt. However, the overall trading relationship is still relevant to any running account analysis.If I take security late, does it protect me?
Security granted to secure past debt in the relation-back period can be vulnerable. It’s much better to embed security in your onboarding terms and perfect it promptly, ideally by registering on the PPSR from day one.Can a liquidator force me to hand back goods instead of cash?
Preference claims usually target the value of the preference (cash paid), but liquidators may also look at other voidable transaction types (for example, undervalued asset transfers). The appropriate remedy depends on the type of transaction and the facts.What Contracts And Policies Help Manage Preference Risk?
You can’t draft your way out of the Corporations Act, but good paperwork reduces risk and strengthens your position.- Terms of Trade: Set clear payment terms, default interest, retention-of-title, and security provisions. Incorporate them via your onboarding workflow and have them signed.
- Credit Application: Capture key trading details and acceptance of your terms. The application should clearly reference your credit terms.
- General Security Agreement: Where appropriate, secure your exposure over a customer’s assets and register the interest to perfect your rights.
- Personal Guarantee And Indemnity: For closely held companies or higher-risk accounts, a director guarantee can provide another recovery path, noting the responsibilities that come with personal guarantees.
- Settlement Deeds: If you resolve a dispute with a liquidator or customer, document it with a clear, enforceable Deed of Release and Settlement.
Key Takeaways
- A preferential payment is a transaction that unfairly puts one unsecured creditor ahead of others in the lead-up to liquidation.
- Defences exist, including good faith (without suspicion), running account, contemporaneous exchange, and secured creditor status.
- Reduce risk by trading on documented terms, embedding and perfecting security interests, aligning payments to supply, and keeping consistent credit control records.
- If you receive a demand, gather your records, map the trading history, assess your security and knowledge, and then consider commercial resolution options.
- Core tools like Terms of Trade, a General Security Agreement, PPSR registration and, in some cases, personal or bank guarantees can move you out of the high-risk unsecured category.
- Directors should monitor their company’s solvency and avoid selective payments that could later be clawed back by a liquidator.
