What Is an Unfair Preference and How Do Creditors Get Caught by It?

You get paid for goods you supplied three months ago. The invoice was overdue, the client finally settled, you moved on.

Two years later, a liquidator sends you a letter demanding the money back. The company is in liquidation, and your payment is now classified as an “unfair preference”. You owe the liquidation estate tens of thousands of dollars for a transaction you thought was closed.

This scenario plays out hundreds of times each year across Australia. Creditors who traded in good faith, who simply got paid what they were owed, suddenly find themselves on the wrong end of a clawback claim. And many have no idea it was coming.

The law on unfair preferences exists to enforce a principle of fairness among creditors. When a company becomes insolvent, the insolvency regime demands equal treatment: all unsecured creditors share the pain proportionately. A creditor who extracts payment shortly before collapse, while others get nothing, disrupts that equality.

Liquidators pursue these claims aggressively. They have statutory powers, years to bring proceedings, and the backing of case law that interprets the rules broadly. If you’ve been paid by a company now in liquidation, you need to understand how these claims work, what liquidators must prove, and what defences might protect you.

This article walks you through the mechanics of unfair preference claims, the defences that actually work, and the practical steps you should take if a liquidator comes knocking.

What Is an Unfair Preference?

An unfair preference is a payment or transfer of value that gives one creditor an advantage over others during the period leading up to a company’s insolvency.

The concept is grounded in a principle called “pari passu”, Latin for “equal footing”. When a company collapses, unsecured creditors are meant to share whatever assets remain in proportion to what they’re owed. If you got paid $50,000 a month before liquidation while another creditor got nothing, you’ve received a preference. You’ve jumped the queue.

The Corporations Act allows liquidators to reverse these transactions. The payment you received can be clawed back into the liquidation pool and redistributed among all creditors.

Most creditors caught by unfair preference claims had no intention of gaining an advantage. You invoiced, you chased payment, you finally got paid. But intention is irrelevant. The law focuses on effect, not motive.

What matters is timing, insolvency, and whether the payment improved your position relative to others.

How Far Back Can a Liquidator Reach?

The clawback period depends on your relationship with the debtor company.

For unrelated creditors, liquidators can pursue payments made within six months before the “relation-back day”. The relation-back day is typically the date when the company entered voluntary administration or when the winding-up application was filed, not the date the liquidation order was made.

This six-month window is longer than many creditors expect. A payment made half a year before any public sign of distress can still be caught.

For related parties, directors, their relatives, related companies, or entities controlled by directors, the clawback period extends to four years before the relation-back day. The law assumes related parties have better access to information about the company’s financial position and are more likely to extract preferential treatment.

You can do the maths. If a company appointed administrators in January 2025, a liquidator can chase payments you received as far back as July 2024 if you’re unrelated, or January 2021 if you’re a related party.

The clock starts running from the relation-back day, not from the date the liquidator was appointed or began investigating. A liquidator might not contact you until years after the payment, but if the payment falls within the statutory period, it is fair game.

What Must a Liquidator Prove?

A liquidator bringing an unfair preference claim must establish several elements. Understand these, because each one is a potential vulnerability in their case.

You Were an Unsecured Creditor

The law only targets unsecured creditors. If you held a registered security interest over the company’s assets (such as a Personal Property Securities Act registration), the preference provisions do not apply to payments within the scope of that security.

Most trade creditors are unsecured. But if you took security, documented it properly, and the payment related to the secured debt, you have a complete defence.

The Company Was Insolvent When You Got Paid

Insolvency is the foundation of every preference claim. If the company was solvent when it paid you, there is no unfair preference, full stop.

Insolvency, in this context, means the company was unable to pay its debts as and when they became due. This is a cash flow test, not a balance sheet test. A company might have valuable assets but still be insolvent if it cannot generate enough cash to meet obligations as they fall due.

Liquidators prove insolvency using a mix of evidence: unpaid creditors, dishonoured cheques, statutory demands, delayed payments to the ATO, overdrawn accounts, supplier threats, and more. They will also rely on the company’s books and the timeline of events leading to collapse.

The onus sits with the liquidator to prove insolvency on the balance of probabilities. But courts are often persuaded by patterns of financial distress visible in the months before liquidation.

You are entitled to challenge the insolvency finding. If you can show the company was solvent at the time, the claim collapses. But this requires evidence, expert reports, and often litigation.

The Payment Gave You an Advantage Over Other Creditors

The liquidator must show the payment resulted in you receiving more than you would have received in the winding-up of the company if the transaction had not occurred.

In most cases, this element is straightforward. If you got paid in full and other unsecured creditors are receiving cents in the dollar (or nothing at all), you clearly received a preference.

The comparison is hypothetical: what would you have received if the payment had never been made and the funds had remained in the company until liquidation?

If the answer is “less than what you actually got”, the advantage element is satisfied.

Defences That Work (and How to Make Them Stick)

Not every payment within the clawback period is recoverable. The law provides defences, but they are narrow, technical, and require evidence.

If a liquidator pursues you, your ability to resist the claim depends entirely on whether you can prove one of these defences.

The Good Faith Defence

This is the most commonly invoked defence, and the one most creditors believe will save them. It often does not, because creditors misunderstand what “good faith” actually requires.

The defence has four elements, and you must prove all of them:

• You acted in good faith in entering into the transaction.
• At the time of the transaction, you had no reasonable grounds for suspecting the company was insolvent.
• You provided value to the company (or reasonably expected to provide value) in exchange for the payment.
• A reasonable person in your circumstances would not have suspected insolvency.

“Good faith” does not simply mean honesty or lack of intent to defraud. It requires an absence of suspicious circumstances that would have put a reasonable person on notice.

Courts assess this objectively. What did you know? What should you have known? Were there red flags you ignored?

If the company was consistently late paying invoices, if you received calls from other creditors chasing payment, if the company’s financial controller mentioned cash flow difficulties, if you were asked to accept partial payment or a payment plan, all of this can undermine the good faith defence.

The “reasonable person” test is critical. Even if you personally did not suspect insolvency, if a reasonable businessperson in your position would have been suspicious, the defence fails.

You need contemporaneous evidence. Emails, file notes, payment histories, normal trading terms. If you can show the payment was made on the same terms as previous payments, within normal trading cycles, and without any warning signs, you strengthen your case.

But if you pressured the company for payment after months of delay, accepted a lump sum to clear aged debt, or negotiated special terms to jump ahead of other creditors, good faith becomes difficult to prove.

The Running Account Defence

This defence applies when you have an ongoing trading relationship with the company involving a series of debits (invoices) and credits (payments) over time.

The defence allows you to aggregate transactions within a defined period (the “relation-back period”) and calculate the net effect. If the overall balance shows you were worse off at the end of the period than at the beginning, there is no unfair preference.

The principle: you gave more value than you received, so you did not obtain an advantage.

This defence is complex. It requires a detailed accounting analysis of every transaction during the relevant period. Courts examine whether the transactions form a continuous business relationship or are isolated dealings.

If you supplied goods on credit, the company paid some invoices, you supplied more goods, the company paid again, and the overall debt at the end of the relation-back period is higher than at the start, you may have a running account defence.

But if the relationship had effectively ended and a final payment simply cleared old debt without any expectation of future supply, the defence likely fails.

Set-Off: No Longer Available

For years, creditors believed they could defend preference claims by setting off amounts the company still owed them.

The logic seemed sound: if the liquidator wants $50,000 back but the company owes me $30,000 on other invoices, surely I can offset and only repay $20,000?

The High Court killed this argument in 2023 in Metal Manufactures Pty Ltd v Morton. The decision confirmed that statutory set-off under the Corporations Act does not apply to unfair preference claims. If a liquidator proves you received a preference, you must repay the full amount. You cannot reduce your liability by pointing to other debts the company owes you.

This ruling closed a loophole many creditors relied on. If you are facing a preference claim, set-off will not save you.

How Liquidators Prove Insolvency

Insolvency is often the most contested element of a preference claim. Liquidators have the burden of proof, but they come armed with evidence.

They start with the company’s financial records. Aged creditor lists, cash flow statements, management accounts, bank statements, tax debt records. They look for patterns: increasing overdue creditors, mounting ATO debt, bounced cheques, overdrawn accounts, delayed supplier payments.

They interview directors, review board minutes, and examine correspondence with creditors. Did the company issue statutory demands? Were there winding-up applications filed? Did the company enter into payment plans or seek extensions from creditors?

Liquidators also rely on “indicia of insolvency”, warning signs courts recognise as evidence of financial distress. Common indicia include:

• Issuing post-dated cheques or requesting extended payment terms
• Paying some creditors in full while leaving others unpaid
• Relying on new credit to pay old debts
• Receiving demands from the ATO or other major creditors
• Defaulting on loan repayments
• Using director loans or related party funds to cover operating expenses
• Failing to lodge tax returns or BAS statements on time

No single indicator proves insolvency, but a cluster of them builds a compelling case.

If you are defending a claim, you can challenge the insolvency evidence. Engage a forensic accountant to review the company’s financial position at the relevant date. If the company had access to undrawn credit facilities, positive cash flow projections, or other resources that would have allowed it to meet debts as they fell due, you may be able to defeat the insolvency finding.

But this requires expertise, evidence, and often significant cost. Courts do not lightly reject a liquidator’s insolvency analysis, especially when the company has since collapsed.

Related Party Risks: When the Clawback Period Extends to Four Years

If you are a director, a director’s spouse, a related company, or an entity controlled by a director, the unfair preference rules treat you differently.

The clawback period extends from six months to four years. The rationale: related parties have inside knowledge of the company’s financial position and greater ability to extract payments ahead of external creditors.

This extended period catches transactions that occurred long before any public sign of distress. A payment made three years before liquidation can still be clawed back if you fall within the “related party” definition.

The definition is broad. It includes:

• Directors and their spouses
• Related bodies corporate
• Directors of related bodies corporate
• Entities in which a director or their spouse has a controlling interest

If you are a related party and received a payment within four years of the relation-back day, the same defences apply, but proving good faith becomes significantly harder. Courts assume related parties have better information about solvency. You will need strong evidence to demonstrate you had no grounds to suspect insolvency and acted at arm’s length.

Document everything. If the transaction was on commercial terms, at market rates, and consistent with historical dealings, gather the proof. If you can show the payment was part of an ordinary trading relationship (not a related party extraction), you strengthen your position.

But expect heightened scrutiny. Liquidators target related party transactions aggressively, and courts are less sympathetic to defences from insiders.

What to Do When You Receive a Liquidator’s Demand

You open the mail and find a letter from a liquidator. It alleges an unfair preference and demands repayment of a sum that may be significant. The letter gives you a deadline to respond, often 14 or 21 days.

Do not ignore it. Do not assume it will go away. And do not pay immediately without assessing your position.

Here is what you should do.

Step 1: Gather the Transaction Records Immediately

Pull every document related to the payment: invoices, payment receipts, emails, terms of trade, prior payment history, account statements. You need a complete picture of the transaction timeline and the relationship with the company.

Check the dates. Does the payment fall within the six-month (or four-year) clawback period? Calculate from the relation-back day, not from the date you received the demand.

If the payment is outside the statutory period, the claim fails on timing alone. You would respond pointing this out, with evidence of the appointment date and payment date.

Step 2: Assess the Insolvency Evidence

Think back to the time of payment. Were there warning signs the company was in financial distress? Late payments, requests for extended terms, bounced cheques, rumours in the industry, calls from other suppliers?

Review your own records. If the company was paying you on time, on standard terms, and you had no contact suggesting financial difficulty, that supports a good faith defence.

If, however, you had been chasing payment for months, accepted a reduced amount, or negotiated special terms, good faith becomes harder to prove.

Step 3: Consider the Defences

Do any of the statutory defences apply?

• Can you prove good faith and absence of suspicion?
• Did you hold security over the debt?
• Was the transaction part of a running account where the net position favours you?
• Were you even a creditor, or was the payment made for some other reason (e.g., a settlement unrelated to debt)?

If you have a strong defence, outline it in your response and indicate you will contest the claim. If your defences are weak or non-existent, you may need to negotiate.

Step 4: Get Legal Advice Before Responding

A poorly worded response can damage your position. Admitting facts without qualification, failing to assert defences properly, or agreeing to repayment without understanding your rights can cost you.

Engage a lawyer who understands insolvency litigation. A specialist will assess the strength of the liquidator’s claim, evaluate your defences, and advise whether to dispute, negotiate, or settle.

Liquidators often overreach. They may claim the full amount without properly proving insolvency, or they may ignore defences you have not yet articulated. A well-constructed response can narrow the dispute or kill the claim entirely.

Step 5: Decide Whether to Settle or Litigate

If the claim is strong and your defences are weak, consider negotiating a settlement. Liquidators are often willing to compromise, particularly if litigation would be costly and the outcome uncertain.

A settlement might involve repaying a percentage of the alleged preference, with no admission of liability, and a release from further claims. This avoids legal fees and the risk of an adverse costs order if you defend and lose.

If your defences are solid, if the liquidator’s evidence of insolvency is thin, or if the amount is worth fighting over, you may choose to dispute the claim in court.

Litigation is expensive, time-consuming, and uncertain. But it can also result in complete vindication if the liquidator cannot prove the elements of the claim or if you can establish a defence.

Weigh the risks, the costs, and the commercial impact. Sometimes the best outcome is a pragmatic settlement that puts the matter behind you.

Recent Case Law Shifts: What Has Changed

Australian courts have clarified and narrowed several aspects of unfair preference law in recent years. If you are assessing a preference claim, these developments matter.

No Set-Off Post-Metal Manufactures

We have covered this already, but it bears repeating. The High Court’s 2023 decision in Metal Manufactures confirmed that statutory set-off under the Corporations Act does not apply to preference claims.

Before this ruling, some creditors successfully argued they could reduce their liability by offsetting amounts the company owed them. That avenue is now closed.

If a liquidator proves a preference, you repay the full amount. You cannot reduce the debt by pointing to other invoices still outstanding.

Good Faith Requires More Than Ignorance

Courts have tightened the good faith defence. It is not enough to say, “I didn’t know the company was insolvent.” You must prove you had no reasonable grounds to suspect insolvency.

Judges apply an objective test. What would a reasonable businessperson in your position have known or suspected, based on the information available at the time?

If the company was slow-paying, if you had to chase repeatedly, if other creditors were complaining, if industry gossip suggested trouble, courts may find that a reasonable person would have been suspicious, even if you personally were not.

The defence is not a shield for wilful blindness. If you chose not to ask questions because you did not want to know the answer, good faith fails.

Insolvency Presumptions and Director Evidence

Courts are increasingly sceptical of director evidence that contradicts documentary records of financial distress. If the company’s books show mounting debts, unpaid creditors, and cash flow strain, a director’s assertion that “we were solvent” carries little weight without corroborating evidence.

Liquidators rely on expert accountants to analyse solvency. If you are disputing insolvency, you need your own expert to review the financials and provide a credible opinion that the company could pay debts as they fell due.

Anecdotal claims about expected contracts, anticipated payments, or optimistic projections are not enough.

When to Seek Legal Advice

You do not need a lawyer to understand the basic mechanics of unfair preference claims. But you do need a lawyer if you are on the receiving end of a liquidator’s demand.

Here is when to pick up the phone.

You Received a Demand Letter

The moment you receive a formal demand alleging an unfair preference, get advice. Do not wait until the response deadline has passed. Do not attempt to negotiate directly with the liquidator without understanding your rights.

A lawyer can assess the strength of the claim, identify defences, and craft a response that protects your position.

The Payment Amount Is Material

If the alleged preference is a significant sum, enough to affect your business, your personal finances, or your peace of mind, engage a specialist. The cost of legal advice is a fraction of the cost of repaying a preference you might successfully defend.

You Are a Related Party

Related party claims attract heightened scrutiny and longer clawback periods. If you are a director, a related company, or otherwise connected to the insolvent entity, you face a higher burden of proof to establish defences.

Do not assume the transaction was legitimate simply because it occurred years ago or was documented. Get early advice on whether the payment is defensible and what evidence you need.

The Liquidator Has Filed Court Proceedings

If the liquidator escalates from a demand letter to court proceedings, you are now in litigation. You need a litigation lawyer, and you need one immediately.

Filing a defence, preparing evidence, engaging experts, and managing court deadlines require specialist knowledge. The stakes are high: if you lose, you may face not only the preference repayment but also the liquidator’s legal costs.

What Liquidators Are Really Looking For

Liquidators are not pursuing preference claims out of spite. They have a statutory duty to maximise the return to creditors. Unfair preferences are low-hanging fruit: payments that can be reversed and redistributed without complex litigation over fault or wrongdoing.

Liquidators prioritise claims that are large, recent, and involve creditors with the financial capacity to repay. They assess the cost of recovery versus the likely return. A $5,000 preference might not be worth chasing if the creditor is likely to defend and the litigation costs will exceed the recovery.

But a $100,000 payment to a solvent creditor within the six-month window, with weak defences, is a prime target.

They also look for patterns. If the company made multiple payments to the same creditor in the lead-up to liquidation, or if related parties extracted funds shortly before collapse, those transactions attract immediate scrutiny.

Liquidators are also willing to settle. They know preference claims are uncertain. Insolvency can be difficult to prove, good faith defences can succeed, and litigation is expensive. If you have a credible defence and the will to fight, a liquidator may accept a discounted settlement to avoid the cost and risk of trial.

Understand the liquidator’s position. They are not the enemy. They are doing a job, recovering funds for creditors who got nothing. But they are also pragmatic. If your defences are strong, if the evidence is ambiguous, or if the cost of pursuing you outweighs the benefit, they will negotiate.

The Pathway Forward

Unfair preference claims are unsettling. You did nothing wrong, you got paid what you were owed, and now a liquidator is demanding the money back.

But the law is clear. When a company collapses, creditors are meant to share the loss equally. Payments made in the twilight of insolvency disrupt that equality, and liquidators have the power to reverse them.

If you are facing a preference claim, your best defence is a clear understanding of the elements the liquidator must prove, the defences available to you, and the evidence needed to support your position.

Act quickly. Gather your records. Assess the strength of the claim. Consider your defences. And get advice from a lawyer who understands how these disputes play out.

Preference claims are not always unwinnable. Liquidators must prove insolvency, and that can be difficult if the company’s financial position was ambiguous. Good faith defences can succeed if you have contemporaneous evidence of ordinary trading and no grounds for suspicion. Running account defences can eliminate liability entirely if the net position favours you.

But you need to engage with the process. Ignoring a demand does not make it disappear. It makes litigation inevitable, and litigation on the liquidator’s terms is expensive.

The right approach is strategic, evidence-based, and focused on the essential question: can the liquidator prove each element of the claim, and can you prove a defence?

Answer those questions, and you will know whether to settle, negotiate, or fight.

Disclaimer: This article provides general information about unfair preference claims under Australian law. It is not legal advice. Every preference claim is fact-specific, and the defences available depend on the circumstances of the transaction and the evidence you can produce. If you have received a demand from a liquidator, you should seek advice from a lawyer experienced in insolvency disputes as soon as possible.