The High Court1 has yesterday unanimously upheld the decision of the Full Court2 that the “peak indebtedness rule” in relation to unfair preference claims brought by a liquidator has no application in Australia.
Background to the “peak indebtedness rule”
To determine whether there has been an unfair preference where there is a running account relationship between an insolvent company and a creditor (for example, where goods are supplied on credit and the price of the goods and payments received are recorded on a running account statement) the court considers all payments to form part of a single transaction and only considers any net advantage which the creditor has received during the relevant period. In other words, the court considers the ultimate effect of the transactions.
To avoid what would be an injustice to the creditor, the Corporations Act recognises that a creditor who continues to supply a company on a running account in circumstances of suspected or potential insolvency enables the company to continue to trade to the likely benefit of all creditors.
There will only be an unfair preference if there has been a net reduction in the insolvent company’s indebtedness to the creditor across the entire single transaction constituted by all of the payments throughout the running account period.
However, until recently, a liquidator could choose any point in the applicable relation-back period – for example, the point of peak indebtedness of the account – as the mark for comparison, and is only required to show that, from that point on, there was a net preferential impact. Doing so has allowed liquidators to maximise the prospect of recovery by ignoring prior supplies to the benefit of the insolvent company before the first payment was made to the creditor during the relevant period.
The legitimacy of the “peak indebtedness rule” and the proper approach for determining whether there is a running account between a creditor and an insolvent company were questions for determination before the High Court.
The High Court’s analysis
Peak indebtedness rule
The starting point of the relevant relationship between the parties is not an arbitrary date selected by a liquidator; but rather the latter of:
- the date of the start of the applicable relation-back period (for example, when the liquidators were appointed as administrators of the insolvent company) or the date of insolvency; or
- if the relationship started before then, the beginning of the continuing business relationship.
Whether there is a running account between a creditor and an insolvent company is a question of fact in each case. The actual business relationship must be evaluated in its commercial context. What the parties intended is relevant, but not determinative.
If a payment can be characterised as reducing past indebtedness, and not for the continuation of supply, that of itself does not necessarily mean that the continuing business relationship between the parties has come to an end.
Again, the law has been settled sensibly; a liquidator is unable to ‘cherry pick’ a date within the applicable relation-back period to maximise the claim against a creditor and potential recovery of an unfair preference.
The decision will necessarily alter the basis upon which the viability of unfair preference claims is assessed and is likely to result in a marked reduction in the number of claims brought by liquidators.
1Bryant v Badenoch Integrated Logging Pty Ltd  HCA 2.
2Badenoch Integrated Logging Pty Ltd v Bryant [No 2]  FCAFC 111.