No peaks in unfair preferences –High Court affirms abolition of “peak indebtedness rule”

Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2

The High Court has unanimously dismissed an appeal against the Full Court decision in Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (in liq) (receivers and managers appointed) [2021] FCAFC 64, finding that the “peak indebtedness rule” does not form part of s 588FA(3) of the Corporations Act and providing guidance as to how to approach the analysis required under that section.

Background

The appellants are the liquidators (Liquidators) of Gunns Limited and its wholly owned subsidiary (together, Gunns).  The respondent, Badenoch Integrated Logging Pty Ltd (Badenoch Logging), is a family-owned business that provides logging and transport services.

The Liquidators alleged that 11 payments made by Gunns to Badenoch Logging were voidable under s 588FE of the Act. The primary judge found that all but two of the impugned payments were voidable as unfair preferences, meaning that the court could make orders including that monies be paid to the company: s 588FF. In doing so, the primary judge applied the “peak indebtedness” rule in considering the “continuing business relationship” exemption in s 588FA(3) of the Act. 

The Full Court overturned the primary judge’s decision and found that the peak indebtedness rule should not be applied to s 588FA(3) of the Act: [112]-[120] of the Full Court judgment.  The reasoning for this was multifaceted but included that the abolition of the rule is consistent with the purpose of the voidable transaction regime, which is to do fairness between unsecured creditors (and, in contrast, the peak indebtedness rule can be arbitrary and actually create unfairness by treating like creditors differently if they have different credit terms).

Questions on appeal

In the High Court, the questions were confined to the operation of s 588FA(3).  Namely:

a.     whether the so-called “peak indebtedness rule” is excluded by s 588FA(3) of the Act;

b.     what is the proper approach to determining whether a “transaction is, for commercial purposes, an integral part of a continuing business relationship” as referred to in s 588FA(3)(a); and

c.     evaluating the facts as to which payments fell within the meaning of a “continuing business relationship” for the purposes of s 588FA(3)(a).

Peak indebtedness rule

The “peak indebtedness rule” permitted a liquidator to choose the starting date within the relevantly prescribed statutory period (in this case, the relation-back period of six months prescribed by s 588FE(2)) to prove the existence of an unfair preference given by the company to a creditor.  The High Court found that the context of the statutory provisions discloses that it cannot be assumed or inferred that, in incorporating the “running account principle” in s 588FA(3) of the Act, the legislature also intended to incorporate the “peak indebtedness rule”: [45].  Indeed, Parliament had deliberately used the words “running account” but had not made any reference to “peak indebtedness” or otherwise repeated words in relation to that which had been judicially determined: [59].

Like the Full Court, the High Court recognised that with or without the “peak indebtedness rule”, arbitrariness may result in the determination of unfair preference claims.  However, it determined that to apply the “peak indebtedness rule” would not serve the purpose of Pt 5.7B of the Act, which is to ensure “equality of distribution amongst creditors of the same class”: [68].  Section 588FA(3) was to embody the “running account principle”, the purpose of which is not to maximise the potential for the claw‑back of money and assets from a creditor (which is the effect of the “peak indebtedness rule”).  Rather, the “running account principle” 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. The prescription of periods within which all transactions in a continuing business relationship are deemed to be a “single transaction” and, accordingly, may be netted off against each other to determine any unfair preference serves this purpose: [70].  

Continuing business relationship

Answering the statutory question under s 588FA(3)(a) whether a “transaction is, for commercial purposes, an integral part of a continuing business relationship” involves an objective factual inquiry: [14].  The High Court warned against treating previous factual findings in other cases as binding precedent, but acknowledged that the concepts of the “mutual assumption” or common business “purpose” of the parties may be useful: [79], [81].  In undertaking this assessment, it is necessary to consider the whole of the evidence of the relationship between the parties, and appropriation of a payment to a past debt is not determinative: [82]-[84].

Conclusion

While this may make some unfair preference claims less viable for insolvency practitioners to pursue, this case has provided clear guidance as to how the courts should undertake the analysis relating to creditors with running accounts.