The good, the bad, the ugly: crucial judgments for liquidators relating to unfair preferences
The High Court has handed down its long-awaited decisions in Bryant v Badenoch Integrated Logging Pty Ltd  (Badenoch) HCA 2 and Metal Manufactures Pty Ltd v Morton  HCA 1 (Morton) providing guidance on common defences to unfair preference claims that may be brought by liquidators. The key takeaways for insolvency practitioners are:
- The peak-indebtedness rule will not be revived. Liquidators cannot choose the starting date to prove the existence of an unfair preference.
- Statutory set-off does not apply to unfair preference claims. The High Court’s judgment extends this logic to other voidable transaction and insolvent trading claims.
In unwelcome news for liquidators, in Badenoch the High Court unanimously upheld the decision of the Full Federal Court which abolished the “peak indebtedness rule”. The Full Federal Court found that liquidators cannot select the date of the first transaction in the relevant relationship between the creditor and the company in liquidation in order to maximise an unfair preference claim.
The appeal to the High Court addressed three issues about the operation of section 588FA(3) of the Corporations Act 2001 (Cth) (Act):
Whether the peak indebtedness rule is part of or is excluded by section 588FA(3).
The High Court reviewed the legislative history of section 588FA(3) and found that, unlike the running account principle it should not be assumed or inferred that the legislature intended to incorporate the peak indebtedness rule into the Act.
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).
The High Court found that it is an objective factual inquiry that necessitates consideration of the whole of the evidence of the actual business relationship between the parties.
What payments, made by the creditor to the company, fell within the definition of section 588FA(3).
The High Court agreed with the Full Federal Court’s assessment of what payments formed an integral part of the continuing business relationship. Relevantly, the High Court agreed that the first payment forming part of the continuing business relationship was the first payment made after the date of insolvency, being a later date than the statutory period. Payments made after the date on which the creditor and the company agreed that the creditor would cease supplying services to the company would not form part of the continuing business relationship as the relationship had ceased.
The decision of the Full Federal Court did leave open one important question; the date for the commencement of the continuing business relationship. In its decision, the Full Federal Court implied (but did not decide) that it may have been willing to consider a commencement date of the continuing business relationship further back in time than either the date of insolvency of the debtor company or the commencement of the six month relation-back period. It appears that the High Court has clarified this issue noting:
[T]he first transaction that can form part of the continuing business relationship contemplated by s 588FA(3) is either the first transaction after the beginning of the prescribed period or after the date of insolvency, or (if the relationship started after the beginning of the prescribed period or the date of insolvency) the first transaction after the beginning of the continuing business relationship, whichever is later.
Creditors can no longer claim set-off against an unfair preference claim
In a win for liquidators, voidable transaction claims are no longer burdened with the risk that creditors may set-off their liability against debts already owing under section 553C of the Act.
In Morton, the High Court held that a creditor is unable to avail itself of the set-off in section 553C to reduce amounts owing in an unfair preference claim. Central to the High Court’s reasoning was that the set-off in section 553C requires ‘mutuality’ between the insolvent company and the creditor. The obligation for a creditor to pay an insolvent company under section 588FF of the Corporations Act is not owed to the insolvency company by virtue of a right it has against the creditor. Rather, it is an obligation found in a judgment or order of the court pursuant to a successful application brought by the liquidator in his or her own right.
Further, for the purposes of assessing whether there is mutuality, the rights of the parties are to be taken and ascertained as at the time of winding up. Therefore, immediately before the winding up there is nothing to set off between the creditor and the insolvent company: the insolvent company owed money to the creditor, but the creditor owed nothing to the insolvent company.
The High Court also clarified that other cases that found that section 553C was available in response to other voidable transaction claims and insolvent trading were incorrect. This is a strong indication that set-off will not be available in response to claims of this nature. However, liquidators should keep in mind that the statutory set-off in section 553C of the Act still otherwise applies where voidable transactions are not concerned.
The decision of the High Court in Badenoch upholding the abolishment of the peak indebtedness rule will undoubtedly impact the quantum liquidators are able to recover pursuant to unfair preference claims. However, the High Court has clarified that it is not open to a creditor to argue that the start of a continuing business relationship for the purposes of section 588FA(3) is a date even further back in time than the statutory period or date of insolvency. This provides some certainty to liquidators moving forward.
Liquidators should otherwise feel relieved that unfair preference claims brought against creditors can no longer be subject to a set off claim under section 553C following Morton. Creditors may be further limited in the extent they can defend other forms of voidable transactions in addition to unfair preferences such as uncommercial transactions (section 588FB), insolvent transactions (section 588FC) and creditor-defeating dispositions (section 588FDB). Practically speaking, liquidators may find it easier and more cost effective to bring voidable transaction claims.
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