The ‘peak indebtedness rule’ is no more (or at least, pending any appeal) following the recent decision of Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (in liq) (receivers and managers appointed) handed down on 12 March 2021.
Section 588FA(3) of the Corporations Act 2001 (Cth) prescribes:
- If a transaction (typically a payment by a debtor (soon to be a liquidated company) to a creditor) is part of an integral part of a continuing business relationship or running account between a company or creditor; and
- The level of the company’s net indebtedness to the creditor increases and decreases from time to time over a series of transactions that forms part of the relationship;
- All the transactions forming part of the relationship as if they are a single transaction;
- That single transaction is an unfair preference if it results in the creditor receiving more than if the creditor were to prove for the debt in a winding up of the company.
Put another way, this means the ’single transaction’ will only be a preference under section 588FA if the payments made by the company exceed the value of the goods or services it received, such that the payments achieved a reduction in the balance of the running account.
Gunns Limited (In Liq) (Receivers and Manages Appointed) (Gunns) was a timber felling business in Tasmania, which operated sawmills and plantations. Gunns was placed into voluntary administration in September 2012 and liquidation in March 2013. Badenoch provided logging and transport services to Gunns.
Between 30 March 2012 to 24 September 2012, Gunns made 11 payments to Badenoch. It was not in dispute that the payments were made during the relation-back period, and at a time when Gunns was insolvent.
The liquidators claimed these payments were unfair preferences, on the basis that Badenock received more than it would have otherwise received if it were to prove for its debt in liquidation.
In the first instance, the trial judge held that only two of the 11 payments received by Badenoch were subject to a running account.
The other nine payments, where the predominant purpose of the payments was to reduce the past indebtedness, did not form part of the relevant continuing business relationship and section 588FA(3) has no application.
Appeal to Full Court
The appeal required the Full Court to determine the following questions (amongst other things):
- Whether any of the impugned payments were an integral part of a “continuing business relationship” within the meaning of s 588FA(3) of the Act such that a series of transactions forming part of the relationship, including the payments, would constitute a single transaction for the purpose of determining whether there has been an unfair preference;
- If so, whether the Liquidators were entitled to apply the peak indebtedness rule and choose any point in the relationship as the starting point of the single transaction for the purpose of s 588FA(3) of the Act.
The Full Court in considering the issues on appeal, held the first four payments were part of the continuing business relationship. This was because at the time of these payments, there was still a genuine belief by Badenoch that Gunns would fulfill its obligations and continue to supply services. However, the remaining payments did not form part of the continuing business relationship, because by that point, the relationship was geared towards cessation, and not of a continuation.
The Full Court proceeded to consider various authorities with respect to a continuing business relationship followed the New Zealand Timberland decision and held that the peak indebtedness rule does not form part of the law of corporate insolvency in Australia.
The Honours held unanimously:
- The Peak Indebtedness Rule was inconsistent with the statute because the statute’s express language clearly states all transactions in the continuing business relationship to be included in the single transaction.
- Section 588FA(3) balances the interests of creditors, and recognises that creditors are not necessarily disadvantaged by payments made to encourage trade creditors to supply goods of equal or greater value.
- Abolishing the peak indebtedness rule is consistent with the legislative intention of Part 5.7B of the Act. The intention being, to promote fairness between creditors.
What does this mean?
This decision is significant because it overhauls the way unfair preference claims are to be assessed. The decision forces further careful consideration and scrutinisation as to the commerciality of pursuing an unfair preference claim when there is a “running account”.
  FCAFC 64.
 Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (in liq) (receivers and managers appointed)  FCAFC 64, .
 Sutherland (as liquidator of Sydney Appliances Pty Ltd (in liq)) v Eurolync Pty Ltd (2001) 37 ACSR 477; Olifent v Australian Wine Industries Pty Ltd (1996) 130 FLR 195.
 (2015) 3 NZLR 365.