Peak indebtedness gets sin binned

The pavlova, women’s right to vote, the flat white, the Rugby World Cup… New Zealand has a storied history of beating Australia to the punch. However, Aussie liquidators might not be so keen to throw their trans-Tasman cousins a friendly ‘chur!’ as their ability to pursue unfair preference claims continues to be eroded following the recent Full Court decision in Badenoch.

The case was heard on appeal from a decision delivered in the Federal Court of Australia on 30 July 2020. The appellant (Badenoch) provides logging and transport services, and the respondents are the liquidators (Liquidators) of Gunns Limited (in liquidation) (receivers and managers appointed) and its wholly owned subsidiary Auspine Limited (in liquidation) (receivers and managers appointed). The Liquidators alleged that 11 payments (impugned payments) made by Gunns to Badenoch from 26 March 2012 to 25 September 2012 (relation back period) were insolvent transactions and voidable under s 588FE of the Act. These impugned payments were made after Gunns’ insolvency on 30 March 2012.

The appeal and cross-appeal were concerned about the availability and scope of the Liquidators’ unfair preference claims. This was determined by observing:

  1. whether any of the impugned payments were an integral part of a ‘continuing business relationship’ within the meaning of s 588FA(3) Corporations Act 2001 (Cth) (Act), such that the series of transactions forming part of the relationship, including the payments, would be taken to constitute a single transaction for the purpose of determining whether there has been an unfair preference (continuing business relationship issue);
  2. 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 (peak indebtedness issue); and
  3. whether Badenoch had established a good faith defence pursuant to 588FG(2) of the Act in respect of any of the impugned payments (good faith defence); and
  4. the availability of set-off under s 553C of the Act (set-off issue).

Primary Judge’s Reasons

Continuing business relationship issue

The primary judge determined that only two of the impugned payments were an integral part of a continuing business relationship between Gunns and Badenoch under s 588FA(3) of the Act. The remainder of the payments were not considered part of the continuing business relationship, and instead deemed ‘single transactions’, as the parties were ‘looking backwards rather than forwards; looking to the partial payment of the old debt rather than the provision of continuing services’. Ultimately, it was found that a continuing business relationship existed from 17 April 2012 to 30 June 2012.

Peak indebtedness issue

The primary judge, Justice Davie, confirmed that the approach in applying the peak indebtedness rule in Olifent v Australian Wine Industries Pty Ltd (1995) 130 FLR was correct. In Olifent, the court found the nature of the running account defence was the same under s 588FA(3) of the Act (introduced into Corporations Act 1989 (Cth)) as it had been under the prior provisions, which indicated there was no intention to alter the law that the liquidator was free to choose any point during the statutory period, including the point of peak indebtedness, to establish a preferential payment.

The conclusion by the primary judge meant the Liquidators were entitled to nominate any point in the continuing business relationship during the relation back period as the beginning of the ‘single transaction’ as per s 588FA of the Act. The peak of Gunns’ indebtedness to Badenoch nominated by the Liquidators was the period after 31 May 2012.

In so finding, Her Honour expressly rejected the position adopted by the New Zealand Court of Appeal in Timberworld Limited v Levin [2015] NZCA 111; [2015] 3 NZLR 365, which had found that the peak indebtedness rule should not be adopted in New Zealand and was not a part of the law of that country in respect of its equivalent to the unfair preference provisions.

Good faith defence

In considering whether Badenoch had established a good faith defence under s 588FG(2) in respect of any of the payments, the primary judge accepted that Badenoch acted in good faith and provided valuable consideration under each transaction by providing logging and transport services up until the relation-back day. However, the primary judge also found that there were reasonable grounds for Badenoch to suspect that Gunns were or would become insolvent, and that a reasonable person in their circumstances would have had grounds for suspecting insolvency from March 2012. This meant the good faith defence was not applicable.

Availability of set-off

The primary judge held that at the time of each impugned payment, Badenoch had notice of facts that ‘were more than sufficient’ to disclose that Gunns and Auspine were not able to pay their outstanding debts, which meant that a set-off under s 553C of the Act was not available to Badenoch.

Appeal

Continuing business relationship issue

Badenoch contended the primary judge erred in not finding that all payments were part of a continuing business relationship.

The Court of Appeal found the primary judge erred in finding that payments 1 and 2 were not part of a continuing business relationship for the purposes of s 588FA(3) of the Act. These payments were found to become part of the relationship because Badenoch was issuing invoices in the context of it continuing to supply services and Gunns continuing to accept those services, not for the purposes of recovering past debts.

However, it also held the primary judge did not err in finding payments 3 and 4 were part of the relationship, and that payments 5 to 11 were not a part of the relationship.

Peak indebtedness issue

Badenoch contended the primary judge erred in finding the peak indebtedness rule applies to claims made in accordance with s 588FA of the Act.

In considering the language of s 588FA(3)(c) of the Act regarding ‘all the transactions forming part of the relationship’, the Court agreed with the statement of the New Zealand Court of Appeal in Timberworld where it was taken to mean all payments and transactions within the continuing business relationship to be netted off against one another, and that a liquidator is not permitted to disregard those payments. Given both parties agreed that the relevant end date for the single transaction is the earlier date of either the date of cessation of the continuing business relationship or the date of liquidation, the issue in dispute is when the single transaction is said to begin. Badenoch contended the relevant start date was either the relation-back day or commencement of the continuing business relationship, whichever is latest, whereas the liquidators said that in accordance with the peak indebtedness rule, they should be free to choose any point in the continuing business relationship within the relation back period.

The Court rejected the findings in Olifent and Rees v Bank of New South Wales [1964] HCA 47; (1964) 111 CLR 210 that picking the point of peak indebtedness as the starting point for the impugned transaction in the context of a continuing business relationship was acceptable.

Firstly, the Court found there was no legislative intention to adopt the peak indebtedness rule when introducing the provision into the 1989 Act. The words of s 588FA establish that when the test in s 588FA(3) is satisfied, there is taken to be a single transaction encompassing within it all payments and all supplies forming a part of the continuing business relationship. It is that single transaction that is the subject of the Court’s consideration under s 588FA(1) and s 588FA(3)(d) in determining whether or not the single transaction constitutes a preference.

Secondly, s 588FA(3) of the Act embodies the doctrine of ‘ultimate effect’, which ensures the general body of creditors are not disadvantaged by payments made to induce trade creditors to supply goods of equal or greater value. The Court reaffirmed the reasons established by the New Zealand Court of Appeal in Timberworld, that if the principle established in Airservices Australia v Ferrier (1996) 185 CLR 483 is that the ultimate effect must be considered in ascertaining the results of a running account, the peak indebtedness rule is detrimental to that principle.

Thirdly, abolishing the peak indebtedness rule is consistent with the purpose of Part 5.7B of the Act, which aims to achieve fairness between unsecured creditors. However, the Court conceded that there is a certain degree of unfairness in either approach of determining when the single transaction begins.

Good faith defence

Badenoch contended that the primary judge erred in finding that Badenoch did not establish they had no reasonable grounds to suspect Gunns and Auspine were or would become insolvent, and that a reasonable person in Badenoch’s circumstances would have had no such grounds for suspecting insolvency as per s 588FG(2)(b) of the Act.

The Court held that from at least March 2012, Badenoch had information available to it indicating Gunns was, or would become, insolvent, and that a reasonable businessperson would have feared Gunns was, or would become, insolvent. It was found that although Badenoch genuinely believed Gunns would pay the invoices owing at some later date, such a belief is insufficient to establish Badenoch had no reasonable grounds for expecting insolvency.

Availability of set-off

Badenoch contended the primary judge erred in not finding that Badenoch was entitled to a set-off in respect of sums owed to it by Gunns, against any amount the Court found it liable to pay the Liquidators under s 553 of the Act.

The Court found it was evident that Badenoch had notice of Gunns’ insolvency throughout the relation back period including at the time of each impugned payment. It was therefore held that even if Badenoch did not actually draw conclusion that Gunns was insolvent from the information it knew, it is enough that it had notice of facts that would support such a conclusion.

This decision is a further instance of a judicial trend narrowing the scope of unfair preference claims, following on from:

  1. grantors of unperfected security interests being found to be ‘secured creditors’ (eg Hussain v CSR Building Products Limited; in the matter of FPJ Group Pty Ltd (2016) 246 FCR 62);
  2. ongoing uncertainty around whether set-off under section 553C is a defence to an unfair preference claim (eg Morton v Rexel [2015] QDC 49, Hussain v CSR Building Projects & Stone v Melrose Crane [2016] FCA 1113); and
  3. the narrowing of the scope for third party payments to be unfair preferences (eg Cant & Anor v Mad Brothers Earthmoving Pty Ltd [2020] VSCA 198);

#peakindebtedness #continuingbusinessrelationship #impugnedpayments #unfairpreference #liquidation #timberworld #badenoch

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