As more companies circle the drain in an increasingly uncertain economic environment, it is timely to review recent developments in unfair preference claims brought by liquidators against creditors. In the recent decision of Bryant & Ors v Badenoch Integrated Logging Pty Ltd  HCA 2 (Gunns), the High Court confirmed the decision of the Full Court of the Federal Court of Australia below, abolishing the application of what has become known as the peak indebtedness rule as inconsistent with the provisions of the Corporations Act 2001 (Cth).
Unfair Preference Claims
Unfair preference claims are brought by liquidators within 3 years of their appointment (or the commencement of winding-up proceedings leading to a winding up order). Under section 588FA of the Corporations Act, liquidators can claw back payments made by a company to a creditor in the six-month period prior to it being placed into liquidation. This period is called the Relation Back Period. Payments made to creditors during the Relation Back Period can be clawed back if:
- the company was insolvent at the time the payment was made;
- the debt is unsecured; and
- the payment results in the creditor receiving more from the company than it would have from the liquidation if the payment was set aside and they have to prove in the winding up in equal competition with all of the other creditors of the company.
Often, companies will make a series of payments to a creditor during the Relation Back Period and creditors will continue to supply the company with goods or services.
Where the payments made are an integral part of a continuing business relationship, all transactions during the Relation Back Period are treated as a single transaction in calculating the preference received by the creditor.
The controversy in Gunns surrounded how to best calculate what the effect of this single transaction is for the purposes of determining the value of any alleged preference. The liquidators argued that the peak indebtedness rule should continue to apply to unfair preference claims. Badenoch argued that the peak indebtedness rule was inconsistent with the wording of section 588FA of the Corporations Act and that the Court should instead look at what the ultimate effect is of the transactions as a whole.
Peak Indebtedness Rule
The peak indebtedness rule involves a simple calculation whereby the liquidator identifies the point in time during the Relation Back Period at which the company was most indebted to the creditor and subtracts the amount the company was indebted to the creditor at the end of the Relation Back Period (usually either the date the liquidator is appointed as either an administrator or liquidator of the company or the date winding up proceedings are commenced in the Court). The figure remaining is the amount the creditor is said to have been preferred by the Company.
The doctrine of ultimate effect involves another simple calculation. All payments made by the Company during the Relation Back Period are totalled. All supplies made to the Company during the Relation Back Period by that creditor are also totalled. The payments less the supples gives you the amount the creditor has been preferred by the Company during the Relation Back Period.
The amount of the preference under the ultimate effect doctrine will usually be less than it would have been under the peak indebtedness rule, but can never be higher.
The High Court unanimously upheld the Full Court of the Federal Court of Australia’s decision, which rejected the use of the peak indebtedness rule because it was inconsistent with the requirement that all transactions be treated as a single transaction. Instead, the High Court affirmed the use of the doctrine of ultimate effect in calculating the preference received by a creditor where there is a continuing business relationship between them and the company.
This decision benefits creditors seeking to defend unfair preference claims brought by liquidators. It also brings certainty in a contentious area of law which had not been finally settled by the High Court for decades.
Vincent Young’s Commercial and Insolvency team is highly experienced in both prosecuting and defending unfair preference claims. If you need assistance with an unfair preference claim, please contact David Greenberg at email@example.com.