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In the recent decision of Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (in Liquidation) (receivers and managers appointed) [2021] FCAFC 64 (Badenoch) the Full Court of the Federal Court of Australia effectively abolished the “peak indebtedness” rule for liquidators pursuing unfair preference claims.

Section 588FA(3) of the Corporations Act 2001 (Cth) (Act) provides where a transaction is part of a continuing business relationship between a company and its creditor, and the company’s net indebtedness to the creditor is increased and reduced from time to time as a result of a series of payments forming part of a running account, the transactions forming part of the relationship will be treated as a single transaction. This is commonly known as the “running account“ rule which, whilst technically forming part of the requirement for a preferential payment to be voidable, has operated as a partial defence for creditors being pursued by liquidators for payments received in preference to other creditors. It is often referred to as the ‘running account’ defence.

First applied in Olifent v Australian Wine Industries Pty Ltd (1996) 130 FLR 195 (Olifent), the “peak indebtedness” rule has operated as a limit or countervailing force on the running account defence. Since Olifent, liquidators have been allowed to select the point of peak indebtedness during the relation back period as the commencement of the period of the continuing business relationship when calculating the value of the “single transaction”. For example, where:

  1. the continuing business relationship commenced before the six months leading up to the relationship back date and ended on the date of liquidation;
  2. at its peak, the company in liquidation owed the creditor $130,000;
  3. at the date of liquidation, the closing balance owed to the creditor was $30,000;
  4. the quantum of the single transaction available to the liquidator after the application of the running account defence would be $100,000.

badenoch case

The facts in Badenoch concerned 11 substantial payments received by Badenoch in the six months leading up to the relation back day, which were pursued by the liquidators as unfair preferences. Badenoch sought to resist the liquidators’ claim on the basis that it had received the payments in good faith and in the course of a continuing business relationship (i.e. under the running accountrule).

At first instance, the trial judge ordered that only two of the 11 payments received by Badenoch within a three month period were subject to a running  account and that the liquidators were entitled to elect the peak indebtedness as the commencement date of the continuing business relationship.

Badenoch appealed the Federal Court decision on a number of grounds, including that the trial judge had erred in determining that the peak indebtedness rule should be permitted and that cases applying this rule in claims under section 588FA(3) of the Act were incorrect at law.

Badenoch counsel relied heavily on the New Zealand case of Timberworld Ltd v Levin (2015) 3 NZLR 365 (Timberworld), which examined a number of Australian authorities and determined that the peak indebtedness rule did not apply in the context of an equivalent New Zealand statutory provision.

Their Honours ultimately decided the prior decisions affirming the peak indebtedness rule (including Olifent) were wrongly decided on the following grounds:

  1. the peak indebtedness rule was “inconsistent with the express language of the statute”;
  2. the language of section 588FA(3) of the Act “embodies the doctrine of ‘ultimate effect’”, which balances the interests of the creditors and recognises that “creditors are not disadvantaged by payments made to induce trade creditors to supply goods of equal or greater value”; and
  3. the abolition of the peak indebtedness is consistent with the legislative intention of Part 5.7B of the Act, which is to promote fairness between creditors.

In particular, the Court referred to the High Court decision in Airservices and acknowledged:

If value provided to the company and a subsequent payment against accrued debt are viewed as part of an arrangement which has the effect of giving the company valuable goods and services, there is no depletion of assets.  If s 588FA(3) applies then it expressly requires them to be viewed that way”.

key points

  • The commencement date for the “single transaction” is likely to be the latter of either the relation-back day or the commencement date of the continuing business relationship.
  • The determination of the closing balance in a running balance defence is likely to be unaffected by the Badenoch case and will remain as either the end date of the continuing business relationship or the date of liquidation, whichever is earliest.
  • The running balance rule may be a complete defence to a liquidator’s preference claim, except where transactions are impugnable as preferential payments within the continuing business relationship (i.e. those transactions that are not within the course of the business relationship but are actually intended to discharge past indebtedness).
  • Creditors will still be required to demonstrate there is a continuing business relationship and that any payments received were in the course of that relationship and not to discharge past indebtedness. The Court set out a useful summary of principals relevant to assessing whether a payment is properly considered to form part of a continuing business relationship.
  • This decision has reduced the prospects of liquidators successfully pursuing the recovery of preference claims

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abolition of the peak indebtedness rule

31 May 2021
nathanael kitingan catherine ciccone tim puget

In the recent decision of Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (in Liquidation) (receivers and managers appointed) [2021] FCAFC 64 (Badenoch) the Full Court of the Federal Court of Australia effectively abolished the “peak indebtedness” rule for liquidators pursuing unfair preference claims.

Section 588FA(3) of the Corporations Act 2001 (Cth) (Act) provides where a transaction is part of a continuing business relationship between a company and its creditor, and the company’s net indebtedness to the creditor is increased and reduced from time to time as a result of a series of payments forming part of a running account, the transactions forming part of the relationship will be treated as a single transaction. This is commonly known as the “running account“ rule which, whilst technically forming part of the requirement for a preferential payment to be voidable, has operated as a partial defence for creditors being pursued by liquidators for payments received in preference to other creditors. It is often referred to as the ‘running account’ defence.

First applied in Olifent v Australian Wine Industries Pty Ltd (1996) 130 FLR 195 (Olifent), the “peak indebtedness” rule has operated as a limit or countervailing force on the running account defence. Since Olifent, liquidators have been allowed to select the point of peak indebtedness during the relation back period as the commencement of the period of the continuing business relationship when calculating the value of the “single transaction”. For example, where:

  1. the continuing business relationship commenced before the six months leading up to the relationship back date and ended on the date of liquidation;
  2. at its peak, the company in liquidation owed the creditor $130,000;
  3. at the date of liquidation, the closing balance owed to the creditor was $30,000;
  4. the quantum of the single transaction available to the liquidator after the application of the running account defence would be $100,000.

badenoch case

The facts in Badenoch concerned 11 substantial payments received by Badenoch in the six months leading up to the relation back day, which were pursued by the liquidators as unfair preferences. Badenoch sought to resist the liquidators’ claim on the basis that it had received the payments in good faith and in the course of a continuing business relationship (i.e. under the running accountrule).

At first instance, the trial judge ordered that only two of the 11 payments received by Badenoch within a three month period were subject to a running  account and that the liquidators were entitled to elect the peak indebtedness as the commencement date of the continuing business relationship.

Badenoch appealed the Federal Court decision on a number of grounds, including that the trial judge had erred in determining that the peak indebtedness rule should be permitted and that cases applying this rule in claims under section 588FA(3) of the Act were incorrect at law.

Badenoch counsel relied heavily on the New Zealand case of Timberworld Ltd v Levin (2015) 3 NZLR 365 (Timberworld), which examined a number of Australian authorities and determined that the peak indebtedness rule did not apply in the context of an equivalent New Zealand statutory provision.

Their Honours ultimately decided the prior decisions affirming the peak indebtedness rule (including Olifent) were wrongly decided on the following grounds:

  1. the peak indebtedness rule was “inconsistent with the express language of the statute”;
  2. the language of section 588FA(3) of the Act “embodies the doctrine of ‘ultimate effect’”, which balances the interests of the creditors and recognises that “creditors are not disadvantaged by payments made to induce trade creditors to supply goods of equal or greater value”; and
  3. the abolition of the peak indebtedness is consistent with the legislative intention of Part 5.7B of the Act, which is to promote fairness between creditors.

In particular, the Court referred to the High Court decision in Airservices and acknowledged:

If value provided to the company and a subsequent payment against accrued debt are viewed as part of an arrangement which has the effect of giving the company valuable goods and services, there is no depletion of assets.  If s 588FA(3) applies then it expressly requires them to be viewed that way”.

key points

  • The commencement date for the “single transaction” is likely to be the latter of either the relation-back day or the commencement date of the continuing business relationship.
  • The determination of the closing balance in a running balance defence is likely to be unaffected by the Badenoch case and will remain as either the end date of the continuing business relationship or the date of liquidation, whichever is earliest.
  • The running balance rule may be a complete defence to a liquidator’s preference claim, except where transactions are impugnable as preferential payments within the continuing business relationship (i.e. those transactions that are not within the course of the business relationship but are actually intended to discharge past indebtedness).
  • Creditors will still be required to demonstrate there is a continuing business relationship and that any payments received were in the course of that relationship and not to discharge past indebtedness. The Court set out a useful summary of principals relevant to assessing whether a payment is properly considered to form part of a continuing business relationship.
  • This decision has reduced the prospects of liquidators successfully pursuing the recovery of preference claims