An interesting quagmire has evolved from the recent High Court decision of Badenoch (dealing with the running account balance defence to unfair preferences) and the Court’s rejection of the peak indebtedness rule.
The Peak Indebtedness Rule
A liquidator has the ability to claw back certain preferential payments made by a company to a creditor under provisions of the Corporations Act 2001 (Cth) (Act) and distribute these funds to all creditors. According to the ‘running account’ principle in section 588FA(3) of the Act, if a transaction is part of a continuing business relationship (CBR) between a company and a creditor, all transactions forming part of that relationship will be treated as a single transaction for the purpose of calculating an unfair preference. The ‘peak indebtedness rule’ provides a mechanism to allow liquidators to select a company’s point of peak indebtedness to a creditor as the starting point of this single transaction.
Here are some ways an uninformed liquidator or creditor may now be manipulated by the other side’s pleadings when it comes to section 588FA(3) of the Corporations Act (assuming that a ‘continuing business relationship’ (CBR) exists and that all other indicia have been satisfied to constitute a claim under section 588FA:
Liquidator:
i) plead that the company was insolvent from the time of the first payment only (not throughout the relation-back period, as is typically done); or
ii) plead that the company was insolvent only from a specific day after the ‘peak indebtedness’ of the company’s debt to the creditor. This is peak indebtedness by stealth and would simply require some basic maths to work out the ideal time to plead the insolvency date.
Creditor:
iii) plead that the company was insolvent throughout the relation-back period (to encapsulate all invoices);
iv) plead that the company was never insolvent (or not insolvent until after the last payment received); or
v) plead a time somewhere between iii) and iv) that gives a mathematical edge.
Why?
The High Court found that the single transaction during a continuing business relationship (‘CBR’) is assessed from the latter of:
a) the first transaction during the relation-back period (i.e., typically a 6-month period); or
b) the first transaction after the Company became insolvent.
Where there is a CBR, if payments exceed the supply of the goods/services between the date in (a) or (b) and the date of CBR ceasing, then this amount is what may constitute the unfair preference.
As a result of the Badenoch decision, the landscape of recovering unfair preferences in liquidations has dramatically changed. Watch this space to see how it unfolds.
Article written by Matthew Hudson (Associate Director) – Brisbane