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Full Federal Court smokes the peak indebtedness rule in Gunns decision!
How the latest Gunns decision creates a fundamental shift in the calculation of unfair preferences claims and what this means in practical terms for trade creditors.
James Devonish FICM CCE
By James Devonish FICM CCE and Alida Chan MICM*
On 10 May 2021, the Full Court of the Federal Court handed down its decision in Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (in liq) (receivers and managers appointed)
[2021] FCAFC 64 (Gunns). The
decision is significant to future and current unfair preference claims, particularly for its implication that liquidators are unable to utilise the peak indebtedness rule when examining a continuing business relationship embodied in a single transaction under section 588FA(3) of the Corporations Act 2001 (Cth)
(Act).
What this means…
Pursuant to the Act, a liquidator of a company may claw back payments it made to a creditor in the period beginning six months prior to the relation-back day (“relation-back period”).1 There are a number of elements that the liquidator must prove to succeed with the claim, including: that the payments were made when the company was insolvent; that they were made in respect of an unsecured debt; and, that the creditor was preferred by the payments over other unsecured creditors.
However, for the purpose of determining the unfair preference amount, when the payments form part of a series of transactions made in the course of a continuing business relationship and the company’s net indebtedness to the creditor is increased and reduced from time to time as a result of these transactions, then section 588FA(3) of the Act requires the various transactions to be considered as one single transaction.
Prior to Gunns, where a continuing business relationship was evident and so as to maximise the amount of the single transaction, liquidators could apply the peak indebtedness rule and choose the starting point of the single transaction in the relation-back period as being the company’s
peak indebtedness to the creditor. In Gunns, the Full Federal Court deemed the peak indebtedness rule as unsound in principle. A Liquidator must take into account all transactions made, while a continuous business relationship exists, in the relation-back period.
Importantly, the Gunns decision also made some important and useful observations as to when a continuous business relationship applies during the relation-back period.
Post-decision effects – hypothetical analysis
In the below hypothetical set of potential preference payments during a relation back period, the effect of: 1. a continuing business relationship being found during the entire relation-back period and the application of the peak indebtedness rule (as during the pre-Gunns period) would mean that the creditor’s liability is
the peak account debt amount ($95,000.00) minus the closing balance ($22,000.00), being $73,000.00; and 2. a continuing business relationship being found during the entire relation-back period in the post-Gunns period will mean that the creditor’s liability is the account start balance ($14,000.00) minus the closing balance ($22,000.00), being -$8,000.00. Therefore, in this post-Gunns hypothetical analysis, there is no unfair preference claimable.
Background to the decision
liquidation)(receivers and managers appointed) were appointed on 25 September 2012 and sought to recoup a total of 11 payments made by the company during the relation-back period, 26 March 2012 to 25 September 2012, to Badenoch Integrated Logging Pty Ltd (Badenoch). The liquidators claimed the payments were unfair preference payments and voidable under section 588FE of the Act.
At first instance, in Bryant, in the matter of Gunns Limited (in liq) (receivers and managers appointed) v Badenoch Integrated Logging Pty Ltd [2020] FCA 713, the primary judge in the Federal Court found only two of the payments were ➤
“Prior to Gunns, where a continuing business relationship was evident and so as to maximise the amount of the single transaction, liquidators could apply the peak indebtedness rule and choose the starting point of the single transaction in the relation-back period as being the company’s peak indebtedness to the creditor.”
an integral part of a continuing business relationship as the rest were made when the company and Badenoch were looking backwards rather than forwards. That is, looking more to reduce old debt rather than supply future transport services under the commercial relationship. The effect of the primary judge’s findings was that the single transaction constituted the period 17 April 2012 to 30 June 2012 only.
The primary judge further relied upon the cases of Rees v Bank of New South Wales [1964] HCA 47 and Olifent v Australian Wine Industries Pty Ltd (1996) 130 FLR 195 (Olifent) to find that the liquidators were entitled to apply the peak indebtedness rule to claim that the single transaction was an unfair preference.
Accordingly, the nine individual payments made outside the period 17 April 2012 to 30 June 2012 could be impugned as individual preferences, whereas the two payments made within that 17 April 2012 to 30 June 2012 period fell to be considered as part of a single transaction under section 588FA(3) of the Act.
Gunns – the Full Court decision
An appeal and cross-appeal from the aforementioned decision was subsequently made and the Full Court of the Federal Court, constituted by Justices Middleton, Charlesworth and Jackson, had to decide, among other things, whether the transactions formed part of a continuing business relationship and whether the peak indebtedness rule applied.
As to the first issue, the Court noted the following applicable principles for the purpose of determining whether a payment
was part of a continuous business relationship: z the payment must be made in circumstances where there is a mutual assumption of a continuing business relationship of debtor and creditor, with an expectation that further debits and credits will be recorded; z it will usually be relevant to consider a statement of account in determining whether, from a business point of view, each particular payment was connected with the subsequent provision of goods or services; z where the relationship contemplates further debits and credits, the application of a payment to a past debt is not unusual and has no significance unless the parties agree that one of the purposes of the payment is to permanently reduce the level of indebtedness below the level existing at the time of the agreement; z knowledge of insolvency, suspicion of insolvency, or reasonable grounds to suspect insolvency will not necessarily destroy a continuing business relationship; z a stop on an account will not necessarily destroy a continuing business relationship; z the continuing business relationship does not need to exist for the entirety of the relation-back period; and z the existence of a continuous business relationship is a question of substance, not form. Importantly, the Full Court observed that the mutual assumption of a continuing business relationship will not necessarily cease whenever the purpose of a payment tips slightly in favour of recovering past indebtedness over securing future supply, such as where a creditor insists on payment of an ordinary invoice before continuing supply on terms.
On the issue of whether the peak indebtedness rule applied, the Justices agreed with the comments made by the New Zealand Court of Appeal in Timberworld Ltd v Levin [2015] NZCA 111 in relation to an equivalent New Zealand provision, being that the effect of the section taken on its face is to require all payments and transactions within the continuing business relationship to be netted off against one another.
The Justices also found that it was the intention of the Parliament to allow creditors to have the benefit of earlier dealings within a continuing business relationship. In arriving to this conclusion, reference was made to the fact that the peak indebtedness rule was not referred to in the Explanatory Memorandum to the insertion of section 588FA(3) into the 1989 Act and that support for the peak indebtedness rule was not evident in Petagna Nominees Pty Ltd & Anor v AE Ledger (1989) 1 ACSR 547 or Queensland Bacon v Rees [1966] HCA 21 (cases specifically referenced in the Explanatory Memorandum).
Ultimately, it was held that Olifent and subsequent decisions were wrongly decided because: z there was no legislative intention
to adopt the peak indebtedness rule when introducing the provision into the 1989 Act; moreover, section 588FA(3) is an expression of the ultimate effect doctrine which recognises that a company’s creditors are not disadvantaged by payments made to induce trade creditors to supply goods of equal or greater value; and z the elimination of the peak indebtedness rule is consistent with the stated purpose of Pt 5.7B of the Act, which is to do fairness between unsecured creditors.
Concluding comments
This decision is a positive outcome for trade creditors facing unfair preference claims and, in the authors’ humble opinion, gives an interpretation of section 588FA(3) of the Act which is consistent with its purpose.
*James Devonish FICM CCE Managing Director Oakbridge Lawyers E: jdevonish@oakbridgelawyers.com.au Direct: 08 8418 1410
*Alida Chan MICM Associate Oakbridge Lawyers E: achan@oakbridgelawyers.com.au Direct: 07 3181 5632
FOOTNOTES: 1 The relation-back day is often the date the liquidator was appointed to the company, but it can be earlier, if the company was in administration or had wind up proceedings on foot, prior to being placed into liquidation. Accordingly, the relationback period is often six months, but it can be longer.
