Gunns: peak indebtedness is shot

Co-author: Ben  Gibson, Barrister, Victorian Bar

Case Name: Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2

Hyperlink: https://eresources.hcourt.gov.au/downloadPdf/2023/HCA/2

Date of Judgment: 8 February 2023

Issues: Voidable transactions and unfair preferences: abolition of the peak indebtedness rule, the existence of a continuing business relationship.

The abolition of the peak indebtedness rule will likely reduce the quantum of unfair preference claims where there is a running account and render some claims unviable for further pursuit.

Where there is a continuing business relationship or “running account”, each payment will not be recoverable as an unfair preference, but the existence and amount of any preference will be determined by the net movement in the running account from the beginning of the continuing business relationship, or the prescribed statutory period, or the date of insolvency, whichever is later, and the date of the winding up.

Liquidators can no longer choose the point of peak indebtedness to maximise the quantum of any unfair preference and trade creditors cannot rely on transactions over the whole of a continuing business relationship as a complete or automatic defence to an unfair preference claim.

The judgment exemplifies the importance of collating all relevant evidence which relates to each voidable transaction during the relation back period for the purposes of making an objective assessment as to whether a continuing business relationship existed at the time of each payment.  This requires an objective characterisation of all relevant evidence (and not merely the parties’ subjective intentions) to discern the “business character” of the transaction.

Introduction

On 8 February 2023, the High Court of Australia delivered judgment in Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2. JWS acted for PwC, the appellant liquidators of the Gunns group, and Ben Gibson appeared as junior counsel for the liquidators.

While the High Court’s confirmation of the abolition of the peak indebtedness rule will be disappointing for liquidators, the judgment provides much needed clarity regarding assessment of the preferential effect of payments occurring within a “running account” and the extent to which certain payments might be claimable in themselves as unfair preferences by reason of having been made after cessation of a continuing business relationship.

The judgment finally confirms:

1. Part 5.7B of the Corporations Act 2001 (Cth) (the Act) does not incorporate the peak indebtedness rule;
2. the first transaction that can form part of a “continuing business relationship” for the purposes of s 588FA(3)(a) of the Act is either the first transaction after the beginning of the prescribed period or the date of insolvency, whichever is later. If the continuing business relationship started after either the prescribed period or the date of insolvency, the first transaction occurring after commencement of the relationship is the starting point;
3. it is an objective factual enquiry to determine when a “continuing business relationship” has ended. While concepts such as the “mutual assumption” of cessation by the parties of the relationship, or one party’s “sole purpose” of making a payment being the recovery of past indebtedness are instructive, they are not determinative.

Peak indebtedness and the commencement of the continuing business relationship

As readers will likely be aware, the “peak indebtedness rule” operated such that where a running account arose in a claim for an unfair preference, a liquidator could elect to impugn only the transactions from the highest point of indebtedness between the creditor and the company with the effect of maximising the preference sought to be returned to the company if the claim was successful.

Since the introduction of the section, and more recently the decision in Timberworld [2015] 3 NZLR 365, questions had lingered about how that rule was to be reconciled with the regime created by s 588FA(3) of the Act, although most courts had continued to apply the peak indebtedness rule. 

In summary, the High Court found:

1. the peak indebtedness rule cannot be inferred or assumed to have been incorporated into the Act by virtue of the references in the Explanatory Memorandum to the Corporate Law Reform Bill 1992 which introduced the predecessor to s 588FA(3) to Queensland Bacon Pty Ltd v  Rees (1966) 115 CLR 266 and Petagna Nominees Pty Ltd & Anor v A E Ledger (1989) 1 ACSR 547, as those cases related to the principles applicable to a running account ;[1]
2. section 588FA presupposes the existence of the relevant prescribed period in s 588FE and also that a transaction must be an insolvent transaction pursuant to s 588FA ;[2]
3. the natural and ordinary meaning of the words “all the transactions forming part of the relationship” means all relevant transactions within the relevant period prescribed by s 588FE(2) to (6B) and which were entered into when the company was insolvent or to the effect of which was to cause the company to become insolvent;[3]
4. while a liquidator is entitled to elect which transactions to impugn as a voidable transaction, that does not enable him or her to determine the first transaction forming part of “the relationship” for the purposes of the deemed “single transaction” in s 588FA(3)(c);[4]
5. the running account principle recognises that a creditor who continues to supply a company on a running account in circumstances of suspected or potential insolvency enables the company to continue to trade to the likely benefit of all creditors;[5] and
6. no difficulty arises by virtue of the longer prescribed periods, for example in s 588FE(4) which is concerned with transactions with related entities, because those prescribed periods do not operate in isolation and so will be fact dependent.[6]  Using the same example, a transaction with a related entity for the purposes of s 588FE(4) must also be an insolvent transaction, which provides some protection as the company is likely to become insolvent later than the commencement of the prescribed period of four years. 

Having regard to the findings above, the commencement of a continuing business relationship for the purposes of s 588FA(3)(a) is either the later of the start of the relation back (or prescribed) period (s 588FE) or the date of insolvency of the relevant company (s 588FC).  By enacting legislation to that effect, Parliament excluded the operation of the peak indebtedness rule.[7]

Cessation of the continuing business relationship

The other significant question in the appeal was the proper approach to determining when a transaction was an “integral part of a continuing business relationship” between a creditor and a company for the purposes of s 588FA(3)(a).  Most importantly, if a transaction is not an integral part of the continuing business relationship, then that relationship may have ceased and subsequent payments might be voidable on a standalone basis. 

Among other relevant factors, courts have previously held that there will be no mutual assumption of a continuing business relationship where the purpose of inducing supply by a payment is subordinated to the predominant purpose of recovering past indebtedness.  The Full Court held that statement should be treated with some caution, but that there was no doubt that where the sole purpose of making a payment was the discharge of an existing debt, there will be a preference.[8] 

Departing from the focus of the Full Court, the High Court held that the appropriate enquiry is an objective factual exercise that considers the whole of the evidence and the “actual business” relationship between the parties, and not merely their subjective intentions (irrespective of whether the parties’ intention in making and receiving a payment is “solely” or for the “dominant” purpose of recovering debts).[9]

In this case, in determining that a continuing business relationship continued to exist until 10 July 2012, the High Court found that:

1. the controlling minds of the creditor believed Gunns would be in a position to pay all of Badenoch’s outstanding invoices;
2. the parties were working towards their business relationship continuing;
3. a change in credit terms in March 2012 did not terminate the relationship;
4. it was not determinative evidence of the cessation of the relationship that Gunns and Badenoch wanted to reduce Gunns’ past indebtedness.[10]   

By contrast, in determining that in a practical “business sense”, the continuing business relationship had ended at least by 2 August 2012, the High Court found that:

1. the parties had agreed that the agreement would cease and agreed a transition plan towards the cessation of supply;
2. Badenoch was intent on maximising the reduction in Gunns’ debt before handing over to another contractor;
3. Gunns knew from Badenoch’s correspondence to Gunns that it would need to find another contractor.[11] 

By reason of these matters, supplies provided after 2 August 2012 were not provided to the pre-existing business relationship, but pursuant to an agreed transition plan to another contractor.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).