Background

On 10 May 2021, the Full Court of the Federal Court of Australia handed down its judgment in Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (in liq)(receivers and managers apptd) [2021] FCAFC 64. Industry commentators have suggested that the judgment in Gunns has the affect of abolishing the peak indebtedness rule. For over 50 years, liquidators have used the peak indebtedness rule to ascertain the amount to be clawed back from creditors as unfair preference payments in the context of continuing business relationships. The judgment of Gunns will likely significantly reduce the quantum of unfair preference claims recoverable by liquidators in the context of claims involving continuous business relationships between the insolvent company and creditor.

It appears that the decision of Gunns has not been appealed to the High Court of Australia, or that if it has, the issue of special leave has not yet been dispensed. In those circumstances, choice of forum might be one way to utilise or challenge the decision of Gunns.

Before Gunns

In determining whether an unfair preference is given to a creditor, section 588FA(3) of the Corporations Act 2001 (Cth) provides that transactions entered into during the relation-back period as part of a continuous business relationship comprise one single transaction. The purpose of that provision is to account for the fluctuating indebtedness to a creditor as ongoing transactions are entered into in the course of a continuing business relationship.¹

Prior to Gunns, a liquidator was typically able to elect the point in time during the continuing business relationship and the relation-back period as the time at which the single transaction was to be considered for the purposes of quantifying an unfair preference claim. Consequently, liquidators would almost invariably nominate the point of peak indebtedness, thereby maximising the quantum of the preference claim.

One difficulty with the peak indebtedness rule is reconciling it with the doctrine of ultimate effect which acknowledges that there is no preference if payments to creditors are made to induce a supply of goods or services of equal or greater value.² Accordingly, the application of the peak indebtedness rule can result in outcomes where the net effect of the payment is effectively disregarded or ignored or which lead to inconsistent and unfair outcomes as between otherwise equally ranking unsecured creditors.

The decision of Gunns

In March 2013, Gunns Limited, a major forestry enterprise, was placed into liquidation, on account of over $780 million owed to its creditors. The liquidators of Gunns Limited alleged that Badenoch, a business which provided transportation and logging services to Gunns, received a numer of unfair preference payments from Gunns Limited during the relation-back period. The liquidators argued that those payments were unfair preference payments and insolvent transactions and thereby voidable transactions under section 588FE of the Act.

First instance

At first instance before the Federal Court of Australia, the liquidators contended that the application of the peak indebtedness rule is the correct method by which to measure the quantum of the unfair preference claim. In its defence, the creditor argued that the court should follow the New Zealand decision of Timberworld,³ which had the affect of abolishing the peak indebtedness rule in New Zealand.

The primary judge, in declining to follow Timberland, decided for the liquidators, accepting that the liquidators and Gunn Limited were entitled to elect the point of peak indebtedness as the initial point for the purposes of establishing the quantum of the preferential payment. The primary judge relied upon previous authorities which considered the peak indebtedness rule in the context of previous legislation.⁴

Appeal

On appeal, a critical issue was whether the liquidators and Gunn Limited were entitled to rely on the peak indebtedness rule to elect the starting point of the single transaction during the relation-back period pursuant to section 588FA(3) of the Act or otherwise.

The Full Court of the Federal Court of Australia unanimously decided that the peak indebtedness rule does not have application in Australia for three main reasons, namely as follows:

• The plain language of the legislation bolstered the creditor’s assertion that the rule was not intended to apply in the context of section 588FA(3) of the Act. The plain language of section 588FA(3) of the Act evidently requires all transactions forming part of the continuous business relationship to be considered as a single transaction. In contrast, the peak indebtedness rule allows the liquidator to separate the transaction into numerous parts, which is irreconcilable with the express language of the Act.⁵
• The peak indebtedness rule is inconsistent with the doctrine of ultimate effect which necessitates a holistic approach when assessing the net effect of payments forming part of the continuous business relationship.⁶
• The purpose of Part 5.7B of the Act is to ensure fairness as between otherwise equally ranking unsecured creditors, which means that creditors should be given the benefit of all earlier dealings within a continuous business relationship when determining whether there has been an unfair preference.⁷

The current position

Following the decision in Gunns, and subject to special leave being sought and granted or some further judicial clarity in the future, a liquidator and company in liquidation in the Federal forum will no longer be able to prosecute unfair preference claims by regard to the peak indebtedness during the relation-back period. Instead, liquidators must holistically assess the transactions to determine if the relationship is a continuing business relationship, and if so, the transactions will be considered as a single transaction.

For liquidators and creditors, a critical issue in assessing the preference payments is whether a continuous business relationship existed during the relation-back period and the parameters of that relationship. To determine this, the court will examine the transactions which comprise the purposed continuous business relationship and whether those payments were made predominantly in connection with the future supply of goods or services.⁸

The essential feature of the relationship is that the payments to the creditor were to induce the supply of future foods or services, not for the fulfilment of a past debt. If the payment is for the predominant purpose of paying or reducing a past debt, then the payment will not comprise part of the continuous business relationship single transaction notwithstanding the fact that subsequent services were also incidentally provided, and the payment would likely be regarded as an unfair preference.⁹

It might be possible to try to argue that those transactions which do not comprise the subsection 588FA(3) single transaction are still otherwise separately caught by subsection 588FA(1) of the Act, but Gunns has made it clear that one would need to somehow overcome the doctrine of ultimate effect in respect of those transactions. Separately, if a liquidator seeks to otherwise overcome Gunns, there may be fertile ground in another forum such as a state court and dabbling in the realm of judicial comity, stare decisis, and jurisdiction. However, such a course is likely to involve appeals in order to settle possibly conflicting law.

For the moment, the peak indebtedness rule is abolished in the Federal forum and as a matter of judicial comity, possibly the state forums as well. It remains to be seen whether any appeal arises out of Gunns or if further judicial clarity will be forthcoming regarding the peak indebtedness rule.