High Court Gunns down Peak Indebtedness Rule

On 8 February 2023, the High Court handed down its highly anticipated judgment in Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2. The upshot of the decision '€“ the Full Court of the Federal Court's decision has been upheld and the peak indebtnedness rule has been abolished.'  You can read our analysis of the earlier decision here. In the proceeding, the Court considered three questions arising from the proper construction of ' s.588FA(3)(a) of the Corporations Act 2001 ("Act"), being the statutory embodiment of the "running account principal."'  That principal, in effect, requires all payments and all supply forming part of a continuing business relationship to be treated as a single transaction, for the purposes of determining whether a transaction is an unfair preference. The judgment was written by Jagot J with Kiefel CJ, Gageler, Gordon, Edelman, Steward, Gleeson JJ unanimously agreeing.

The peak indebtedness rule

Firstly, the Court asked '€“ does s.588FA(3) of the Act permit or exclude the operation of the "peak indebtedness rule."'  That rule, in effect, allows a liquidator to choose the starting date within the statutory period for the purposes of the "single transaction" (typically the point of peak indebtedness - thereby maximising any unfair preference claim). After a comprehensive analysis of the history of s.588FA(3), and the formation of the peak indebtedness rule, the Court held that it is not incorporated in s 588FA(3):

"'€¦the cases which concluded that the "peak indebtedness rule" is to be read into s. 588FA(3) of the Corporations Act wrongly assumed that the "running account principle" included the "peak indebtedness rule", did not involve full argument on or reasoning about the issue, or must now be considered to be wrong in that respect.[76]'€¦"

Rather, the first transaction that can form part of the continuing business relationship is either:

• the first transaction after the beginning of the relation-back period; or
• the first transaction after the date of insolvency; or
• (if the relationship started after the beginning of the relation-back period or date of insolvency) the first transaction after the beginning of the continuing business relationship,

whichever is the later. The Court emphasised that the purpose of the running account principal is not to maximise the amount recoverable by the liquidator which is, in effect, how the "peak indebtedness rule" operates.'  Rather, the running account principle recognises that a creditor that continues supply to a potentially insolvent company enables the creditor to continue trading, which potentially benefits all creditors.'  This is why the section requires all transactions in the continuing business relationship to be deemed as a "single transaction", and netted off against each other.

When does a continuing business relationship exist?

Next, the Court asked '€“ how do we determine whether a "transaction is, for commercial purposes, an integral part of a continuing business relation" as referred to in s 588FA(3)(a) of the Act? The Court held that the task is one of characterisation of the facts, involving an objective ascertainment of the "business character" of the relevant transaction and a consideration of the whole of the evidence of the "actual business" relationship between the parties:

'€¦it is not the case that a continuing business relationship necessarily continues unless and until it can be inferred that the sole mutual assumption or purpose of the creditor and debtor in respect of the transaction is the reduction of indebtedness'€¦ The statutory task remains one of characterisation of the facts [85].

Were specific payments part of the running account?

Finally, the Court asked '€“ were certain payments from Gunns Limited (in liq) ("Gunns") to Badenoch Integrated Logging Pty Ltd ("Badenoch") an integral part of a continuing business relationship within the meaning of s 588FA(3) of the Act? The Court held that the Full Court did not err in its conclusions that:

• certain payments were transactions forming an integral part of the continuing business relationship;
• other (later) payments were not transactions forming part of the continuing business relationship; and
• the continuing business relationship did not cease until 10 July 2012 (when Badenoch ceased supplying to Gunns for a second time) and that, applying s 588FA(1) to the deemed single transaction created by s 588FA(3)(c) and as required by s 588FA(3)(d), there could be no unfair preference given by Gunns to Badenoch.

The Court emphasis that "[t]he necessary focus is on the "actual business" relationship, "in a business sense" [89].

Take Aways

The High Court's affirmation of the Full Court of the Federal Court's decision to abolish the peak indebtedness rule is a significant departure from what was regarded as settled law in Australia. While the decision was not unexpected, given the difficulty in faulting the Full Court of the Federal Court's reasoning, it represents a substantial blow to liquidators. The decision confirms the increase in the threshold that liquidators will have to meet to show the termination of a continuing business relationship, and significantly limits a liquidator's ability to pursue an unfair preference claim in the context of a continuing business relationship.