Full Court of the FCA ‘gunns’ the peak indebtedness rule
- Published 12.05.2021
- The FCA has applied a different formula to calculating the running account reduction to a liquidator’s unfair preference claim.
- The FCA said the New Zealand Court of Appeal’s approach in Timberworld Ltd v Levin (NZLR 2015) (Timberworld) ought to be adopted rather than the peak indebtedness rule which has been applied in Australia.
- Under the Timberworld approach all payments received by the creditor are netted off against further supply amounts to determine any preferential benefit to the creditor.
The running account reduction provisions
Under the Corporations Act 2001 (Cth) (Act) liquidators of insolvent companies can seek repayment of monies received by creditors of the company which were received by a creditor in the 6 months prior to liquidation in preference to other creditors. If the creditor can demonstrate there was a continuing business relationship, the various transactions may be viewed as a single transaction in determining any unfair preference to the creditor.
The peak indebtedness rule
The ‘peak indebtedness rule’ is a method used to calculate the deemed unfair preference amount under a running account in determining the ‘single transaction benefit’. Under the peak indebtedness rule the liquidator takes the difference between the peak indebtedness owing by the company to the creditor during the relation back period and the indebtedness owing by the company as at the relation back date.
The Timberworld approach
In New Zealand the deemed unfair preference amount includes all payments and transactions forming part of the running account and these amounts are netted off against one another. This method was outlined in Timberworld.
On 10 May 2021, the Full Court of the FCA handed down its decision on an appeal and a cross-appeal from the decision of a single judge in the FCA.
Badenoch Integrated Logging Pty Ltd (‘Badenoch’) provided logging and transport services to Gunns Ltd (in liq) (‘Gunns’). The liquidators of Gunns brought proceedings to recover 11 payments received by Banenoch in Gunns’ final months as unfair preference payments. The primary judge found there was a running account due to ongoing supply by Badenoch but only in respect of two out of the 11 payments and that the liquidators were entitled to apply the peak indebtedness rule. The appeal and cross-appeal concerned amongst other questions whether the peak indebtedness rule may be applied.
The Full Court concluded that the peak indebtedness rule has been incorrectly applied in the past and made the following comments following an examination of the origin of the peak indebtedness rule and the parliamentary intention of s588FA(3) of the Act:
- Notwithstanding that the peak indebtedness rule may have formed part of the common law, the Parliament was not intending to adopt the peak indebtedness rule in the context of s588FA(3) of the Act, the language in s588FA(3)(c) points clearly against the application of the peak indebtedness rule.
- Olifent v Australian Wine Industries Pty Ltd (FLR 1996) and the decisions which followed it, were wrongly decided.
- The peak indebtedness rule impermissibly severs the single transaction into two parts.
- Section 588FA(3) of the Act embodies the doctrine of ‘ultimate effect’ which recognises that the general body of creditors are not disadvantaged by payments made to induce creditors to supply goods/services of equal or greater value.
- Abolition of the peak indebtedness rule is consistent with the stated purpose of Pt 5.7B of the Act.
The Full Court agreed that the New Zealand Court of Appeal in Timberworld was the correct approach.
This decision is a good result for creditors. Below is an example of how it would work in practice.
|1 February 2019||$50,000|
|15 February 2019||$10,000||$60,000|
|1 March 2019||$30,000||$30,000|
|15 March 2019||$15,000||$45,000|
|1 April 2019||$20,000||$25,000|
|15 April 2019||$30,000||$55,000|
|16 April 2019||$30,000||$25,000|
Peak Indebtedness benefit $60,000 - $25,000 = $35,000
Timberworld benefit $80,000- $55,000 = $25,000