by Bradley Vos

A recent judgment in the full federal Court of Australia (Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (In Liq)) (“Gunns Case”) has found that a liquidator is unable to apply the ‘peak indebtness rule’ for the recovery of unfair preference payments under Section 5.7B of the Corporations Act (“The Act”) between an Insolvent Company and Trade Creditors with a continuing business relationship.

Overview of Recovery of Unfair Preference payments

Under Division 2 of Part 5.7B of the Act, a transaction between a creditor and Insolvent entity may be voidable against a Liquidator if the transaction ultimately results in the creditor receiving from the company, more than it would otherwise receive if the transaction was set aside, with the creditor proving for this debt in the winding up.  In situations where a continuing business relationship exists, which is where the level of indebtness to the creditor is increased and reduced over this time through a series of transactions, the series of transactions forms a single transaction that may give rise to an unfair preference.

What is the Peak Indebtness Rule

In circumstances with a running trade account between a supplier and Insolvent entity in a continuing business relationship, a Liquidator was able to select any point in time within the relationship (and the Relation back period) from which the voidable preference payments would commence.  This is typically the point in time when the Company is most indebted to the supplier so as to maximise the difference between this amount and the closing balance on the relation back day.  In doing so, Liquidators maximised the quantum of any claim for unfair preference payments made to the supplier in this time.

Court’s View

The Court considered however, that the purposes of 5.7B of the Act do not align with this approach, which is to “do fairness between unsecured creditors”.  To this end, the Court emphasised the “doctrine of ultimate effect” which provides incentives, in the form that no preference will exist, for trade creditors that continued supply to the insolvent company, providing value to the Company during this time of financial distress.

Ultimately, Liquidators must now take a more considered approach to determining the quantum of any preference claims against trade creditors by examining a more global view of the dealings between the Insolvent and trade creditor in determining if there has been a benefit to the trade creditor over and above what has been supplied.  This will also further incentivise trade creditors, or those with a continuing business relationship to continue doing business with Companies experiencing some form of financial hardship, which would likely be significant portion in today’s uncertain economic climate.

Brad is a Senior Financial Analyst at Condon Advisory Group. He specialises in Personal and Corporate Insolvency.