High Court delivers for liquidators with one judgment but takes away with another

The High Court's decisions in Metal Manufacturers Pty Limited v Morton [2023] HCA 1 and in Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2 provide a win for liquidators in one judgment and a loss in the other.

The win

In Morton the High Court answered a resounding "No" to the question: "Does s 553C of the [Corporations] Act entitle a creditor to set off an amount equivalent to that received as an unfair preference in repayment of a debt, which the creditor is ordered...[by a court] to repay to a company in liquidation, against the amount of another debt which the creditor can prove in the winding up of the company?"

We like Justice Gageler's simple reasoning: "There is...no mutuality of interest between an amount of an unfair preference which a creditor is ordered under s 588FF(1)(a) of the Act to repay to a company in liquidation and a debt incurred by the company provable by the creditor in the winding up of the company."

The loss

In Badenoch, the High Court administered the last rites to the "peak indebtedness rule" that liquidators often rely on when considering a running account in an unfair preference claim. Liquidators used to look at the running account between the debtor and creditor and choose the point of "peak indebtedness" in the six months prior to their appointment, and then compare that against the balance of the account at the time of their appointment. If the debtor's indebtedness to the creditor had decreased during that time (because the creditor had worked at recovering the debt owed to it), the liquidators could seek to recover the difference from the creditor as a voidable unfair preference.

The High Court looked at the Explanatory Memorandum to the relevant part of the Corporations Act and the cases that developed and applied the peak indebtedness rule. It held that the rule has no place in a liquidator's analysis of a running account and that earlier cases that had applied it were wrongly decided. Instead, a liquidator must look at all the transactions in the running account during the relevant period to decide whether the ultimate effect is an increase or decrease in the indebtedness of the debtor during the period. Only a decrease in indebtedness could then be pursued by the liquidator as an unfair preference.

The decision may make some unfair preference claims uneconomic for liquidators to pursue.

Which transaction in the running account is the first a liquidator can look at?

The High Court clarified that, if the company in question is insolvent before the start of the relation-back period, the first transaction in the period is the one to compare against the indebtedness at the end. If the company becomes insolvent after the start of the relation-back period, it is the first transaction after the date of insolvency.

Assessing the continuing business relationship

In seeking to defend a liquidator's unfair preference claim, a creditor will often say that there was a continuing business relationship with the debtor, such that the debtor's payments to the creditor induced further supply that came to be of benefit to the debtor. In response, the liquidator will point to events in the relationship that they say amount to an end to that relationship (such as stopping supply), and will say that all payments after that point reduced the debtor's indebtedness to the creditor and were preferential.

The High Court has now emphasised that it is necessary to consider the whole of the evidence of the "actual business" relationship between the parties in assessing whether the continuing business relationship is at an end. The creditor in Badenoch ceased supply to the debtor at one point and renegotiated additional credit terms but then recommenced supply. The High Court found that to have maintained the continuing business relationship and payments made at that time were not recoverable by the liquidators. Later though, the creditor proposed termination of the supply and received payments mostly in reduction of the debtor's indebtedness to the creditor. The relationship was found to be at an end and those payments were found to be unfair preferences.

Key takeaways

A creditor cannot set-off a debt still owed to it by the company against a liquidator's recovery of an unfair preference claim from the creditor during the liquidation.

The peak indebtedness rule is no longer part of a liquidator's tool bag in unfair preference claims. The High Court has clarified the starting point for a liquidator's analysis of the running account between a creditor and debtor. Common debt recovery steps like a creditor stopping supply will not necessarily bring an end to the continuing business relationship between the creditor and debtor

Our team of Insolvency & Restructuring experts is available to guide liquidators and creditors through these judgments and to assist with their application to particular unfair preference recovery claims that are underway or that may emerge in the future.

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