TGIF 24 February 2023 – Something for everyone: High Court sets the record straight on unfair preference claims

The decisions in Metal Manufactures Pty Limited v Morton [2023] HCA 1 and Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2 have been viewed as conflicting for liquidators. In this week’s TGIF, we examine these proceedings and why the decisions benefit both liquidators and creditors.

Key takeaways

• The ‘peak indebtedness rule’ has been abolished, meaning liquidators can no longer choose the highest value of the debt as the starting date for the assessment of a single ‘running account’ transaction in an unfair preference claim.
  
  
• The ‘business character’ of a transaction will be assessed objectively to determine whether the running account constitutes a ‘continuing business relationship’.
  
  
• A liability arising from an unfair preference claim cannot be set-off by a debt against the company in liquidation.
  
  
• For the purpose of set-off, ‘mutual dealings’ with a company in liquidation are not the same as dealings with the liquidator of that company.

Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2

Background

The liquidators of a timber company, Gunns Limited (in liq) (Gunns), sought to recover payments to a timber services supplier, Badenoch Integrated Logging Pty Ltd (Badenoch) as an unfair preference.

The Federal Court trial judge agreed that the peak indebtedness rule applied under section 588FA(3) of the Corporations Act 2001 (Cth) (Act), in support of Gunns’ liquidators’ unfair preference claim. That decision was overturned on appeal to the Full Court of the Federal Court. Our earlier coverage of the Full Court’s decision is available here.

The liquidators for Gunns were subsequently granted leave to appeal to the High Court. 

The ‘peak indebtedness rule’

The primary question considered by the High Court was whether a liquidator could choose the starting date of the single running account transaction within the prescribed statutory period to prove the existence and quantum of an unfair preference payment.

The High Court answered this question in the negative.

The High Court’s decision means that:

• liquidators can no longer choose the starting date of the single running account transaction when formulating and advancing an unfair preference claim;
  
  
• liquidators must consider the ultimate effect of the transaction;
  
  
• the relevant ‘starting date’ for assessing the continuing business relationship is either the first transaction after the beginning of the statutory period or after the date of insolvency or (where the relationship starts after the beginning of the period or date of insolvency) the first transaction after the beginning of the continuing business relationship, whichever is later; and
  
  
• liquidators must consider the net result of these transactions in determining whether an unfair preference claim is sustainable.

Continuing business relationship

The unfair preference regime in respect of running accounts only captures transactions which are, for commercial purposes, an integral part of a continuing business relationship. Transactions meeting this description are treated as a single transaction in assessing whether an unfair preference payment has been made.

In this case, the High Court held that:

• in assessing whether or not a “transaction is, for commercial purposes, an integral part of a continuing business relationship”, it is necessary to conduct an objective factual inquiry. The underlying intentions of one or both of the parties to the transaction may be relevant to, but are not determinative of, this question;
  
  
• the task is one of characterisation of the facts, involving an objective ascertainment of the ‘business character’ of the relevant transactions; and
  
  
• it is therefore necessary to consider the whole of the evidence of the ‘actual business’ relationship between the parties.

Applying this approach, the High Court considered that certain payments were made by Gunns to Badenoch after the parties had agreed to terminate the contract and transition to a new supplier to replace Badenoch. This meant that the business relationship between the parties was at an end at the time these later payments were made. In contrast, the High Court considered that earlier payments by Gunns to Badenoch were made to continue the pre-existing relationship between the parties, irrespective of whether the amounts were paid in reduction of past indebtedness or to induce further supply.

Having identified the transactions that formed part of the continuing business relationship between the parties, the ultimate result was that the net indebtedness of Gunns to Badenoch increased during the period in question. Necessarily, there could be no unfair preference relating to the deemed single transaction.

Metal Manufactures Pty Limited v Morton [2023] HCA 1 

Background

In the six months prior to its winding up, MJ Woodman Contractors Pty Ltd (MJ Woodman) made two payments, one for A$50,000, and the other for A$140,000, to Metal Manufactures Pty Ltd (Metal Manufactures). Separately, and not in contention, was a debt of A$194,727.23 that was owed to Metal Manufactures by MJ Woodman.

The liquidators of MJ Woodman sought to recover both payments to Metal Manufactures, on the basis that they constituted an unfair preference under section 588FF(1)(a) of the Act. Metal Manufactures sought to set-off the liquidator’s claim against the A$194,727.23 debt it was owed, relying on section 553C(1) of the Act to do so.

The trial judge referred the question of whether set-off was available in the circumstances to the Full Court of the Federal Court. The Full Court held that set-off was not available: a decision that Metal Manufactures sought to appeal before the High Court.

High Court decision

The High Court upheld the ruling of the Full Court of the Federal Court and dismissed the appeal.

For their Honours, section 553C(1) only operated to set-off liabilities that existed before the winding up of a company. In other words, set-off is only available where:

• there is a liability to set-off against; and
  
  
• the liability being set-off arose prior to the creditor company entering liquidation.

It was not in dispute that the unfair preference claimed by the liquidator of MJ Woodman would constitute a liability to Metal Manufactures. However, the liquidator’s right to pursue that claim under section 588FF(1)(a) only crystallised after the commencement of the liquidation of MJ Woodman, rendering it ineligible for set-off.

In any event, their Honours considered that set-off would not be available as there was no ‘mutuality of interest’. MJ Woodman, a company, owed a debt to Metal Manufactures, not the liquidator of MJ Woodman, who was acting on behalf of its creditors. To recover that debt, Metal Manufactures would have to prove for their debt in the ordinary way.

Comment

Among insolvency practitioners, the High Court decisions in Bryant v Badenoch and Metal Manufacturers v Morton were both anticipated and dreaded. In the days since the decisions were handed down, the commentary has been largely uniform: Bryant v Badenoch was good news for creditors and bad news for liquidators, while the opposite was true of Metal Manufactures v Morton.

A deeper dive into the decisions, however, reveals a benefit to both: clarity. Liquidators will no longer push to apply the peak indebtedness rule and creditors will no longer consider set-off as a standard form response.

The decisions assist liquidators by simplifying the route to settlement in unfair preference claims before the commencement of proceedings. Equally, in simplifying the work of liquidators, more funds may also be left in the pool for creditors.