A mixed bag for liquidators in High Court decisions on claims of unfair preference or other voidable transactions

The Restructuring & Insolvency team
09 Feb 2023
Time to read: 4 minutes

Insolvency practitioners and creditors facing voidable transaction claims will need to reassess the value of any potential or threatened unfair preference claims or other voidable transaction claims, following two important insolvency decisions in the High Court yesterday (Metal Manufactures Pty Limited v Morton [2023] HCA 1 (Metal Manufactures); Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2 (Badenoch).

It held that:

  • there is no set-off between a debt owed to a creditor by a company in liquidation and the liquidator’s voidable transaction claim against the creditor; and
  • a liquidator cannot rely on the “peak indebtedness rule” when bringing unfair preference claims.

Set-off between a liquidator’s and creditor’s claims

Where there have been mutual debts, claims or dealings between an insolvent company in liquidation and its creditor, they are set off against one another, and only the balance can be claimed by the company or against the company (as the case may be). Does the set-off apply as between a claim that the company’s liquidator has against a creditor and the creditor’s claim against the company? Historically set-off was thought to be precluded but, for at least 15 years, courts have held (albeit occasionally reticently) that it applies, so that a creditor can deduct their claim against the company from their liability to the liquidator. The High Court decided today in Metal Manufactures that that is not permitted.

The Full Federal Court had held that set-off was not available against a liquidator’s unfair preference claim. The creditor appealed on the grounds that:

  • at the time of the commencement of the liquidation, the liquidator’s claim exists and can therefore be set off against the creditor’s claim, even though the claim depends on a liquidation subsequently occurring and the liquidator bringing proceedings; and
  • the liquidator’s claim against the creditor and the creditor’s claim against the company are “mutual”, because the liquidator holds their claim for the benefit of the company.

The High Court rejected these arguments and dismissed the appeal. It held that:

  • at the crucial time, being the moment immediately before the commencement of the liquidation, the liquidator and the company had no claim against the creditor that could be set off. The creditor’s debt to the company comes into existence only after the liquidation commences and the Court makes an order in unfair preference proceedings brought by the liquidator;
  • the dealings are not mutual. One dealing is between the creditor and the company and the other is between the creditor and the liquidator (who acts as an officer of the court, not an agent of the company). The beneficial interests in the claims are also not mutual. The payments were for the benefit of the company but the unfair preference claim is not for the benefit of the company. Instead, the benefit of the unfair preference claim is for the people entitled to be paid in accordance with the statutory provisions for the proof and ranking of debts and claims in a liquidation.

The Court unanimously concluded that set-off against a liquidator’s voidable transaction claim is not permitted and that a series of cases saying otherwise (including Re Parker, Buzzle Operations v Apple Computer and Hall v Poolman) were wrongly decided.

Peak indebtedness: what part of the continuing business relationship counts?

Where a person had a continuing business relationship with a company that goes into liquidation, and the company’s liquidator seeks to recover payments made by the company to the person as unfair preferences, the continuing business relationship is assessed as a whole and only the net preferential effect can be clawed back by the liquidator. For example, a supplier who regularly supplied goods to the company and regularly received payments would only be liable to repay the amount by which the payments exceeded the value of the goods. An unfair preference conferred more than six months before the commencement of the external administration is not voidable under the Corporations Act.

The question for the High Court in Badenoch was: over what period within the six month period should the calculation be made? There are several possible answers, including:

  1. the period of the continuing business relationship within the six months. The creditor argued that this was the correct approach;
  2. the period of the continuing business relationship, starting from the point of “peak indebtedness” in the running account within the six months (because the liquidator may choose to impugn only the transactions for that shorter period). The liquidator argued that this was the correct approach; or
  3. the whole period of the continuing business relationship, not limited to six months. Although the Full Court left this possibility open, neither the creditor nor the liquidator argued that it was correct and the High Court rejected it.

The High Court unanimously held that the first approach was correct. The relevant period is the period within the six months from when the continuing business relationship started or the company became insolvent, whichever is later.

The Court was also required to consider how to determine whether a transaction is “an integral part of a continuing business relationship”. It held that the focus should be on the nature of the commercial relationship between the parties at the time of the transaction and the objective character of the payment.

Key takeaways

The Metal Manufactures decision will be welcomed by liquidators, whose voidable transaction claims are now likely to recover significantly more for creditors than they have in the past.

As we flagged in From Red to Black in the event the High Court was to displace the peak indebtedness rule, the Badenoch decision will be a disappointment to liquidators, whose unfair preference claims will reduce in value and who can no longer choose the optimal period over which to calculate a running account.

Conversely, Badenoch will benefit creditors who receive payments in the six months before a company’s external administration who are able to demonstrate that they received them as an integral part of a continuing business relationship with the company.

The characterisation of a payment as being, or not being, an integral part of a continuing business relationship will therefore depend less on the parties’ mutual assumptions or purposes in making or receiving payments, and more on its objective business character.

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