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23 Jul 2020

As liquidators prefer it – the doctrine of peak indebtedness is here to stay

By Alistair Fleming and Melissa Ferreira

This decision puts to rest some of the uncertainty which arose due to the NZCA's approach in Timberworld and helps to solidify liquidators' prospects of recovering maximum preferential payments.

Preferential payments can be an important source of funding for liquidators – and the recent decision in Bryant in the matter of Gunns Limited v Bluewood Industries Pty Ltd [2020] FCA 714 is a source of some relief for liquidators.

Timberworld – uncertainty over the impact on Australian liquidators

Australian courts have for a long time accepted the doctrine of "peak indebtedness" which enables a liquidator to claim the difference between the peak and lowest points of indebtedness of a "running account" during the relation back period, as the value of the unfair preference.

New Zealand however, which has a provision nearly identical to Australia's section 588FA, has a different view. In the New Zealand Court of Appeal (NZCA) decision in Timberworld Ltd v Levin [2015] NZCCLR 12, the NZCA rejected the Australian position and policy justifications instead deciding on the basis of a "plain meaning" reading of the provision, that "to arrive at some artificial point during the course of all the relevant transactions and to select the date of peak indebtedness (resulting in the transactions prior to this point being disregarded) would be to ignore the express wording used by Parliament". The NZCA also closely considered Airservices Australia v Ferrier (1996) 185 CLR 483 where the Australian High Court had held "[the purpose of the running account principle is] to ensure that the effect of a payment made during the six month period cannot be viewed in isolation from the general course of dealing between the creditor and the debtor before, during and after that period". The Australian High Court went on to conclude it would be "necessary to consider the ultimate and not the immediate effect of individual payments".

Australia not swayed – the doctrine continues to apply

Since the Timberworld decision, there has been a question mark in Australia as to whether and to what extent Australian courts would change their approach to this doctrine, having regard to the views of the NZCA in relation to an almost identical provision. The risk is that, if the New Zealand position was to be followed in Australia, the value of preferential payments ultimately recoverable by a liquidator in a running account scenario could be significantly reduced, as the focus would be more on payments in isolation rather than the overall course of dealing.

The recent Federal Court of Australia decision in Bryant in the matter of Gunns Limited v Bluewood Industries Pty Ltd helpfully considered the NZCA approach in Timberworld and ultimately determined not to follow it in Australia.

In Gunns v Bluewood, Justice Davies disagreed with the NZCA, instead finding both the ultimate effect and peak indebtedness doctrines were reconcilable because (as held by the majority in Compass Airlines) "the whole point of the [ultimate effect doctrine is] to ensure that the effect of a payment that induces the further supply of goods and services is evaluated by the ultimate effect that it has on the financial relationship of the parties". In other words, where a running account exists, the nature and effect of the dealings as a whole becomes more significant than the individual payments, as it is those dealings which lead to the continued trading and ultimately the true value of the preference.

Preferential payments

This decision puts to rest some of the uncertainty which arose due to the NZCA's approach in Timberworld and helps to solidify liquidators' prospects of recovering maximum preferential payments – an important source of free assets in most liquidations.

It is also a reminder of the potentially large amounts of risk faced by companies trading on a running account basis through the COVID-19 pandemic. Given the widespread economic impact of the pandemic, it is expected recipients of alleged preferential payments will have increased difficulty establishing that they or a person in their shoes did not have a reasonable basis to suspect that the company was insolvent at the time they received the payments.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.