Key points [sidebar]
- Statutory set-off under Corporations Act s 553C is unavailable to respondents to unfair preference claims, and by extension unavailable to respondents to insolvent trading claims.
- The ‘peak indebtedness rule’ has no basis in current law.
- Within a s588FA(3) ‘continuing business relationship’, the assessment of unfair preference is to be made by considering the ultimate effect of all transactions during the relevant period in the relationship as a whole.
- Whether a transaction is an integral part of a continuing business relationship involves an objective factual inquiry. Intention may be relevant but is not determinative. An objective assessment of the business character of the transaction is necessary, as is the whole of the evidence of the actual business relationship between the parties.
- The quantum of the preference is to be calculated as follows:
- The start date of the calculation period is the later of the first transaction after (a) the start of the prescribed period; or (b) the date of insolvency;
- The end date of the calculation period is the earlier of either (a) the date of commencement of the winding up; or (b) the date the continuing business relationship ceased to exist;
- All transactions during the calculation period are then netted off against each other.
Introduction
In two highly anticipated decisions handed down on 8 February 2023— Metal Manufactures Pty Ltd v Morton [2023] HCA 1 (Morton) and Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2 (Bryant)—the High Court has resolved two areas of uncertainty in respect of external administrations under Part 5.7B of the Corporations Act 2001(Cth) (the Act), which had lingered since enactment of the so-called Harmer Amendments in 1993.
As a result of the High Court’s decisions, it has now been confirmed that a creditor cannot use the statutory set-off provision in s553C to defend against an unfair preference claim and the ‘peak indebtedness rule’ is unavailable to liquidators in unfair preferences claims.
Morton
In Morton, Kiefel CJ, Gordon, Edelman and Steward JJ, with Gageler J concurring in a separate judgment, upheld the finding of the Full Federal Court that statutory set-off under s553C is not available to a defendant in a proceeding for the recovery of an unfair preference under s588FA of the Act.
Section 553C includes a temporal element which looks at the rights of the parties as at the time of the winding up. In order for a set-off to be available, there must be “an obligation or liability prior to liquidation”. A cause of action for recovery of an unfair preference does not come into existence until after commencement of the winding up and, accordingly cannot be the subject of any set-off against pre-existing amounts owing to the creditor.
Further, there is no mutuality with the pre-existing amount owed to the company by the creditor, as there is no dealing between the same persons, with the liability created by s588FF(1)(a) being one that arises upon the application of the liquidator, not in their capacity as an agent of the company but in the liquidator’s own right as an officer of the Court. Similarly, the amount recoverable under s588FF(1)(a) is neither for the liquidator’s own benefit nor for the benefit of the insolvent company. Rather, any amount recovered would be applied under the statutory scheme of liquidation for purposes of priority payments and pari passu distribution to creditors.
The Court said that permitting a preferred creditor to use s553C to set off its liability would “undermine a purpose of the recovery of unfair preferences …which is to restore to the pool of distributable assets those payments made under voidable transactions”.
While the specific facts of this case related to an unfair preference action under s 588FA, the reasoning of the High Court applies to any claims brought under s588FF regarding voidable transactions more generally, and likely by extension in insolvent trading claims brought under s588M.
Bryant
Jagot J gave the lead judgment in Bryant, concluding that Pt 5.7B of the Act does not incorporate the ‘peak indebtedness rule’ (which previously operated to permit a liquidator to choose the high point of indebtedness for purposes of calculating reduction in indebtedness in an unfair preference claim).
Determining whether a transaction is an integral part of a continuing business relationship for purposes of s588FA(3) “involves an objective factual inquiry”, requiring consideration of “the whole of the evidence of the ‘actual business’ relationship between the parties”.
For a continuing business relationship that began before the prescribed period, the High Court held that the relevant transactions forming part of the relationship for the purpose of s588FA(3)(c) must be transactions within the prescribed period and which are entered into when a company is insolvent or have the effect of causing the company to become insolvent.
This means that “the first transaction that can form part of the continuing business relationship contemplated by s 588FA(3) is either the first transaction after the beginning of the prescribed period or after the date of insolvency, or (if the relationship started after the beginning of the prescribed period or the date of insolvency) the first transaction after the beginning of the continuing business relationship, whichever is the later”.
Her Honour noted that s588FA(3) incorporates the ‘running account principle’ but this does not mean that the ‘peak indebtedness rule’ is also incorporated. Rather, s588FA(3) is to be read “as embodying the ‘running account principle’ and its associated requirement to determine the question of an unfair preference by reference to the ultimate effect of the transactions during the relevant prescribed period in the running account as a whole”. The relevant starting date for this assessment is dictated by the operation of s588FA(3)(c) and cannot be chosen by the liquidator.
Liquidators calculating the quantum of unfair preference claims in circumstances of a continuing business relationship need to identify the start and end dates of the relevant period, by reference to the duration of the continuing business relationship, the 6 month relation-back period provided in s588FE(2)(b) and the date of insolvency, and then calculate the net effect of all transactions during the relevant period.
Conclusion
Morton finally disposes of any doubt regarding set-off as a defence but Bryant represents a change in the approach to quantum in running account cases by ruling out the “peak indebtedness rule”. Liquidators will be happy to see the back of the perennial set-off arguments, but will no longer have the luxury of choosing the high point of the running account. Both decisions provide a welcome degree of certainty and clarity in this space.
The abolition of the peak indebtedness rule and emphasis on the “objective factual inquiry” in identifying the transactions which constitute a continuing business relationship means that moving forward liquidators will need to closely analyse all available evidence to properly categorise the nature of the business relationship with the relevant creditor. This will be crucial for both the assessment of the value of any unfair preference claim and the proper pleading of any such claim. Time will tell whether the Bryant decision will cause liquidators to become more bullish when it comes to choosing dates of insolvency.
Author: Allie Umoff, Special Counsel, LK
