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Changes the Game for Creditors

How The Badenoch Ruling Changes the Game for Creditors

Last month, the Full Court of the Federal Court made a decision in the case of Badenoch Integrated Logging Pty Ltd v Bryant concerning the matter of Gunns Ltd and the distribution of their liquidated funds. The case was an appeal against the previous court decision in 2020, in which Gunns would have been able to apply the ‘peak indebtedness rule’ in their unfair preference claims against Badenoch.

The appeal ruled in favour of Badenoch and overturned the previous court decision, which means that there is a new precedent for applying the ‘peak indebtedness rule’ in unfair preference claims against creditors by liquidators, where there is a running account. This court ruling is a positive outcome for creditors in the future. We caught up with Craig Mason at SMS Law to discuss the changes, and how it will affect businesses in the future.

Some Quick Definitions:

Preferential payment: when a company in financial trouble has made payments to unsecured creditors ahead of secured creditors without a good reason to do so, other than following the personal preferences of the company’s directors. These transactions are deemed to be somewhat voidable.

Unfair preference claim: a claim that a preferential payment was made at the expense of the liquidator, or debtor.

Peak Indebtedness rule: a rule created by precedence in the case of Rees v Bank of New South Wales [1964] HCA 47 that allows liquidators to choose that the highest point of indebtedness, rather than the actual beginning date of the relation back-period, to be taken into account when determining preferential payments.

What actually happened?

Gunns was a Tasmanian business that dealt with forest management, wood chipping, sawmilling, and veneer production. They went into voluntary administration, and subsequently liquidated, in the 2012-2013 financial year.

Badenoch provided logging and transport services to Gunns, and in 2020, the liquidators of Gunns tried to recover 11 payments received by Badenoch as unfair preference payments. The court originally decided that the liquidators were entitled to apply the ‘peak indebtedness rule’ for two of their 11 payments, which meant that Badenoch would need to make repayments back to Gunns’ liquidators.

Badenoch contended that the running account with Gunns ran uninterrupted from the start to the end because, as creditors will know, there is a big difference between credits and debits that fall inside and outside the scope of the running account in regard to possible preference.

However, the recent appeal brought by Badenoch was about whether the ‘peak indebtedness rule’ should have been allowed, and when the running account relationship started and ended.

“The Court followed the decision of Timberworld (New Zealand case), and decided that the peak indebtedness rule does not form part of the law of corporate insolvency in Australia. In a running account situation, a liquidator must now look at the overall effect of the payments in the context of the continuing business relationship”

– Craig Mason, SMS Law

Using the Timberworld Ltd v Levin case as precedent, the court ruled that the ‘peak indebtedness rule’ had been applied incorrectly and should not apply in this case.

What has changed?

The ruling in Badenoch Integrated Logging Pty Ltd v Bryant effectively removed a liquidator’s ability to apply the ‘peak indebtedness rule’ when pursuing unfair preference claims in the instance of a running account. The decision included a summary of what factors need to be considered when determining whether a payment to a creditor was made as part of the running account.

“The Full Court provided a summary of the factors indicating a continuing business relationship and therefore where section 588FA of the Corporations should apply, including:

Must be a mutual understanding of a continuing business relationship;
Was the payment made in connection to further supply? If so, was the payment made to discharge past debts or to induce further supply, or both?
If the payment was made to discharge past debts on the account it does not necessarily mean a cessation of the continuing business relationship;
A stop on the account will not necessarily cease the continuing business;
Knowledge or suspicion of insolvency does not automatically stop the continuing business relationship.”

– Craig Mason, SMS Law

In the future, a liquidator must now look at the overall effect of the payments in the context of the running account, which can help to reduce the negative impact for creditors in future unfair preference claims made by liquidators.

What does this mean for creditors?

The new court ruling is a positive outcome for creditors because the Badenoch Integrated Logging Pty Ltd v Bryant appeal case sets a precedent in favour of creditors for future unfair preference claims. The likelihood for a creditor to face an unfair preference claim should significantly reduce, and the application of the ‘peak indebtedness rule’ in running account situations is now much clearer. This should help ensure that all unsecured creditors are treated equally in the period leading up to the appointment of a liquidator of a company.

“The decision may reduce the value of potential preference claims made by liquidators and, should you receive correspondence from a liquidator regarding a preference claim, it will be imperative that the running account/continuing business relationship be scrutinised.”

– Craig Mason, SMS Law

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