In summary, the High Court held that:

• A liquidator cannot rely on the ‘peak indebtedness rule’ when bringing unfair preference claims; and
• It is not possible to set-off a debt owed to a creditor by a company in liquidation against the liquidator’s voidable transaction claim against the creditor.

Peak Indebtedness, and Badenoch

If a creditor has a continuing business relationship and operates a running account with a company that subsequently has a liquidator appointed, and the company’s liquidator then seeks to recover any particular payments (unfair preferences) made by the company to the creditor, a court will consider the continuing business relationship as a whole (and, in effect, the running account as a single transaction). Accordingly, in such circumstances, the liquidator can recover only the amount constituting the net advantage to the creditor. The Corporations Act recognises that a creditor who continues to supply the company effectively facilitates the continuing trade of the company, to the benefit of other creditors.

If there is a net reduction in the company’s indebtedness to the creditor during that running account period, then that will constitute an unfair preference to that creditor, save that any unfair preference conferred more than six months before the commencement of the external administration is not voidable.

Liquidators would often try to choose a particular point in that six-month/ relation-back period, being a point of ‘peak indebtedness’ of the running account, to argue that there was a net advantage to the creditor as a result of any subsequent payments that were made by the company.

The High Court was required to determine whether the ‘peak indebtedness rule’ was an appropriate approach, and over what period within that six-month/ relation-back period should any calculation be made. For example, possible approaches include:

• the period from when the continuing business relationship started within the six months (as the creditor argued);
• the period of the continuing business relationship, starting from the point of ‘peak indebtedness’ (as the liquidator argued); or
• the whole period of the continuing business relationship, not limited to six months.

The High Court held that the first approach was correct. The Court also held that the focus should be on the nature of the commercial relationship between the parties at the time of the running account, and the objective character of the payments.

Set-off of claims, and Metal Manufacturers

Often a creditor has mutual debts with a company that subsequently has a liquidator appointed. The question for the High Court to determine was whether a creditor could, in the case of an unfair preference claim by a liquidator, deduct (or set-off) their claim against the company from their liability to the liquidator.

The High Court held:

• the creditor’s debt to the company only comes into existence after the company’s liquidation commences and a court makes an order in proceedings brought by the liquidator that a payment constitutes an unfair preference. Accordingly, at the moment immediately prior the commencement of the liquidation, the liquidator and the company had no claim against the creditor capable of being set off.
• the relevant transactions cannot constitute mutual debts, as the transacting parties are different in each case. That is, one transaction is between the creditor and the company (prior to liquidation), whereas the other transaction is between the creditor and the liquidator.Further, the benefit derived from the transactions differs, with one transaction being for the benefit of the company, whereas the other transaction is for the benefit of those entitled to be paid in accordance with the proof and ranking of debts and claims admitted in a liquidation.

Conclusion

The decisions of Badenoch and Metal Manufacturers provide mixed outcomes for creditors and liquidators alike.

Badenoch will prevent liquidators from relying on the ‘peak indebtedness’ rule and, in turn, reduce claims, and the quantum of potential unfair preference claims, against creditors if running accounts were involved.  Badenoch prevents liquidators from choosing particular convenient dates in the assessment of any net advantage to a creditor.

Conversely, Metal Manufactures provides greater certainty and confidence to liquidators to reject set-off claims made by creditors in the context of unfair preference claims. In turn, Metal Manufacturers provides liquidators with potentially greater returns in the administration.

Further information / assistance regarding the issues raised in this article is available from the author, Bill Fragos, Special Counsel or your usual contact at Moray & Agnew.