Peak indebtedness rule gone but fairness not forgotten

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The Full Court of the Federal Court held on May 10, 2021 that Liquidators were not entitled to apply the so called “peak indebtedness rule” for the purpose of determining whether there was an unfair preference under Section 588FA(1) of the Corporations Act 2001 (Cth).

The Full Federal Court abolished the “peak indebtedness rule” in favour of the stated purpose of the Act which is: “In essence to do fairness between unsecured creditors”.

The doctrine of “ultimate effect”, thereby, staged a delayed “return” as the appropriate test to apply to answer questions about whether payments to creditors constitute “unfair preferences” and section 588FA(3) of the Act, which concerns questions about when a payment to a creditor is part of a continuing transaction, was confirmed as not supporting the application of the “peak indebtedness rule”.

The Full Court held that:

“Section 588FA(3) of the Act embodies the doctrine of ‘ultimate effect’ which recognises that the general body of creditors are not disadvantaged by payments made to induce trade creditors to supply goods of equal or greater value”

and, that the embodiment of the doctrine of “ultimate effect”, as above stated:

“Is consistent with the purpose behind Pt 5.7B of the Act which aims to balance the interests of unsecured creditors and persons who have engaged in fair transactions with the insolvent company...The effect is to set apart certain trade creditors from the general pool of unsecured creditors and provide an incentive to continue providing value to companies in financial distress”.

I refer above to the doctrine of “ultimate effect” having staged a “delayed” return because the New Zealand Court of Appeal in its decision in Timberworld Ltd v Levin (2015) 3 NZLR 365 reached the same conclusion about the Australian law of peak indebtedness in 2015 and the various Courts in Australia have had an opportunity to consider and apply the law in the manner the Full Federal Court has now reconciled it since at least 1992, being when Section 588FA(3) was inserted into the Act, and as recently in the various “Gunns Limited (In Liquidation) (Receivers and Managers Appointed) decisions” in first instance in the Federal Court which, naturally, included the Appellant in the recent Full Federal Court decision and Edenborn Pty Ltd.

The Full Court’s decision includes a summary of the applicable principles for the purposes of determining whether any payment to a creditor was part of a continuing business relationship and is an exciting and compelling read for any person interested in the “preference claim” law in practice.

As a declaration of interest, John Park, Partner, in the Dentons Perth office, and author of this update was the lead solicitor and junior counsel in the below referenced “Edenborn proceedings in the Federal Court” and, therefore, will likely appear more excited than he needs to be about the recent Full Federal Court decision because, in his opinion, the Full Federal Court “got it right” by agreeing with the submissions put for his client in those “Edenborn proceedings”.

For reference:

Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (in liq) (receivers and managers appointed) [2021] FCAFC 64 delivered on May 10 2021.

Bryant, in the matter of Gunns Limited (in liq) (receivers and managers appointed) v Edenborn Pty Ltd [2020] FCA 715 delivered May 27 2020.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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