Australia: Gunns Liquidators Prevail On Peak Indebtedness, Set-Off And The Court's Discretion

This week, the Federal Court published judgments in three unfair preference claims brought by the liquidators of the Gunns Group. We acted for the liquidators in each proceeding.

The liquidators were successful in each proceeding. The judgments provide clarity on some previously debated aspects of Australia's unfair preference regime. The key matters are discussed below. The three judgments are available here: Edenborn, Bluewood, Badenoch.

Peak indebtedness rule

The judgments affirm the operation of the peak indebtedness rule in Australia.

The peak indebtedness rule applies where the preferred creditor and the insolvent company conducted business on the basis of a running account. The rule provides that it is open to a liquidator to calculate the value of the preference claim by subtracting the debt due to the creditor on the relation back day from the debt due to the creditor at the highest point of indebtedness in the running account during the relation back period.

There has been debate about whether the peak indebtedness rule should continue to apply in Australia following the New Zealand Court of Appeal decision in Timberworld Ltd v Levin [2015] 3 NZLR 365 (Timberworld), which held that the peak indebtedness rule does not apply in New Zealand (based on a similar statutory provision to s588FA(3) of the Corporations Act).

All three defendants in the Gunns proceedings relied on Timberworld to argue that previous Australian cases that applied the peak indebtedness rule were wrongly decided and should not be followed.

The Federal Court was not persuaded that the peak indebtedness rule no longer applies under Australian law. In affirming the rule's operation, the Court disagreed with the conclusion in Timberworld that the peak indebtedness rule "does violence" to the ultimate effect doctrine as recognised by the High Court of Australia.

Set-off

Two of the defendants in the Gunns proceedings also argued that they were entitled to set off any preferential payments against the debts due to them at the relation back day.

The Court cited a long list of authorities that held that set-off is not available in unfair preference claims, and the more recent decisions that held that set-off may apply. However, the Court ultimately did not need to decide whether set off is generally available as a defence in unfair preference proceedings. This was because the Court found that the defendants had notice that Gunns was insolvent at the time of payment (so s553C did not apply).

Discretion

A further issue raised in the Gunns proceedings was whether the Court has a discretion under s588FF of the Corporations Act to reduce the amount otherwise payable as a preference, and, if so, whether the Court's discretion should be exercised.

The Court ruled that the use of the word "may" in s588FF means it is a discretionary power, but that discretion must be exercised judicially in light of the purpose and object of Part 5.7B of the Corporations Act. In declining to exercise the discretion against granting the liquidators relief, the Court cited the law's protection against unfairness to unsecured creditors generally which is enshrined in s 588FA(3)'s codification of the "running account principle" and the doctrine of ultimate effect. 

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