The Peak Indebtedness Rule

What is the Peak Indebtedness Rule?

The purpose of the peak indebtedness rule is to increase the chance of substantiating an unfair preference claim. It allows liquidators who are experiencing a running account to decide on the best peak of the Company’s indebtedness to the creditor and use it as the beginning for each singular transaction. A running account can further be explained as a principle whereby the company that has entered into liquidation maintains a business relationship with the supplier.

The purpose of this is to ensure that all transactions between the two parties are considered a single transaction making it easier to establish when an unfair preference has occurred. The running account principle is outlined in section 588FA(3) of the Corporations Act 2001 (Cth) (Act) and the peak indebtedness rule is codified in the Bankruptcy Act 1924 (Cth). Last year, the High Court of Australia handed down a decision that will change the way in which the peak indebtedness rule will operate in Australia.

 

Case Study: Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2 (‘Badenoch Decision’)

Facts

The two companies entered into a commercial relationship in 2003 whereby Badenoch Integrated Loggin Pty Ltd (Badenoch) would supply timber harvesting and hauling services to Gunns Limited (in liquidation) (Gunns) in exchange for payment.

Despite knowing that Gunns was struggling financially, Badenoch continued to provide timber services to Gunns until August 2012 when the agreement was terminated. On 25 September 2012, Gunns appointed liquidators. When the agreement was terminated Badenoch, in an act of good faith, continued to provide services for a short period with the purpose of assisting a future timber supplier.

Afterwards, Gunns made a claim against Badenoch to ensure repayment for services and that the transactions were considered voidable.

 

Issues

Two key issues arose including the peak indebtedness rule and the continuing business relationship.

 

Federal Court Decisions

The initial decision was presided over by Justice Davies who held that there was an ongoing business relationship between Badenoch and Gunns and the peak indebtedness rule as outlined in section 588FA(3) of the Act applied. Accordingly, liquidators were granted the freedom of selecting a date for the first singular transaction.

 

High Court Decision

The decision was appealed to the High Court of Australia in which they examined the role of the peak indebtedness rule and the continuing business relationship between the two parties. The Court held that the rule is not valid under the unfair preference scheme and accordingly liquidators cannot rely on it to determine the first transaction of a commercial relationship. Additionally, the start of the continuing business relationship is the first transaction after the start of the prescribed period or when the company is considered insolvent. Accordingly, if a debt occurs during the continuing business relationship between the two parties it will be included in the first transaction.

 

Takeaway

In conclusion, the peak indebtedness has been abolished and liquidators are no longer able to rely on this rule to determine the first singular transaction. Accordingly, please do not hesitate to contact our office if you seek legal advice relating to the peak indebtedness rule or unfair preference claims.

 

*This article was prepared with the assistance of Annabel Randall.