The High Court in Metal Manufactures Pty Limited v Morton [2023] HCA 1 (“Morton”) and Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA (“Badenoch”) provided some much needed clarification for liquidators and creditors in the area of unfair preference claims.
In short, the High Court confirmed:
- There is no set-off under section 553C of the Corporations Act 2001 (Cth) (“Act”) of debts owed by companies in liquidation to the recipient of “unfair preference payments” (determined in Morton); and
- The peak indebtedness rule does not apply in respect of identifying the starting point of a running account (determined in Badenoch).
Morton
A summary of the judgment can be found here.
Morton concerns the operation of section 553C of the Act, importantly the mutual credit and set-off provisions which have long been asserted by creditors as a defence to an unfair preference claim.
Importantly section 553C of the Act refers to a mutual credit and set-off.
To consider the decision of the High Court, analysis must be given to the facts of this matter.
In short, goods were supplied by Metal Manufactures Pty Limited (“Metal Manufactures”) to MJ Woodman Electrical Contractors Pty Ltd (“MJ Woodman”) on credit. During the course of the relationship between the parties, MJ Woodman owed Metal Manufactures two debts. One in the amount of $190,000 and a second debt in the amount of $194,727.23.
MJ Woodman subsequently went into liquidation.
During the six-month relation back period, the debt of $190,000 was paid back to Metal Manufactures.
The liquidator claimed that the payment of the $190,000 was an unfair preference payment.
Naturally, Metal Manufactures contended that section 553C entitled it to set off this potential liability against the amount owed to it.
The High Court held:
- The essential requirement of mutuality for section 553C of the Act to apply was absent. This was because
a. There were no mutual parties as the second debt was between the creditor and the company and the first was between the creditor and the company’s liquidator (noting that the liquidator is an officer of the Court and not a representative of the company); and
b. There was no mutual interest in the claims as payment of the second debt (by way of set-off) was for the benefit of the creditor, whereas the recovery of the first debt (by way of unfair preference) was for the benefit of the company’s creditors.
The Court ultimately held that liability for an unfair preference payment could not constitute a mutual credit, mutual debt or dealing between the parties. Thus, there is no valid set-off against pre-existing amounts owed to the preferred creditor.
Badenoch
A summary of the judgment can be found here.
The High Court was required to consider the operated of section 588FA(3) of the Act, importantly:
- Whether the peak indebtedness rule had operation in the context of section 588FA of the Act;
- The correct approach for determining whether “a transaction is, for commercial purposes, an integral part of a continuing business relationship…” (our emphasis); and
- Whether the payments in this case fell within the category described at point [2] above.
Prior to the decision in Badenoch, it was common place for a liquidator to choose a starting date (within the statutory period) to prove the existence (and quantum) of an unfair preference payment. Naturally, this would allow the liquidator to maximize the quantum of his/her claim (within the statutory framework). The peak indebtedness would then be compared to the amount owing to said creditor, the difference would then be claimed by the liquidator as an unfair preference payment (once again, subject to the statutory framework).
The High Court held that the peak indebtedness rule does not have operation under section 588FA of the Act. The High Court further noted that it was the intention of the legislature to give effect to the running account principle. As such, the liquidator is required to look at the transactions in the running account during the statutory period as a whole and determine the ultimate effect of those transactions.
Once a running account was established between the company and the creditor, the question of an unfair preference is determined by the ultimate effect of the transactions which is the net effect of all payments made and all goods and/or services between the company and the creditor during the entire period of the running account.
The question then turned to defining and qualifying the term “continuing business relationship.” The High Court formed the view that creditors ceasing supply and negotiating alternative terms (and then recommencing supply) as was the case in Badenoch did not amount to the end of the business relationship. It was the termination of supply that was ultimately found to be the cessation of a continuing business relationship. Once the business relationship was terminated, the liquidator was then able to claim the relevant payments after this event as unfair preference payments.
This is a very important consideration for creditors as there is now High Court authority which permits creditors to continue with their standard debt recovery steps within the course of the continuing business relationship as these steps should not impact the creditor’s ability to rely on the statutory defences available in the Act.