Insolvency Update: High Court hands down much-anticipated decision in Badenoch and Metal Manufactures

In October 2021 and December 2021, we published insolvency updates relating to the quantification of preference claims in Australia and also the availability of statutory set-offs under section 553C of the Corporations Act 2001 (Act). 

On 8 February 2023, the High Court of Australia (High Court) handed down its much-anticipated decision in both Badenoch and Metal Manufactures, dismissing both appeals and confirming that:

1. No set-off is available under section 553C in respect of debts owed by a company in liquidation to the recipient of an unfair preference (Metal Manufactures); and
2. Peak indebtedness has no place in a liquidator's analysis of a running account (Badenoch).

Metal Manufactures Appeal

In the matter before the Full Court of the Federal Court of Australia (Full Court), the Full Court was asked to answer the question, "is statutory set-off, under section 553C(1) of the Corporations Act 2001 (Cth), available to the defendant in this proceeding against the plaintiff's claim as liquidator for the recovery of an unfair preference under section 588FA of the Act?"

The Full Court answered ‘no’.

The High Court agreed with the Full Court confirming that set-off under section 553C was not available in relation to an unfair preference claim for the following reasons:

1. The statutory right of set-off under section 553C(1) of the Act requires that the mutual credits, mutual debts or other mutual dealings be credits, debts or dealings arising from circumstances that subsisted before the commencement of the winding up.
2. There is no liability, contingent or otherwise, to expel an unfair preference payment prior to the commencement of the winding up.
3. The right of a liquidator to sue for an order under section 588FF gave rise to a contingent liability, but one that did not exist prior to the commencement of the winding up.
4. The requirement of mutuality was not capable of being satisfied because there was no dealing between the same persons (i.e. the right to sue to recover an unfair preference is a right that only the liquidator has) and there was no mutuality of interest.

As a result of the High Court’s determination, decisions such as, Re Parker, Buzzle v Apple, Shirlaw v Lewis, Hall v Poolman and Stone v Melrose Cranes are now considered to be wrongly decided to the extent they are inconsistent with the High Court's reasoning above.

Additionally, the reasoning of the High Court has broader application to all voidable transactions, not just unfair preferences, as well as insolvent trading claims.

Badenoch Appeal

With respect to Badenoch, the Full Court held that the peak indebtedness rule should not be applied, thereby ending its use.  The "peak indebtedness rule" permits a liquidator to choose the starting date within the relevantly prescribed statutory period (in this case, the relation-back period of six months prescribed by section 588FE(2)) to prove the existence, and amount, of an unfair preference given by the company to a creditor.

The High Court was required to consider three questions concerning the operation of section 588FA(3):

1. Whether the so-called "peak indebtedness rule" is part of or is excluded by section 588FA(3) of the Act?
2. What is the proper approach to determining whether a "transaction is, for commercial purposes, an integral part of a continuing business relationship" as referred to in section 588FA(3)(a) of the Act?
3. Were certain payments in this case from the debtor ("Gunns") to the creditor ("Badenoch"), for commercial purposes, an integral part of a "continuing business relationship" between them within the meaning of section 588FA(3) of the Act?

The High Court answered these questions as follows:

1. With respect to the first question, the High Court noted that the Act does not incorporate the “peak indebtedness rule”. Rather, Justice Jagot stated that:

“the first transaction that can form part of the continuing business relationship contemplated by s 588FA(3) is either the first transaction after the beginning of the prescribed period or after the date of insolvency, or (if the relationship started after the beginning of the prescribed period or the date of insolvency) the first transaction after the beginning of the continuing business relationship, whichever is the later.”

2. The second question concerns whether a "transaction is, for commercial purposes, an integral part of a continuing business relationship" and requires an objective factual inquiry. The High Court determined that the task is one of characterisation of the facts, involving an objective ascertainment of the "business character" of the relevant transaction. As such, it is necessary to consider the whole evidence of the “actual business” relationship between the parties.
   
   
3. Finally, the High Court agreed that the Full Court did not err in concluding that:

1. 1. certain payments were transactions forming an integral part of the continuing business relationship between Gunns and Badenoch;
   2. other (later) payments were not transactions forming part of the continuing business relationship between Gunns and Badenoch; and
   3. the continuing business relationship did not cease until 10 July 2012 and that, applying section 588FA(1) to the deemed single transaction created by section 588FA(3)(c) and as required by section 588FA(3)(d), there could be no unfair preference given by Gunns to Badenoch.

In light of the reasons set out above the High Court dismissed the appeal and by doing so ended the application of the “peak indebtedness rule” in Australia.

Authors: Gavin Stuart, Emma Boyce and Gabriella Porcu