In Metal Manufactures Pty Ltd v Morton  HCA 1 (Metal Manufactures) and Bryant v Badenoch Integrated Logging Pty Ltd  HCA 2 (Badenoch), the first High Court decisions of this year, the Court finalised its position on unfair preference claims.
- Set-off does not apply between a debt owed by a company in liquidation to the creditor.
- Set-off also does not apply for a liquidator’s voidable transaction claim against the creditor.
- For unfair preference claims, liquidators cannot rely on the peak indebtedness rule.
- These rulings establish both benefits and disadvantages for liquidators when recovering funds on an unfair preference claim.
Set-off and Metal Manufactures
In situations where mutual debts, dealings or claims have been exchanged between an insolvent company in liquidation and its creditor, they are set off against each other and only the balance can be claimed. Whether set-off applies in a claim between the company’s liquidator against a creditor, or vice versa, has been unclear for the last 15 years, thus the High Court’s guidance was critically needed.
In Metal Manufactures, Metal Manufactures Pty Ltd was paid $190,000.00 during the relation back period from MJ Woodman Electrical Contractors Pty Ltd (MJ Woodman). Before MJ Woodman went into liquidation, it purchased and received goods from Metal Manufactures which totaled $194,727.23. MJ Woodman’s liquidator claimed the payment of $190,000.00 to Metal Manufactures was an unfair preference as defined by section 588FA of the Act. Metal Manufactures in contrast claimed the benefit of a set-off of $194,727.23 was available.
The Court concluded that statutory set-off under section 553C(1) of the Corporations Act 2001 (Cth) (Act) is not a defence to a claim for recovery of an unfair preference. It held that the crucial time when determining whether a claim against or by a liquidator exists is not at the time of commencement of the liquidation, but instead the moment immediately before the commencement of the liquidation. In Metal Manufactures, immediately before liquidation began, there was no claim by the liquidator and company against the creditor that could be subject to set-off. Further, the Court held that the liquidator’s claim against the creditor and the creditor’s claim against the company are not mutual. Instead, they are separate dealings, as the liquidator acts as an officer of the court not an agent of the company. The beneficial interests in the claim are also not mutual, as the payments were made for the benefit of the company while an unfair preference claim is for the benefit of the people entitled to be paid in a liquidation.
Peak indebtedness and Badenoch
When a person has had a ‘continuing business relationship’ with a company that goes into liquidation, the liquidator may attempt to recover payments made to the person as unfair preferences. When this occurs, the continuing business relationship is assessed as a whole and the liquidator can only recover the net preferential effect. Under the Act, an unfair preference conferred more than six months before the beginning of external administration is not voidable. Liquidators have traditionally relied on the ‘peak indebtedness rule’ – that the period of continuing of business relationship starts from the point of ‘peak indebtedness’, allowing them to recover more funds.
In Badenoch, Gunns Limited (in Liq) (Recievers and Managers Appointed) (Gunns) was placed into voluntary administration in September 2012 and liquidation in March 2013. From 30 March 2012 to 24 September 2012, Badenoch Integrated Logging Pty Ltd (Badenoch) provided services to Gunns which totaled $3,360,876.16 and was paid while Gunns was insolvent. What was in dispute was over what period in the six-month period should the calculation be made.
The Court determined that the ‘peak indebtedness rule’ does not apply and part 5.7B of the Act does not incorporate this rule – instead the six-month period should be calculated as the period within six months from when the continuing business relationship began or the company became insolvent, whichever is later. Further, the Court held that to determine whether a transaction is ‘an integral part of a continuing business relationship’ as under section 588FA(3)(a) of the Act, it should focus on the nature of the parties’ commercial relationship at the time of the transaction and the objective character of the payment.
What this means for liquidators
The decision in Metal Manufactures will undoubtedly be supported by liquidators who are more likely to recover significantly more funds for creditors under voidable transaction claims. However, liquidators may be disappointed by the decision in Badenoch who may find their unfair preference claims will reduce in value and are limited by a certain time period. Creditors, on the other hand, will welcome the decision in Badenoch, if they are able to demonstrate they received integral payments within six months before a company’s external administration.
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Craig Higginbotham and Charlotte Bathgate
13 April 2023