Two recent judgments from the High Court of Australia have clarified important aspects of voidable transactions law. While not binding in New Zealand, these decisions provide important insight for businesses and insolvency practitioners on both sides of the Tasman, and are likely to be persuasive to New Zealand courts.
Set off unavailable for unfair preference claims
The High Court of Australia in Metal Manufactures Pty Ltd v Morton  HCA 1 has confirmed that unfair preference claims sit outside the set off regime in liquidation. Where a liquidator seeks to recover payments from a creditor on the basis of unfair preference, the creditor cannot set off those claims against other amounts owed to it by the company.
Set off in liquidation
Liquidation triggers an automatic set-off of between a company in liquidation and its creditors, under both New Zealand and Australian law. Where there have been mutual dealings between an insolvent company and a creditor, an account is taken of what is due from each party to the other, the sums are set off against each other, and only the balance is admissible as a claim against the company or payable to the company.
But critical to that right of set off is that the pool of claims provable in a winding up is limited to debts and claims which arose before the company entered liquidation.
A recipient of an alleged unfair preference could not rely on that right of set off as a defence to an unfair preference claim. The unfair preference liability was not present at the date of liquidation. Immediately prior to liquidation there was nothing to set off between the company and the recipient. The contingent capacity of the liquidator to claim under the unfair preference regime could not and did not yet exist. The recipient could therefore not identify a relevant mutual dealing.
The claim failed for two further reasons. First, there had been no dealing between the same persons. The unfair preference claim is a claim by the liquidator, not the company. Second, there was no mutuality of interest. The amount recoverable by the liquidator was not for the liquidator or the company’s benefit, but to be distributed to creditors in accordance with the statutory scheme.
Decision is consistent with creditors’ priorities in liquidation
Allowing a creditor to rely on a set off as a defence to an unfair preference claim would defeat the rule that unsecured creditors are paid “pari passu”, after preferential and secured claims are met. That creditor would effectively rank first; by setting off its claim, the net effect is that the creditor would be paid the value of its claim (or the value of the unlawful preference claim, whichever is less) before all other creditors. If set off is unavailable, the funds received would be added to the pool of the company’s assets and be distributed according to the statutory scheme.
Conversely, where set off does apply, it does not defeat the statutory scheme. Rather, by setting off claims between the parties as at the date of liquidation, set off determines the net position of the parties which then informs what can be claimed in the liquidation in the ordinary way.
“Peak indebtedness” is no more
The peak indebtedness rule has been firmly axed by the High Court of Australia in Bryant v Badenoch Integrated Logging Pty Ltd  HCA 2.
The peak indebtedness rule is (or was) the ability for a liquidator to set the start of a “continuing business relationship” (or “running account”) between a company in liquidation and a creditor as the point at which the company is at “peak indebtedness”, allowing a liquidator to maximise voidable transaction recoveries.
The peak indebtedness rule has already been rejected in New Zealand but, until recently, appeared to be settled law in Australia. However (as foreshadowed in our New Zealand/Australia insolvency law comparison in June 2022), that settled position has come into question and has now been firmly rejected by the High Court of Australia.
Why did the Court reject “peak indebtedness”?
The Court was faced with two choices in interpreting the relevant provision. If it rejected the peak indebtedness rule, assessing the running account by reference to all transactions in the prescribed claw-back period would result in arbitrary results. But, if it accepted the peak indebtedness rule, the liquidator would be able to choose a date with equally arbitrary results. The Court concluded the former was preferable as it reflected a legislative choice by parliament.
The Court also considered that the peak indebtedness rule was not required to uphold the “running account principle”: that liquidators are required to treat a series of transactions as a single transaction because they are a part of a continuing business relationship. The Court found that the purpose of the running account principle is not to maximise the potential claw-back from a creditor, which is the effect of the peak indebtedness rule. Rather, the running account principle recognises that a creditor who continues to supply a company on a running account in circumstances of suspected or potential insolvency enables the company to trade to the likely benefit of all creditors. Including all transactions within the prescribed period as a single transaction and netting them off against each other to determine any unfair preference serves that purpose.
The Court rejected the argument that fixing the start of the single transaction at the start of the relevant period operates favourably for those seeking to defraud creditors or provide related party recipients a preference. Although those scenarios have longer prescribed periods, they also require the relevant transactions to be with a related party or made for the purpose of defeating creditors. The operation of those longer periods depends on the specific transactions forming an integral part of the continuing business relationship.
Transactions prior to insolvency not voidable
The High Court of Australia has helpfully addressed some questions left unanswered by New Zealand judgments on the point. In New Zealand, it was left uncertain whether a running account analysis can include transactions during the clawback period (as it was then), but before the company became insolvent. The High Court of Australia found that it does not. The first transaction that can form part of a “continuing business relationship” is either the first transaction after the beginning of the clawback period, or the date of insolvency, or (if the relationship started after those dates) the first transaction after the beginning of the relationship, whichever is the latter.
The liquidators had argued that the prospect of a company becoming insolvent within the relevant period was a fatal difficulty with rejecting the peak indebtedness rule. The Court disagreed, considering that any “difficulty” indicates that those transactions were not in fact “insolvent” transactions and should not be included in the single transaction.
We agree with the High Court of Australia’s approach. The purpose of the voidable transaction regime and running account principle is to establish the net effect of transactions during insolvency. Including pre-insolvency transactions runs counter to that purpose.
1. Companies Act 1993 (NZ), s 310; Corporations Act 2001 (Cth), s 553C.
Our thanks to Nathan Whittle for preparing this article.
This article is part of our regular publication Restructuring & Insolvency: Rescue & Recovery. Read the other articles in this series below.