The peak indebtedness rule which is applied by Courts under the current unfair preference provisions of the Corporations Act 2001 (Cth) is sometimes difficult to understand.
The New Zealand decision of Timberworld Limited v Levin & Ors  NZCA 111 (“Timberworld”) provides a fresh opportunity to discuss the current Australian position, how this operates compared to the growing body of case law in New Zealand, and what’s next in this area.
It is well known that under the unfair preference provisions which applied before 1993, the High Court of Australia in Airservices Australia v Ferrier (1996) 185 CLR 483 (“Airservices”) held that the running account defence was a complete defence in circumstances where the ultimate effect of the transactions carried out as part of a continuous business relationship between the debtor and creditor and where it did not result overall in there being any preferential effect.
The majority (Dawson, Gaudron and McHugh JJ, with Brennan CJ and Toohey J dissenting) remarked that if the purpose of the payments made during the continuous business relationship was to induce the creditor to provide further goods or services (in addition to satisfying any indebtedness owing), then the payments made will not be a preference unless the payments exceed the value of the goods or services provided in return. Airservices provided a clear factual illustration of this defence, as the Court found that payments made by Compass Airlines to the Civil Aviation Authority for airport and air navigation services during the relation back period were not preferences because the value of the services exceeded the payments made. Put simply, a commercial airline could not have any value at all without air traffic controllers.
This common law position was intended to be enshrined in the unfair preference provisions that were redrafted after the Harmer Report. The running account “defence” is now found within the terms of section 588FA(3) of the Corporations Act 2001 (Cth), as follows:
588FA Unfair preferences
- a transaction is, for commercial purposes, an integral part of a continuing business relationship (for example, a running account) between a company and a creditor of the company (including such a relationship to which other persons are parties); and
- in the course of the relationship, the level of the company’s net indebtedness to the creditor is increased and reduced from time to time as the result of a series of transactions forming part of the relationship;
- subsection (1) applies in relation to all the transactions forming part of the relationship as if they together constituted a single transaction; and
- the transaction referred to in paragraph (a) may only be taken to be an unfair preference given by the company to the creditor if, because of subsection (1) as applying because of paragraph (c) of this subsection, the single transaction referred to in the last-mentioned paragraph is taken to be such an unfair preference.
However, since Airservices, Courts have chosen to implement the continuous business relationship test in the section by reference to a peak indebtedness rule as first articulated by Barwick CJ in Rees v Bank of New South Wales (1964) CLR 210 at 226:
“In my opinion the liquidator can choose any point during the statutory period in his endeavour to show that from that point on there was a preferential payment and I see no reason why he should not choose, as he did here, the point of peak indebtedness of the account during the six months period.”
What has always been curious about this approach is the absence of words to the same effect within section 588FA(3).
New Zealand position
In Timberworld, the New Zealand Court of Appeal was faced with two appeals in relation to the New Zealand unfair preference provisions in cases in which the court below chose not to adopt the “peak indebtedness” rule to determine whether there was an unfair preference during a continuous business relationship.
What is of particular interest is that the creditors relied on Airservices as authority that the peak indebtedness rule does not apply under the New Zealand unfair preference provisions. Counsel for the liquidators in the appeals relied upon a number of Australian cases decided since Airservices to demonstrate that the peak indebtedness rule was good law in Australia, notwithstanding any contrary assertions in reliance of Airservices.
In the unanimous decision of O’Regan P, Stevens and Miller JJ, the Court of Appeal remarked that it is difficult to reconcile the peak indebtedness rule which emerged in Australia against the ultimate effect doctrine articulated by the High Court in Airservices. In a clear critique of the subsequent Australian authority, the Court stated that “Australian Courts seem to have assumed the rule had weight of authority and sufficient pedigree to warrant its direct application. We have located no Australian authorities offering a considered analysis of the rule.”
The Court of Appeal instead reverted to the words of the provision and acknowledged that the words of section 292(4B) of the New Zealand Act (which replicates the wording of section 588FA(3)(c) set out above) specifically require all transactions to be considered as if they were one transaction. In short, the Court was of the view that in adopting the peak indebtedness rule, the Courts are forced to disregard certain transactions which fall within the relation back period but precede the point of peak indebtedness. This interpretation was said to undermine the wording of section 292(4B) and would, therefore, be contrary to its statutory purpose. It follows that transactions within the relation back period before the point of peak indebtedness are relevant in determining whether there is any preferential effect.
What’s next in Australia?
Timberworld effectively holds up a mirror to the current state of the Australian common law in connection to peak indebtedness and reflects back to us possible faults and imperfections in our Courts’ approach to what are fairly clear provisions.
Although Australian Courts are not bound by the New Zealand Court of Appeal’s judgement, what will likely be a consequence of Timberworld is that creditors will find solace and confidence in asserting that the peak indebtedness rule has no statutory basis in Australia, and should therefore no longer be accepted by Australian Courts.
If, in the near future, a creditor is successful in running a defence on the basis that the peak indebtedness approach is incorrect, then this is likely to open up an additional line of defence to many unfair preference claims.