The recent High Court decision in Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2 (“Bryant”) has abolished the ‘Peak Indebtedness Rule’ and significantly altered the application of the ‘Running Account’ Defence to unfair preference claims.

What is an unfair preference payment?

For those unfamiliar, an unfair preference is a payment made by a company to a creditor which places the creditor in a better position as compared to what the creditor would be in if the transaction was set aside, and the creditor were to prove the debt in the winding up of the company.[1]

Unfair preferences can only arise for payments to creditors made in the relation back period, typically the six months prior to the company entering administration or liquidation.

Unfair preferences are one of several voidable transactions provided for by the Corporations Act 2001. [2]

It is not uncommon for creditors who are pursued for an unfair preference to be confused as to why a claim is commenced against them in circumstances where they may feel they have done nothing wrong. In turn, it is equally important for both creditors and insolvency practitioners to be apprised of the defences which may be deployed in response to an unfair preference claim.

This article focuses on one of those defences, the Running Account Defence, and examines the practical impact of the Bryant decision on how that defence is applied.

What is the Running Account Defence

The Running Account Defence (also known as the continuing relationship defence) may be enlivened where an alleged unfair preference forms a part of the continuing business relationship between the company and the creditor.

For the Running Account Defence to be enlivened, a creditor must show:-

1. The transaction is for a commercial purpose;
2. The transaction formed an integral part of a continuing business relationship between the company and the creditor; and
3. In the course of the relationship between the company and the creditor, the company’s net indebtedness to the creditor increased and reduced from time to as the result of a series of transactions forming part of the relationship.[3]

Should the above elements be satisfied, the transaction in question will ordinarily only be taken to be an unfair preference if the company’s debt to the creditor at the time the company went into administration or liquidation was larger than the debt during the relation back period.

Should the debt at the time of administration or liquidation be smaller than the debt during the relationship back period, the unfair preference will be limited to the difference between the current debt and prior debt, rather than the full amount of the transaction in question.

As an example, the Running Account Defence may apply in a situation where a creditor has supplied ongoing materials to the company. In such an arrangement, it would not be uncommon for the company to pay invoices raised by the creditor whilst continuing to incur further debt by way of further materials being supplied. The company’s indebtedness to a creditor may fluctuate, despite otherwise being an ordinary part of the company and creditor’s ongoing business relationship.

Prior to the Bryant decision, liquidators were able to choose the point in the relation-back period where the company’s indebtedness to the creditor was at its highest. The consequences of doing so was that liquidators were able to restrict the effect of the running account defence and ensure the unfair preference that could be pursued remained as large as possible. This practice was preferred to as the ‘Peak Indebtedness Rule’. The Bryant decision has abolished this practice.

Bryant Decision

Bryant concerned Gunns Limited (in liquidation), a business engaged in timber felling and the operation of sawmills. Badenoch Integrated Logging Pty Limited (Badenoch) provided logging and transport services to Gunns Limited.

Following a period of financial troubles, on 25 September 2012, Gunns Limited voluntarily appointed administrators and soon after entered into liquidation. The liquidators then moved to pursue Badenoch with a view of having a number of payments from Guns Limited to Badenoch declared void as unfair preferences.

By effect of the Peak Indebtedness Rule, the liquidators attempted to argue that the unfair preference subject to their claim was $1,251,000.

Badenoch opposed this position by instead arguing that all of the transactions during the continuing relationship should be calculated and assessed as their net effect. By consequence, Badenoch argued that as of 25 September 2012, Gunns Limited’s indebtedness to Badenoch had actually increased by $158,000, and the Running Account ought to provide a full defence to the unfair preference claim.

The High Court ultimately found that the Peak Indebtedness Rule could not be used when assessing the Running Account Defence in the context of section 588FA(3) of the Corporations Act.

In reaching this conclusion, the High Court held that:-

“all the transactions forming part of the relationship” for the purpose of the deemed “single transaction” in s 588FA(3)(c) must mean “the relationship” starting at the beginning of the prescribed period, or the date of insolvency, or (if the relationship started after the beginning of the prescribed period or the date of insolvency) the beginning of the continuing business relationship, whichever is the later.[4]

The effect of Bryant is that the Peak Indebtedness Rule is no more.

Rather, when assessing the Running Account Defence, the size of the company’s debt to a creditor at the start of the ongoing relationship or at the date of insolvency (whichever is later) must be taken into account. This amount should than be compared to the size of the debt as at the start of administration or liquidation.

If the current debt is larger than the initial debt, then the creditor’s position has been worsened and the Running Account Defence will apply in full. If the current debt is smaller than the initial

The Impact

Ultimately, the Bryant decision brings consistency to how the Running Account Defence may be assessed and applied.  Although in some instances this may lead to the Running Account Defence becoming a full defence to an unfair preference when it may not have been before, each case must be assessed on its own merits.

Determining whether or not a Running Account Defence may be a viable defence to an unfair preference claim remains a complicated task. Liquidators and creditors alike will be benefited from thorough, practical and commercially sensitive advice when considering the Running Account Defence.

For further information on this judgment, company liquidation or unfair preferences more generally, contact our specialist insolvency lawyers today.

[1] Corporations Act 2001 (Cth) s 588FA.

[2] Corporations Act 2001 (Cth) s 588FE.

[3] Corporations Act 2001 (Cth) s 588FA(3).

[4] Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2 [74] .

The content of this publication is intended to provide a summary and commentary only. It is not intended to be comprehensive nor does it constitute legal advice, and has been prepared based on applicable legislation and case authority at the date of publication. You should seek legal advice on specific circumstances before taking any action.