Tom Zreika
The High Court’s recent judgment in Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2 (“Bryant”) has fundamentally changed how the Running Account Defence is applied in unfair preference cases, specifically through the abolition of the ‘Peak Indebtedness Rule.’
Understanding Unfair Preferences
An unfair preference refers to a payment made by a company to a creditor that provides that creditor with a better outcome than they would receive if the payment were voided and they instead claimed their debt during the liquidation process of the company.
These transactions are relevant only when they occur during the relation-back period -commonly the six months prior to the company entering liquidation or administration. Such preferences are part of a broader category known as voidable transactions, governed under the Corporations Act 2001 (Cth).
Creditors often question the basis of an unfair preference claim, especially if they’ve acted in good faith. It’s therefore crucial for both insolvency practitioners and creditors to understand the defences that can be raised in these scenarios.
What is the Running Account Defence?
Also known as the continuing business relationship defence, this defence may be available when a payment challenged as an unfair preference was part of a broader, ongoing commercial relationship between the company and the creditor.
To rely on the Running Account Defence, the creditor must demonstrate:
- The transaction served a commercial purpose.
- It formed part of an ongoing business relationship; and
- The company’s debt fluctuated – rising and falling – as a result of regular transactions within that relationship.
If these conditions are satisfied, the payment will typically be considered an unfair preference only if the company’s debt to the creditor was lower at the time of administration or liquidation compared to the debt during the relation-back period.
In practical terms, if a company consistently purchases goods or services and pays invoices while continuing to trade, the outstanding balance may vary. In such a scenario, the overall relationship – not individual payments – becomes the focus of analysis.
Pre-Bryant Use of the Peak Indebtedness Rule
Before the Bryant decision, liquidators could select the point in the relation-back period when the company’s debt to the creditor peaked. This enabled them to isolate the largest possible unfair preference by narrowing the effect of the Running Account Defence. This practice was known as the ‘Peak Indebtedness Rule.’
The Bryant Case
The dispute involved Gunns Limited, a timber business that engaged Badenoch Integrated Logging Pty Ltd for logging and transport services. When Gunns went into administration on 25 September 2012 and subsequently entered liquidation, the liquidators sought to void a series of payments made to Badenoch as unfair preferences – citing a total of $1.25 million.
Badenoch contested the claim, asserting that the transactions were part of a continuing business relationship and should be considered on a net basis. They argued that, at the point of liquidation, Gunns owed them more than at the beginning of the relation-back period – by about $158,000 – so no preference had been gained.
The High Court rejected the use of the Peak Indebtedness Rule under section 588FA(3) of the Corporations Act. The Court clarified that the assessment must consider all transactions within the relevant ongoing relationship, starting from either the beginning of the prescribed period, the date of insolvency, or the initiation of the ongoing relationship – whichever is later.
Consequences of the Decision
The Bryant ruling mandates a holistic view of the trading relationship and no longer allows liquidators to select the peak point of debt for calculation. This results in a fairer and more consistent application of the Running Account Defence.
While this change may allow some creditors to defeat unfair preference claims that would have previously succeeded, it also reinforces the importance of context in ongoing commercial relationships.
Each case remains fact specific.
Creditors and insolvency professionals should seek detailed, practical advice when assessing the viability of this defence.
For tailored advice on unfair preferences, liquidations, or implications of the Bryant decision, consult with our insolvency legal team.