Under Section 588FF of the Corporations Act, PwC applied to claw back 11 payments totalling $3.3 million made by Gunns in the period between 30 March and 25 September 2012 to the respondent, Badenoch Integrated Logging — a company that provided logging services to the Gunns Group.

The trial judge found in May 2019 that Badenoch Integrated Logging had to pay the sum of over $2 million plus interest to PwC, represented in this claim by Johnson Winter Slattery.

On appeal, the Full Court of the Federal Court, in reducing the quantum of the judgment, found that the “peak indebtedness rule” no longer applied. Last week, an appeal against the Full Court’s decision was heard by the High Court of Australia. 

Peak indebtedness is a legal principle established decades ago, which enabled liquidators to maximise their recoveries of unfair preference claims (and, in turn, the pool of funds recovered for the benefit of unsecured creditors).

In conversation with Lawyers Weekly, lead partner on the case, Paul Buitendag and partner Pravin Aathreya explained exactly how this case could impact businesses across the country — and the implications of it.

“[Our] legal argument was focused on the critical question as to whether the old status quo should survive, in particular, whether the peak indebtedness rule continues to operate despite the express terms of section 588FA of the Corporations Act,” Mr Buitendag said.

“The liquidators argued that the peak indebtedness rule works in harmony with the purpose of Part 5.7 B of the Corporations Act, which is to achieve fairness between all unsecured creditors by empowering liquidators to pursue clawbacks of certain pre-insolvency payments made by the company.”

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According to JWS, if the Full Court’s judgment is upheld, unfair preference claims will largely no longer exist, giving rise to unrestricted ruthless debt collection activity.

In particular, trade creditors with a “running account” stand to significantly benefit by being largely immune from unfair preference claims, as the Full Court’s approach would mandate consideration of all transactions in the relevant period (including previous supplies of goods and services), rather than permitting a liquidator to pick the peak indebtedness point in order to maximise the quantum of the claim. Such an approach would, in many instances, render most preference claims against such trade creditors unviable.

The net effect of this is that liquidators will recover less money for the general body of unsecured creditors. Mr Buitendag said that this would have a “major impact” on insolvency practices across the country.

“It’s not only of significant importance for liquidators in bigger insolvencies but also in the SME market to have a fair and equal recovery and getting all these principles to work in harmony with each other. But it’s also important for the administrators of the Fair Entitlements Guarantee scheme (FEG) to have the opportunity of recouping for the benefit of the taxpayer funds advanced by FEG to employees who didn’t get paid,” he explained.

“The removal of the peak indebtedness rule will not only change 65 years of Australian law, but if the High Court upholds that decision, a lot of SME market liquidators will significantly be impacted in the conduct of external administrations, in particular, their capacity to discharge their duties to recover funds into the administration to the benefit of unsecured creditors.”

However, SME market liquidators won’t be the only parties affected by the outcome of this case, Mr Aathreya said.

“This is not just something where liquidators are going to be the sole or majority parties affected. There’s a much greater macro effect on the broader economy and society. If there [are] fewer liquidators around, there are fewer cops on the beat to enforce deterrence against corporate misconduct. That is a bad thing — in general, and for society, because it means bad corporate actors are not being held to account,” he said.

“This will be a particularly acute and pernicious trend in SME insolvencies, which comprise over 80 to 90 per cent of all insolvencies in Australia. You hear about all the big corporate collapses, but what you don’t hear about are the smaller and medium-sized businesses where the directors have stripped out the assets, made payments to favoured suppliers, or related parties.”

Because of this, misconduct of the directors within these companies can be left inconsequential, explained Mr Buitendag.

“In your smaller and medium-sized enterprises, usually when a liquidator knocks on the door, there is not a pile of cash sitting in these enterprises’ bank accounts that the liquidator can then utilise to investigate the company’s affairs (in particular, the conduct of the company officers and directors to determine if there was untoward conduct to the detriment of the company or its creditors),” he said.

“And we’ve seen this over and over again when you have dodgy directors doing untoward things; liquidators’ hands are often tied behind their backs because they don’t have funds to investigate what the company directors did in running a company into the ground. Usually, preference payment recoveries assist liquidators to properly investigate the affairs of the company and, more so, the affairs and the conduct of the company’s officers and directors. That critically important funding stream will largely be denied to liquidators if the Full Court’s decision remains undisturbed.”

The firm and the broader business community now await the High Court’s judgment, which has been reserved.

More to come.