Voidable transactions: Court of Appeal confirms liquidators may not take “peak indebtedness” approach

The Court of Appeal has confirmed that liquidators cannot take the “peak indebtedness” approach to maximise the quantum of voidable transaction claims, where a claim is brought against a creditor who was in a continuing business relationship with the liquidated company.

In a decision released on Friday, the Court of Appeal has rejected attempts by liquidators to themselves choose the most advantageous starting point for measuring the start of the “continuing business relationship”. Rather, the Court of Appeal has confirmed those earlier High Court decisions which held that the courts should look at the whole course of trading under the continuing business relationship (and within the two year “specified period”).

Who needs to read it?

Developments on voidable transactions will always be of interest to insolvency practitioners. However, this decision will also be welcome news for businesses in trading relationships, which now have more certainty as to the scope of their potential exposure to liquidators’ claw back claims where credit is supplied to customers on an ongoing basis.

Why should I read it?

Since the amendments to the Companies Act 1993 (the “Act”) in 2006, the application of the continuing business relationship (or running account) test under section 292(4B) of the Act has been hotly debated. The statutory test applies to transactions that took place as part of a continuing business relationship, and provides that all transactions between a creditor and the liquidated company should be treated as a “single transaction” where:

  • An individual transaction is, for commercial purposes, an integral part of a continuing business relationship; and
  • In the course of the relationship, the level of the company’s net indebtedness to the creditor has increased and reduced from time to time as the result of a series of transactions.

If those criteria are met, then rather than being able to potentially set aside all of the individual payments made by the liquidated company, liquidators may instead only set aside the net reduction in indebtedness across the course of the continuing business relationship.

The timing of this statutory “single transaction” has been a particularly contentious area of the law, and one which the Court of Appeal’s judgment has now clarified. The “peak indebtedness” approach taken by some liquidators sought to measure only those transactions within the continuing business relationship that occurred after the point in time at which indebtedness owed to the creditor peaked. The obvious effect of this approach is to maximise the quantum of voidable transaction claims. This approach has been inconsistently applied by both the New Zealand and Australian courts.

The Court of Appeal’s decision in Z Energy has expressly rejected the “peak indebtedness” approach in New Zealand, on the grounds that:

  • The statutory wording does not permit a liquidator to disregard some of the transactions within the specified period;
  • The Australian cases which had applied the peak indebtedness approach had done so without any significant analysis of the so-called rule;
  • The effect of the High Court of Australia’s decision in Airservices Australia v Ferrier was that allowing a liquidator to pick a point of peak indebtedness was inconsistent with the basic principle of the continuing business relationship test, which is that the ultimate effect of transactions within the continuing business relationship must be considered.
  • The peak indebtedness approach is artificial, and can lead to vastly different outcomes on the basis of credit arrangements (i.e. where companies may have differing levels of ‘peak’ indebtedness) even where creditors have advanced the same value of goods and received the same payments in return.
  • If Parliament had intended to adopt the peak indebtedness rule, it could have done so without difficulty. It chose not to. Any change to the legislative policy would be a matter for Parliament.

For the above reasons, the Court of Appeal concluded that section 292(4B) test applies to all transactions within the continuing business relationship (and within the two year “specified period”).

What next?

Trade creditors who are faced with claims by liquidators attempting to claw back payments should closely review the circumstances of trading with their customers. Where the dominant purpose of the company’s payments to the creditors was to induce further supply of goods or services, then the “running account” exception at section 292(4B) of the Companies Act 1993 may well provide a means to resist, or at the very least reduce, a liquidators claim.

Please contact one of our experts if you have any questions about the Court of Appeal’s judgment, and what the “running account” defence may mean for your business.