"The peak indebtedness rule is not part of the law in New Zealand", according to the Court of Appeal, in a decision dismissing two appeals on an issue "significant for both liquidators and creditors generally".

Liquidators cannot choose the point of "peak indebtedness" as the starting point for their calculation of whether the net effect of credits and debits means that the creditor obtained a preference. Rather, the correct approach is to include all transactions that are part of the running account and within the specified period.

Unfortunately, the Court has left unclear the question of whether transactions should be excluded if they in fact occurred when the company was able to pay its debts.

What does "no peak indebtedness" mean?

The essence of a voidable transaction claim is that a creditor must return to the liquidator a payment received while the company was unable to pay its debts, if the payment enabled the creditor to receive more than it would in a liquidation. To determine this, it is first necessary to determine how much the creditor received.

The 2006 reforms introduced an approach that, where there had been a continuing business relationship, both the credits and the debits are to be counted as if they were a "single transaction" so as to find the net payment over time. But which credits and debits to include?

The Court rapidly dismissed the idea that the starting point should always be the date of the very first transaction between the creditor and the company in liquidation. In this situation there would logically be no recovery as the balance at the beginning would always be zero.

Liquidators have for some time argued that they can select the point at which the "single transaction" starts, so as to pick the point at which the debt is highest; the "peak indebtedness". That would maximise recoveries from creditors who have been preferred, resulting in the greatest recovery for liquidators on behalf of the body of creditors generally.1

The Court rejected that argument and said that all transactions within a continuing business relationship ought to be included, back to the start of the specified period.2

The decision can be illustrated with the following examples:

  1. Liquidators cannot choose the point of peak indebtedness3:

  1. Rather, all transactions within the continuing business relationship and during the specified period must be counted:

  1. In one of the cases, the continuing business relationship had started after the specified period began. In such a case, all transactions were to be included:

Why did the Court reject "peak indebtedness"?

Statutory interpretation requires an analysis of the language of the provisions, and their policy setting. The Court was unanimous in its decision, relying on:

  • the words of the statute. They refer to "all the transactions" forming the continuing business relationship
  • the purpose of the particular provisions. They were intended to identify the "ultimate effect" of the insolvent transactions. Starting the calculation at an arbitrary point within the relationship, the point of peak indebtedness, did "violence" to this purpose
  • the complete lack of analysis of the so called "rule" in either the 2006 law reform materials, or the Australian case law. Proponents of peak indebtedness often point to Australian case law and argue that New Zealand's law was intended to match Australia's. However the Court of Appeal reviewed the cases and "located no Australian authorities offering a considered analysis of the rule"
  • the policy setting in the recent Supreme Court judgment in Fences & Kerbs (see here for our commentary on this case). That is, the certainty afforded to those who trade with insolvent companies on an ordinary basis.

Is this a complete answer?

In our view, the Court of Appeal was right to reject the alleged "rule", for the reasons it relied on. But the Court has regrettably not stated its conclusions in a way that guides liquidators and creditors in all cases. It missed the opportunity to do that, and has somewhat unhelpfully stated its conclusions in stark terms, perhaps creating uncertainty.

The reasons stated by the Court all make sense where the company was unable to pay its debts throughout the specified period.4 But what if the company became unable to pay its debts only part way through the specified period?

Should transactions before that date be included in the calculation of the "single transaction"? On the plain words of the decision, the answer appears to be yes, but of course the Court was not deciding that question so its comments are not binding in such a situation.

In our view, to include pre-insolvency transactions would be as wrong as to exclude some of the transactions during insolvency. As with the peak indebtedness rule, to include earlier transactions would "do violence" to the purpose of establishing the net effect of transactions during insolvency.5

Consider the case where all transactions preceded the onset of insolvency. Even if some fell within the specified period, none would be voidable because the basic test for voidable transactions would not be met. The transactions did not occur while the company was unable to pay its debts.

So, if the relationship continued into insolvency, on what basis should such transactions be counted towards the voidable "single transaction"?

We remain of the view that the onset of inability to pay debts is the correct starting point for the calculation (or the start of the specified period if insolvency pre-dates that period):

Both policy and the language of the statute point to that approach.6

Where to from here?

The Court said that this is a "vexed area of the law of insolvency and one that has resulted in uncertainty at first instance in New Zealand". Knowing that insolvency practitioners and creditors would be anxious for the Court to provide clarity, it is regrettable that the Court did not give a more complete answer. However, for cases where insolvency began before the specified period, the law is now clear. All transactions in the continuing business relationship, back to the start of the specified period, must be included.

That is, subject to anything the Supreme Court may have to say.

But, the stark language used by the Court of Appeal does not explain that its finding was driven by the factual context. The decision does not decide the starting point where insolvency sets in after the start of the specified period. In our view, the start of the specified period should not be the starting point in those cases, despite anything in this judgment.

Click here for a copy of the judgment.

Click here, here and here for our previous commentary on this litigation.

Our thanks to Nupur Upadhyay for writing this Brief Counsel.


1 Voidable transaction recoveries go to preferential and ordinary creditors, but not secured creditors.

2 Two years prior to the liquidation, or the application to liquidate, whichever is earlier.

3 All of the graphs in this article assume that all of the transactions form part of the "continuing business relationship". The only question is the start date for the "single transaction".

4 Provided, of course, that a continuing business relationship can be proved. In some cases, payments to reduce debt, with prospect of any continued supply, will be outside a "continuing business relationship". Such issues were beyond the scope of the case: see paragraph [96], and are outside this article.

5 By referring to "insolvency" in this article, we are referring to the company's inability to pay its debts.

6 Section 292(4B)(a) and (d) link back to section 292(1) in a way that appears to require the transactions making up the "single transaction" to be, in themselves, insolvent transactions.

The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.