Insolvency - unfair preferences and statutory set-off under section 553C

In October 2021, we published an insolvency update relating to the quantification of preference claims in Australia, specifically the recent Badenoch decision and its impacts on the peak indebtedness rule.

Late last week, the Full Court of the Federal Court of Australia (Full Court) delivered the much-anticipated judgment in Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228.

In this judgment the Full Court was asked to answer the question "Is statutory set-off, under s 553C(1) of the Corporations Act 2001 (Cth), available to the defendant in this proceeding against the plaintiff's claim as liquidator for the recovery of an unfair preference under section 588FA of the Act?"

The Full Court answered no.

We set out the details of the judgment and its effect below.

The facts  

In this matter, Morton as a Liquidator of MJ Woodman Electrical Contractors Pty Ltd (Company) brought proceedings against Metal Manufacturers Pty Ltd (Metal Manufacturers), seeking the repayment of $190,000.00 that Metal Manufacturers had received during the relation-back period.

Metal Manufacturers defended the proceedings, claiming an entitlement to set-off against the unfair preference the sum of $194,727.23, which was another amount that the Company allegedly owed to Metal Manufacturers.

In its defence, Metal Manufacturers specifically relied on the right of set-off under section 553C of the Corporations Act 2001 (Cth) (Act), which applies in circumstances “where there have been mutual credits, mutual debts or other mutual dealings between an insolvent company that is being wound up and a person who wants to have a debt or claim admitted against the company”.

The decision

As stated above, the Full Court has ruled that the creditor of an insolvent company has no statutory right of set-off against a liability to repay an unfair preference.

To reach this decision, the Full Court reasoned that the requisite mutuality between the Company’s indebtedness to Metal Manufacturers and Metal Manufacturer's liability under a court order to pay in respect of the unfair preference at the liquidator’s suit was not present.

The lack of mutuality arose as Metal Manufacturer's interest in the alleged debt was a different interest to the Company’s interest as a payee of the unfair preference and the Company’s interest was not that of a creditor.

At paragraph [154] of the judgment, the Honourable Chief Justice Allsop explained the distinction between the different interests, as follows:

“There is simply no mutuality between debtor and creditor in respect of the obligation of the creditor to comply with an order of the Court made under s 588FF of the application of the Liquidator. It is a new right; and a new obligation; one to cure the dislocation to the order of priorities made by the payment, which discharged the debt, subject to the operation of the statute.”

There are two distinct debts being considered in this decision:

  1. A debt which is owed by the Company to Metal Manufacturers from historical dealings (Debt 1); and

  2. A debt which is an obligation of Metal Manufacturers to pay the Company pursuant to an order sought by the liquidator pursuant to exercise of statutory duties (Debt 2).

The distinction between these debts is that:

  1. Debt 2 is received by the Company beneficially and is not received by virtue of its own interest or right. Rather it is received for the benefit of all creditors and for the estate’s administration under the statutory regime;

  2. while Debt 1 is received by the Company for its own benefit.

Effect of the decision

The factual matrix in this matter is familiar ground for practitioners working in the insolvency area. As such, this judgment has significant impacts for liquidators prosecuting unfair preference claims, and creditors seeking to resist them.

The purpose of the voidable preference regime is to preserve the order of priorities set out in the Act by ensuring that all unsecured creditors are treated equally in accordance.

The decision means that a creditor who has obtained an unfair preference under section 588FA of the Act cannot seek to circumvent the application of the voidable preference regime by seeking to rely on section 553C of the Act to set-off a pre-existing debt against the unfair preference amount.

The overriding purpose of the law of set-off is to protect the interests of creditors that have genuine mutual debts with a company that has entered liquidation, and this should not be confused with the pari passu principle or result in a “dislocation [of] the order of priorities” under the Act.

The clarity that this decision has provided will no doubt change the way parties defend against unfair preference claims and how liquidators approach them. With other activity expected in the insolvency space into 2022, it will be interesting to see the impact of this decision.  

If you have an unfair preference claim and need assistance or tailored advice, please contact the specialist Insolvency team at Bartier Perry who will be happy to assist.  

Authors: Gavin Stuart, Emma Boyce and Gabriella Porcu