In recent times, reliance on s553C of the Corporations Act 2001 (Cth) (Act) as a set-off defence to an unfair preference claim (brought by a liquidator), under s588FA of the Act, has been a friend to defendant creditors and the enemy of Liquidators.
Relevantly, section 553C of the Act sets out that where there have been mutual credits, mutual debts or other mutual dealings between a company that is being wound up and a creditor seeking to have their claim admitted in the winding up, an account is to be taken of what each party owes the other. Those sums are to be set-off against each other, and only the balance is admissible to proof or payable to the company.
Legal precedent, judicial direction and interpretation on the applicability of s553C of the Act (as a defence to an unfair preference claim) has been varied and inconsistent, with no clear or binding superior Court authority on point. Until now…
In the significant Full Federal Court decision of Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228 (Morton), handed down on 16 December 2021, the Full Federal Court has provided certainty and set legal precedent by confirming that the statutory set-off, under s553(C)(1) of the Corporations Act 2001 (Cth) (Act), cannot be relied upon by a creditor to reduce an unfair preference claim under s588FA of the Act.
Brief facts of Morton
- Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd (Company) brought proceedings against Metal Manufacturers Pty Limited (Metal Manufacturers), seeking that $190,000 paid by the Company to Metal Manufacturers, during the Relation Back period, be repaid pursuant to s588FA of the Act. A standard and uncontroversial preference claim.
- However, Metal Manufacturers defended the liquidator’s claim, on the basis that Metal Manufacturers was entitled to set-off claims in the total sum of $194,727.23, against the liquidators claim, pursuant to s553C(1) of the Act. A previously controversial defence to a preference claim (but one that has been accepted in some Courts).
- The liquidator accepted that IF a set-off pursuant to s553C(1) of the Act applied, then he would have no claim.
- However, the liquidator submitted that the right to set-off pursuant to s553C(1) of the Act did not apply to preference claims and was not available to Metal Manufacturers.
- Given the previous inconsistent judicial guidance (or lack thereof), Justice Derrington of the Federal Court reserved the question for consideration of the Full Federal Court of Australia, the relevant question being:
“Is statutory set-off under s 553C(1) of the Corporations Act 2001 (Cth) (Act) available to the defendant in this proceeding against the plaintiff’s claim as liquidator for the recovery of an unfair preference under s 588FA of the Act?”
The Decision
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- On 30 August 2021, the Full Court of the Federal Court of Australia heard argument on how the question should be answered and on 16 December 2021, the Full Court handed down its decision and answered the question “No”: set-off was not available as a defence to an unfair preference claim.
- The leading decision of Chief Justice Allsop, went through an exhaustive analysis of the history before section 553C was enacted, the unfair preference regime and its interplay with section 553C, to come to its conclusion.
- The Chief Justice spent some time on the fundamental issue of mutuality, as this goes to the very heart of the ability to set-off and ultimately found that there is a lack of mutuality between what is owed by the company in liquidation to the creditor, and the liability of the creditor pursuant to a court order to pay the company at the suit of the Liquidator (which can only be brought after a company enters liquidation).
- Accordingly, it was concluded that the essential requirement of mutuality under section 553C of the Act is absent.
- Justice Middleton succinctly summarises the Chief Justice’s substantial and considered reasoning by noting [at 218] “…The ultimate conclusion is that the relevant legislative provisions deny the character and quality of mutuality to the debt of the company to the creditor and the obligation of the creditor to pay the company under s 588FF…”
and [at 219] “…The significant point (again as observed by the Chief Justice) is that the obligation to pay under s 588FF arises from an order of the Court sought upon the application of the liquidator. It is not an obligation owed to the company arising from a right it has against the creditor…”
And so, in a win for liquidators (and a blow to creditors) there is binding legal precedent confirming that set-off is no longer available as a defence to an unfair preference claim.
It is also now clear that a trade creditor cannot try to “double dip” by seeking a running account defence as well as a set-off defence to a preference claim.
Given the recent FCAFC decision in Badenoch and the abolishment of the peak indebtedness rule (a win for creditors and blow to liquidators), which reduced the number of claims available to Liquidators (or at least the quantum with respect to available claims), we think it likely that following Morton, Liquidators will hastily revisit potential preference claims now available to them, which claims (prior to Morton) may not have been pursued on the basis of a s553C set-off defence.
We consider that the Full Federal Court has struck a fair and reasonable balance and reached the right legal outcomes in both the Badenoch and Moreton decisions in 2021. We expect to see more preference claim actions commencing from 2022.
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The blog published by Rostron Carlyle Rojas Lawyers is intended as general information only and is not legal advice on any subject matter. By viewing the blog posts, the reader understands there is no solicitor-client relationship between the reader and the author. The blog should not be used as a substitute for legal advice from a legal practitioner, and readers are urged to consult RCR on any legal queries concerning a specific situation.
