The Federal Court of Australia has confirmed that creditors are no longer entitled to protection under section 553C of the Corporations Act 2001 (Cth) (“the Act”) against a liquidator for an unfair preference claim. The set-off protection, provided by section 553C, was historically used as a means of reducing, setting-off or defeating a claims brought by liquidators under section 588FA.
Mutual Debts, Credit and Set-Off
The application of setting-off mutual credits has recently gained judicial attention in relation to its use against a claim by a liquidator for recovery of an unfair preference payment. The set-off protection provided by the Act gives a statutory protection for creditors against insolvent companies. The relevant section provides:
… where there have been mutual credits, mutual debts or other mutual dealings between an insolvent company … and a person who wants to have a debt or claim admitted against the company:
(a) an account is to be taken of what is due from the one party to the other in respect of those mutual dealings; and
(b) the sum due from the one party is to be set off against any sum due from the other party; and
(c) only the balance of the account is admissible to proof against the company, or is payable to the company…
The protection has historically been utilised in litigated proceedings as a counter-claim or defence against a claim by a liquidator where the debtor has outstanding credits against the plaintiff.
In the recent case of Metal Manufacturers Pty Ltd, the Full Court of the Federal Court of Australia (“Federal Court”) delivered a judgment which carries substantiative implications for creditors in defending against a liquidator’s claim for unfair preference payments. The Federal Court confirmed that the statutory set-off can no longer be relied on by creditor in defending the claims of a liquidator.
The Liquidator in these proceedings sought to recover an unfair preference payment to a creditor in accordance with sections 588FA and 588FF of the Act. The defendant in the proceedings, being Metal Manufacturers, claimed a defence of set-off under section 553C, but was ultimately denied access to this provision for reasons set out below.
Metal Manufacturers Pty Ltd Judgment
The key question considered by the Federal Court was whether a creditor in a liquidation is entitled to a set-off claim under section 553C specifically against an unfair preference claim under section 588FA of the Act. In short, Allsop CJ, with Middleton and Derrington J in agreeance, denied the entitlement.
In the judgment, Allsop CJ stated that “there is a lack of mutuality between the indebtedness of a company to the creditor and the liability of the creditor pursuant to court order to pay the company at the suit of the liquidator”. The mutuality referred to by Allsop CJ and section 553C is where a creditor and company both transact with each other. In those circumstances, the creditor seeks to rely on their dealings with the company to utilise the protection provided by section 553C. However, as Allsop CJ stated, a liquidator relies on an entirely separate set of dealings, such that there is no mutuality between them and the defendant:
In such circumstances, the debts are not, and cannot be, mutual. One debt was owed by the company in its own right to the creditor arising out of historical events in the ordinary course of business dealings. The other obligation to pay is payable by the creditor to the company not as its pre-existing creditor, but pursuant to an order of the court obtained by the liquidator pursuant to his or her rights and exercising his or her statutory duties.
Drawing on His Honour’s findings, the company is not, in essence, a creditor of the party who received the unfair preference, but rather stands “as a payee pursuant to court order in an action brought by a liquidator”. In that way, the credits are not “mutual” and therefore cannot be set-off.
His Honour noted that the allowing a section 553C set off to a priority payment is against the priority-based, pari passu distribution structure prescribed by section 556 of the Act. Pari passu distributions simply mean that assets of a company in liquidation are to be distributed equally, among creditors of the same rank, in proportion to their credit. Reason being that allowing a defence under section 553C would ultimately give the defendant “access to preference recovery funds in priority to priority creditors”, which may in turn result in circumstances of unsecured creditors receiving greater payment in front of higher ranking or secured creditors.
Ultimately, Allsop CJ, with Middleton and Derrington J agreeing, found on all accounts that the set-off claimed as a defence to an unfair preference is entirely different to the type of interest that the set-off protection seeks to protect. The intention of the set-off regime is so distinct from the circumstances of a defence to an unfair preference payment that such a case cannot be classified as “mutual”. The action by a liquidator to recover an unfair preference “is a new right; and a new obligation”, and different in both “character and quality of mutuality”.
Developments Moving Forward
Where creditors commonly claimed offsetting mutual credits as a way to militate against unfair preference payment claims, the Court has now restricted the use of section 553C in those circumstances. In our view, this judgment is likely to result in fewer claims by liquidators for unfair preferences payments from being defended. In turn, this should make the process of recovering company assets and making distributions to creditors easier for liquidators.
If you require assistance in recovering or defending against claims for unfair preference payments, or voidable transactions generally we invite you to contact our Brisbane Lawyers on (07) 3009 8444 or by email at [email protected] or our Sydney Lawyers on (02) 9307 8900 at [email protected].
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