SECTION 553C SET-OFF OF UNFAIR PREFERENCE CLAIMS – THE ANSWER IS NO.   - JHK Legal Commercial Lawyers

6 June 2022

SECTION 553C SET-OFF OF UNFAIR PREFERENCE CLAIMS – THE ANSWER IS NO.  

Written by: Anna Hendricks

In what was a significant win for Liquidators in Australia, the Full Court has held that section 553C of the Corporations Act 2001 (the Act) is not available as a set-off defence to a preference claim brought by a Liquidator. The decision seemed obvious to many, yet competing lines of authority which suggested otherwise had many concerned.[1]

For some time now there has been significant controversy towards the set-off defence, with Courts often deciding that the creditor had “notice” of the insolvency, and therefore the set-off defence would not be available. This meant that Courts were often not required to consider subsection 1 of section 553C of the Act.  In 1997, Justice Mansfield in Re Parker said the following:

“…the two debts are between the same companies. The burden of them would lie in the same interests. They are commensurable, in that they both sound in money. I see no reason why, having regard to the substance of the two debts, they should not be set-off.”[2]

What changed all of this and any questions surrounding the set-off defence was the decision in Morton as liquidator of MJ Woodman Electrical Contractors Pty Ltd (In Liq) v Metal Manufacturers Pty Ltd [2021] FCAFC 228 (the Morton Case), which was handed down on 16 December 2021.

In the Morton Case, 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 answer was no.

THE ACT

Section 553C of the Act provides the following:

  1.  Subject to subsection (2), 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:
  • an account is to be taken of what is due from the one party to the other in respect of those mutual dealings; and
  • the sum due from the one party is to be set off against any sum due from the other party; and
  • only the balance of the account is admissible to proof against the company, or is payable to the company, as the case may be.

Section 553c (1) is subject to subsection (2) which says that the set-off at (1) isn’t available in the event that at the time of giving credit to the company, or at the time of receiving credit from the company, the person had notice of the fact that the company was insolvent.

Under section 588FA of the Act, an Unfair Preference received by a creditor can occur when:

  • a debtor company owes a creditor an unsecured debt; and
  • the debtor company and the creditor are parties to a transaction; and
  • receipt of the payment results in the creditor receiving more than it would have received had the debtor company been in liquidation and the liquidator paid all unsecured creditors a dividend.

Unfair Preferences are the most common type of voidable transactions whereby ultimately, a creditor has received an advantage over other creditors.

BACKGROUND TO THE MORTON CASE

To summarise, the facts of the Morton Case were as follows:

  1. Morton as a Liquidator of MJ Woodman Electrical Contractors Pty Ltd (Company) issued proceedings against Metal Manufacturers Pty Ltd;
  2. The proceedings sought repayment of $190,000.00 that Metal Manufacturers Pty Ltd had received during the relation-back period;
  3. In its defence, Metal Manufacturers Pty Ltd sought to set-off its obligation under section 588FF to repay the preference, claiming that the sum of $194,727.23 was owed by the Company to Metal Manufacturers Pty Ltd; and
  4. The debts owed by the Company to Metal Manufacturers Pty Ltd were unrelated to the debts the payment of which constituted unfair preferences.

THE DECISION

As mentioned above, the Full Court held that the Company had no statutory right of set-off against a liability to repay an unfair preference. To reach this decision, the Full Court turned to the mutuality between the Company’s indebtedness to Metal Manufacturers Pty Ltd.

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.”

The Court also noted that section 553C of the Act seeks to achieve the equitable principle of equality and had the Court accepted Metal Manufacturers Pty Ltd’s set-off defence, it would not be possible for funds to be equally distributed to creditors of which were owed monies.

TAKEAWAY

The decision handed down in the Morton Case indicates that in defending an unfair preference claim, a creditor can no longer use the set-off defence in relation to another debt owed by the company to the creditor. The Morton Case, whether supported or not, has provided clear guidelines and a pathway for both Liquidators and creditors in issuing and defending unfair preference claims. Undoubtedly, Liquidators have been afforded more freedoms in pursuing unfair preference claims, and creditors are limited in how they can defend such proceedings.

Importantly, we want to note that in May of this year, the High Court granted Metal Manufacturers Pty Ltd special leave to appeal the decision in the Full Federal Court in the Morton Case. Interestingly, leave was granted without an oral hearing, to which approximately only 1.7% applications are. The impeding Appeal will have left Liquidators around the country concerned as to the possibility of the decision being overturned. We will be sure to keep you updated on developments.

HOW JHK LEGAL CAN HELP YOU

At JHK Legal we regularly act on behalf of Administrators and Liquidators in relation to unfair preference claims. In addition, we often act for recipients of unfair preference payments. Our lawyers at JHK Legal have a wealth of knowledge in relation to this area of law and if you require any advice or assistance in relation to voidable transactions, or any other insolvency matters, please do not hesitate to reach out.


[1] Re a Debtor [1927] 1 Ch 410; Re Clements; Ex parte Trustee; Golsbrough Mort & Co Ltd (1931) 7 ABC 225; Re Smith (1933) 6 ABC 49; Calzaturuficio Zenith Pty Ltd v NSW Leather & Trading Co Pty Ltd [1970] VR 605; Painter v Charles Whiting & Chambers Ltd (1932) 4 ABC 203; Re Buchanan Enterprises Pty Ltd (No 2) (1982) 7 ACLR 407.

[2] (1997) 150 ALR 92.