Set-off shield to unfair preference claims dropped

Introduction

Last Thursday (16 December 2021), in the decision of Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228 (MJ Woodman), the Full Court of the Federal Court delivered a highly anticipated decision surrounding section 553C of the Corporations Act 2001 (Cth) (Act) and a liquidator’s unfair preference claim.

The Court found that section 553C of the Act (which has previously been used as a defence to a liquidator’s unfair preference claim, some would argue controversially) was not available to a defendant of a liquidator’s unfair preference claim.
Section 553C of the Act

Section 553C of the Act had from time to time favourably served defendants of unfair preference claims. Section 553C(1) of the Act has been applied  where an insolvent company and a creditor, seeking to have their debt or claim admitted in the winding up process, share mutual debts, mutual claims or any other mutual dealings.

Section 553C(1) operates to set-off the amounts owed as between the parties against each other, provided that the creditor had no notice of the Company’s insolvency (pursuant to section 553C(2) of the Act). The balance after the set-off  would either be able to be proved in the winding up by the creditor or payable to the liquidator as the case may be. The key requirement is that there be mutuality between the debt claimed by the creditor and the debt claimed by the company. Generally, mutuality may be found where the claims arise between the same parties and in the same interests.

Criticism of Section 553C of the Act

Over the years there has been much criticism of section 553C of the Act, particularly in the context of its use as a defence to an unfair preference claim under section 588FA of the Act. One of the criticisms is directed to the interplay between the two sections. The unfair preference provision under section 588FA of the Act is designed in part to ensure that creditors of an insolvent company receive a more even distribution of the company’s assets.

However, a creditor who has received payments from a company prior to its liquidation may be able to retain those payments by relying on a set-off claim if there remains a balance owing to the creditor after taking into account those payments. Essentially, the creditor who received payments from the company has an advantage over other creditors who did not receive any payments and the purpose of section 588FA is undermined.

Earlier decisions in different Australian jurisdictions regarding sections 553C and 588FA of the Act demonstrate the unsettled law in this area.

Relying on a set-off claim under section 553C of the Act in defence to a liquidator’s unfair preference claim appeared to gain momentum after the decision in Morton & Anor v Rexel Electrical Supplies Pty Ltd [2015] QDC 49, in which the Queensland District Court allowed the defendant creditor’s set-off claim.

In the matter of Hussain v CSR Building Products Ltd [2016] FCA 392, Justice Edelman opined that there are “powerful….arguments.. to suggest that a set-off is not available against a liquidator’s claim to recover preference payments.”  

In Stone v Melrose Cranes & Rigging Pty Ltd, in the matter of Cardinal Project Services Pty Ltd (in liq) (No 2) [2018] FAC 530, the Court took into consideration the creditor’s set-off claim pursuant to section 553C and reduced the amount awarded to the liquidators for their unfair preference claim.

Decision of the Full Court of the Federal Court

On Thursday, 16 December 2021, Chief Justice Allsop handed down the leading decision in MJ Woodman. The decision effectively means that creditors will no longer have the set-off defence available to them in respect of an unfair preference claim. The Full Court’s decision was heavily influenced by the requirement of “mutuality” between the interests of an insolvent company and the creditor under section 553C of the Act.

In the Full Court’s decision, Chief Justice Allsop concluded that:

“[154] …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 on 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 obligation to pay under s 588FF is not owed to the company by virtue of a right it has against the creditor. It is an obligation found in a judgment or order of the Court of which the company is the recipient pursuant to a successful application brought by the liquidator in his or her own right…

[155] …A conclusion of mutuality for the purposes of s 553C as propounded by the creditor would see … the consequence that proceeds of a preference recovery action under s 588FF would go first to pay an erstwhile preferred creditor in priority to priority creditors, such as employees of the insolvent company. Such a conclusion offends the notion of fairness that underpins mutuality in s 553C and the statutory order of priority of certain creditors, built in respect of some upon the protection of the vulnerable..."

In essence, the decision makes clear that there is no mutuality and therefore no set-off between a creditor’s debt claim against the company and a liquidator’s unfair preference claim, where the proceeds of such claim are recovered for the benefit of creditors of the company rather than the company itself.

What now?

Now that the decision in MJ Woodman has clarified that a set-off defence under section 553C of the Act is not available to a liquidator’s unfair preference claim, liquidators may now have a sense of relief around this area of law.

The team here at Hicksons are ready to provide expert support on the changes and issues.
 
Post by Hicksons Partner, Marc Rossi, Senior Associate, Roxanna Lam, and Solicitor, Mahnaz Bokan.

 

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