Can I “Set Off”an Unfair Preference Claim?

The full federal court, in the recent decision of Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228 considered the provisions of...

The full federal court, in the recent decision of Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228 considered the provisions of s553C of the Corporations Act 2001 (Cth) (“the Act”) and whether the right of set off was available as a defence to unfair preference claims bought by a Liquidator in line with the provisions of s588FA of the Act.

What are the provisions included in s553C of the Corporations Act?

S553C notes:

(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 account balance is admissible to proof against the Company or is payable to the Company, as the case may be.

(2) A person is not entitled under this section to claim the benefit of set-off if, at the time of giving credit to the Company, or at the time of receiving the credit from the Company, the person had notice of the fact that the Company was insolvent.

What’s the ultimate effect of s553C?

The underlying principle of s553C is to help ensure that a creditor isn’t required to pay back a debt that is owed to a company in full but only receive a proportionate distribution of a debt that was owed to it by the company in circumstances where there had been mutual dealings between the parties.

Put simply, if company A owes $5,000 to company B, company B owes company A $2,500 and mutual dealings can be established, pursuant to s553C, company A is entitled to “set off” the $2,500 it is owed by company B with company A effectively now only required to pay company B $2,500.

This mutuality is the key to allowing company A to evoke the right of set-off.

It has often been a point of contention as to whether this mutual right of set-off was available in circumstances where an unfair preference was being pursued by a liquidator in the case of a Company winding up and, in this circumstance the full federal court is directly asked to consider, via special case, the following question:

Is statutory set-off, under s 553C(1) of the 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?

What was the Courts determination?

The court determined that no, this defence was not available in circumstances where a liquidator was pursuing the recipient of a preference payment pursuant to s588FA of the Corporations Act.

The primary rationale behind the court’s decisions was that the obligation to repay a preference claim to a liquidator is an entirely new obligation borne out of the statutory duties required of a Liquidator.

There is no nexus between the incurrence of debt in the ordinary course of business by a debtor to a company and the obligation to repay a preference claim in circumstances where a company is placed into liquidation.

Accordingly, as there is no mutuality in the way that the opposing debts arose, there is no right of set off available. This now provides certainty to liquidators pursuing preference payments and takes away the ambiguity around the set off arguments often run by a party defending a preference claim.

What does that mean for the party having to defend a preference claim bought by a Liquidator?

The set-off argument is no longer available to a party that is the recipient of a preference payment as defined by s588F of the Act. Other defences are available, including running account and the good faith defence to preference claims.

Clients should be aware that whilst this argument has now been settled, and it is still worth seeking advice from a qualified insolvency expert in circumstances where they are subject to a preference claim.

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