Statutory set-off no longer a defence to an unfair preference claim

In the past, the reliance on section 553C of the Corporations Act 2001 (Cth) (Act) as a ‘set-off’ defence to an unfair preference claim, under section 588FA of the Act, has caused controversy in the insolvency profession. Due to a recent decision of the Federal Court of Australia, the ‘set-off’ defence is no longer a defence to an unfair preference claim.

On 16 December 2021, the Full Court of the Federal Court delivered the judgment in Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228, confirming that a creditor of an insolvent company cannot rely on the right of set-off under section 553C of the Act in response to an unfair preference claim under section 588FA of the Act.

The case

The defendant, Metal Manufacturers Pty Ltd (Creditor), received payments of $190,000 during the relation back period from MJ Woodman Electrical Contractors Pty Ltd (Company). Before going into liquidation, the Company also obtained goods from the Creditor on credit terms in the amount of $194,727.23.

The Creditor sought to set-off the unfair preference in the amount of $194,727.23, being the amount owed by the Company to the Creditor.

The decision

Justice Derrington reserved the following question for consideration by the Full Court:

“Is statutory set-off, under s553C(1) of the Act, available to the defendant in the proceeding against the plaintiff’s claim as liquidator for the recovery of an unfair preference under s558FA of the Act?”

The Full Court’s answer to this question was no.

The Full Court rejected the Creditor’s argument that a liability to repay a preference can be set-off against another debt owed to the same creditor and disagreed that it fell within the scope of section 553C of the Act.

The Creditor was unable to satisfy the elements of mutuality. Specifically, the lack of mutuality arose from the different interests. That is, the right to seek repayment of the preference is not the right of the company, but instead, it is a right executed by a liquidator in their duty to gather in the assets of a company for the benefit of unsecured creditors.

In addition, the Court reiterated that section 553C of the Act is based on the equitable principle of equality. The purpose of the unfair preference provisions is to achieve fairness. Accordingly, if the Court was to accept the Creditor’s position, the funds disgorged by the Creditor would not be available to distribute equally to other unsecured creditors and to priority creditors.

Summary

• A creditor cannot rely on section 553C of the Act as a defence to an unfair preference claim by setting off another debt owed by the company to the creditor.
• The underlying purpose of the statutory set-off is to protect creditors where genuine mutual debts or dealings exist without affecting the pari passu distribution.
• Under section 588FA of the Act, the obligation to pay will arise from a court order made following a successful application by a liquidator. Therefore the right to seek repayment of the preference is not the right of the company but a right executed by a liquidator.

This article is not exhaustive on this complex area of law, various exceptions and qualifications apply. Gavin Parsons and Associates can assist you with your enquiries and explain how the new laws apply to you. Contact us on (02) 9262 4471 for a free no obligation consultation.