Section 553C set-off of unfair preference claims - Full Federal Court says no!

Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228.

In a resounding judgment delivered last week, the Full Federal Court has confirmed that a statutory set-off under section 553C is not available to a defendant in unfair preference proceedings.   

Key Takeaways

• Although historically courts have found that the right of set-off under s 553C of the Corporations Act 2001 (Act) is unavailable in unfair preference claims, a number of authorities over the past decade threw that position into doubt. In other instances where the issue was the subject of submissions, including by JWS whilst acting for the liquidators of the Gunns Group, the courts ultimately didn’t need to decide the point, leaving the position unclear. 
• The Full Federal Court in MJ Woodman has now clarified the position, deciding that where a creditor has received an unfair preference under s 588FA of the Act, that creditor may not rely upon a statutory set-off under s 553C to reduce or eliminate its unfair preference liability by reason of debts owed by the company to the creditor. That is so even where those debts are unrelated to the debt underpinning the unfair preference.
• Liquidators can now pursue unfair preference claims with certainty that the creditor cannot use a statutory set-off in order to, in effect, receive a greater return than they would have if they had received no unfair preference.

Right to set-off under the Corporations Act

Section 553C of the Corporations Act provides an automatic set-off for 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.

This is subject to subsection (2), which provides that set-off is not available where the person claiming the benefit of the set-off had notice of the fact that the company was insolvent at the time of giving credit to, or receiving credit from, the company.

Competing lines of authority

Historically, authorities have held that the right of set-off under s 553C is not available in unfair preference claims.[1]

Over the past decade, however, a competing line of authorities has developed suggesting otherwise[2].  For example, Young JA in Buzzle Operations Pty Ltd v Apple Computer Australia Pty Ltd (NSWCA, 2011) suggested that a s553C set-off may be available in connection with the repayment of uncommercial transactions under s 588FE(3) (though his Honour ultimately did not need to decide the point). 

By contrast, Justice Edelman’s remarks in the Federal Court judgment Hussain v CSR Building Products Ltd (2016)[3] contemplated a return to the historic approach. The factual circumstances of Hussain are not relevant, save that Edelman J, in considering whether a set-off under s 553C could apply in the context of a s 588FA unfair preference claim, noted that there were “powerful contrary arguments that might have been made to suggest that a set-off is not available against a liquidator’s claim to recover preference payments”[4].

His Honour ultimately did not have to consider the issue due to the lack of proof of insolvency and a finding that the relevant debts were secured.

The arguments in the Gunns matters

Johnson Winter & Slattery acted for the liquidators of Gunns Limited (in liquidation) against Bluewood and Badenoch who submitted that they had a right to set-off amounts still owing from Gunns against any sum that the Court found them liable to pay the liquidators as an unfair preference.

The liquidators made detailed submissions in contending that set-off was not available against a liability arising by reason of an order under s 588FF, but in the event that it was, then s 553C(2) prevented the creditors claiming set-off as they had notice of Gunns’ insolvency at the time credit was given.

The conclusion in the Gunns matters

In both Bluewood and Badenoch, Davies J held it was unnecessary to decide whether set-off applied, as s 553C(2) operated to prevent s 553C from being available in any event. Relevantly, her Honour held that in each instance where a debt arose that the creditors sought to set-off, they had notice of facts that were more than sufficient to disclose that Gunns lacked the ability to pay its debts as and when they fell due. Accordingly, the creditors were not entitled to a set-off.

As to resolving the set-off issue, her Honour remarked that if she were to deal with the issue, she would have called for further submissions from the creditors to address the liquidators’ arguments.

On appeal by Badenoch, the Full Federal Court adopted Davies J’s approach in concluding that the question of s 553C’s potential application as a defence to an unfair preference claim did not need to be resolved, and otherwise upheld Davies J’s findings regarding the operation of s 553C(2).

The death of set-off as a defence to an unfair preference claim

Edelman J’s judgment in Hussain flagged that there were “powerful arguments” as to why set-off does not apply to preference claims. However, the position remained unanswered until the decision of Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited.

Background - Woodman Electrical Contractors decision

In the liquidation of MJ Woodman Electrical Contractors Pty Ltd (In Liq), a creditor had received unfair preference payments totalling $190,000 in the relation back period. The creditor sought to rely upon s 553C of the Act to set-off its obligation under s 588FF to repay the preference, against debts totalling $194,727.20 owed by the company to the creditor.  Those debts were unrelated to the debts the payment of which constituted unfair preferences. 

The liquidator conceded that if set-off was available to the creditor, the unfair preference proceedings ought be dismissed. 

In those circumstances, a special case was referred to the Full Federal Court on the question as to whether a statutory set-off under s 553C was available to the creditor against the liquidator’s claim for recovery of an unfair preference under s 588FA.

The Full Court’s answer was a resounding ‘no’. 

In the leading judgment delivered by Chief Justice Allsop, the Court considered the interaction between unfair preference claims and found:

• In order for there to be a set-off under s 553C, there must be mutual credits, mutual debts or other mutual dealings between the insolvent company being wound up and the person who wants to have a debt or claim admitted against the company;
• In order for there to be mutuality, the rights or obligations from the dealings that give rise to the credits, debts or claims must be between the same parties, in the same interests, and must exist as at the relevant date;
• In this case, there must be mutuality between the indebtedness of the company to the creditor and the liability of the creditor pursuant to the court order to pay the company under s 588FF;
• The law surrounding voidable transactions enables liquidators to seek the assistance of the court in augmenting the estate, and does not create any right of action in the company. The company in liquidation receives money pursuant to a court order in an action brought by a liquidator in the execution of his or her duty to gather in the estate for the benefit of all unsecured creditors;
• The right of a liquidator to recover an unfair preference does not exist prior to the liquidation, and therefore at the relevant date, there is an absence of any right or equity in the company, or duty or obligation in the creditor, to recover or repay the preference; and
• There is therefore a lack of mutuality between the indebtedness of the company to the creditor and the liability of the creditor who is required to pay a sum pursuant to court order following unfair preference proceedings. The essential requirements of s 553C are not met. 

Conclusion

This case offers assurance to liquidators as it confirms the prevailing view that proceeds of unfair preference claims cannot be eroded by the application of set-off against other debts owed by the company to creditors.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).