Recent judicial consideration of statutory exception to pari passu rule

Recent judicial consideration of statutory exception to pari passu rule

A recent case considered the statutory exception to the pari passu rule contained in section 553C of the Corporations Act 2001 (Cth) which deals with rights of set-off during liquidation.

What is required for a set off under section 553C?

The section provides a mechanism for setting off opposing claims that exist or are incipient as at the time of the winding up.  A set-off under this section requires that:

  • the creditor’s claim is provable in the winding up;
  • the claims exist at the date of the winding up;
  • the claims are capable of being converted into monetary amounts; and
  • the element of “mutuality” exists.

The element of mutuality means that credits, debts or claims arising from the dealings must be between the same parties and the benefit or burden of those credits, debts or claims must lie in the same interest, although it is not necessary that the claims are similar in nature.  The rationale for this section was set out by the High Court in Gye v McIntyre[1] (which considered s 86 of the Bankruptcy Act 1966 (Cth), a similar provision to section 553C):

Where there are genuine mutual debts, credits or other dealings, it would be unjust if the trustee in bankruptcy could insist upon having 100 cents in the dollar upon the whole of the debt owed to the bankrupt but at the same time insist that the bankrupt’s debtor must be satisfied with a dividend of some few cents in the dollar on the whole of the debt owed by the bankrupt to him…

Notice of insolvency and restriction to the right of set-off under section 553C(2)

There is a carve out to this right to set-off, namely, where a party has notice of the fact that the company was insolvent at the time of the relevant transaction (ie giving or taking of credit between the parties). 

The Victorian Supreme Court recently construed this exception in Façade Treatment Engineering Pty Ltd (in liq) v Brookfield Multiplex Constructions Pty Ltd[2]

The case involved Multiplex’s attempts to set-off amounts it claimed were due to it as completion costs and liquidated damages arising from Façade’s breach of the subcontract between it and Multiplex, against monies due to Façade under payment claims submitted by Façade to Multiplex.

The case was an appeal from the decision of Vickery J in the Supreme Court of Victoria. 

Ultimately, it was held that the relevant time for assessing Multiplex’s notice of Façade’s insolvency was the date at which the Subcontract was entered into, not the date of Façade’s breach which gave rise to Multiplex’s entitlement to claim completion costs and liquidated damages.

There were two grounds of appeal relevant to this discussion and they were expressed by the appellant, Façade, as follows:

Ground 5 – The learned trial judge erred in finding that the time for assessing notice of Façade’s insolvency for the purpose of section 553C(2) of the Corporations Act was 7 September 2011 (being the date of the Subcontract), and not when the debts which [Multiplex] sought to set off were incurred.

Ground 7 – The learned trial judge’s finding that section 553C(2) of the Corporations Act did not preclude the set-off proposed by Multiplex interfered with the well-established statutory regime and its underlying principle of pari passu, by which creditors of a company in liquidation are allowed to, and required to, share rateably in the available assets.

Ground 5 – what the parties said

Façade’s submissions included that the relevant time for assessing Multiplex’s “knowledge” of its insolvency for the purposes of section 553C(2) was when Multiplex accrued its entitlements to the completion costs and liquidated damages, that is, upon Façade’s breach, by which time Multiplex did in fact have notice of Façade’s insolvency.

Multiplex submitted that the purpose of section 553C(2) is to deny set-off to persons who voluntarily take the risk of engaging in dealings with a company that they know to be insolvent. A person who enters into a contract with another long before that second person’s insolvency, has no such choice when indicators of insolvency later appear but performance under the contract continues.  Multiplex submitted that the relevant date for “knowledge” of Façade’s insolvency for the purposes of the section 553C carve out was the date the parties entered into the subcontract.

Ground 7– what the parties said

Façade submitted that to allow the set-off claimed by Multiplex would be contrary to the pari passu principle and would operate unfairly to the general body of creditors.

Multiplex submitted that section 553C was intended to create a statutory exception to the pari passu principle.

The Court’s findings

The Court held that the relevant credits and debits as between the parties were:

  • amounts outstanding under two payments claims claimed by Façade;  and
  • costs to complete and liquidated damages claimed by Multiplex under the subcontract.

In relation to the timing of the receipt of the above credit, the Court concluded at [222]:

[t]he relevant dealing giving rise to the payment claims was the entry into the Subcontract, which occurred on 7 September 2011.  That was the date on which it could be said that Multiplex received credit from Façade in respect of the construction work that Façade was required to carry out and for which it was required to issue payment claims.

This was contrary to Façade’s submission that it received credit under the payment claims when those claims were submitted to Multiplex.

In relation to the amounts claimed as costs to complete and liquidated damages by Multiplex, the Court said at [226]:

In our view, Multiplex is correct to submit that the language of s 553C(2), referring as it does to the giving of credit to or the receiving of credit from the insolvent company, is not apt to apply to defaults under a contract that result in one party accruing rights to recover under the contract… in this case, the entry into the Subcontract by Façade and Multiplex involved the mutual giving and receiving of credits between the parties, most of which were contingent on future events contemplated by the Subcontract, such as the performance of construction work, the issuing of payment claims, the failure to complete on time and the like.

In relation to Ground 7, the Court accepted Multiplex’s submission that section 553C(2) is intended to create an exception to the pari passu principle and concluded that the general principle of pari passu cannot override statutory provisions.

Lavan Legal comment

  • Liquidators should consider seeking advice in relation to this section when winding up a construction business (or any company with ongoing contractual relationships).
  • Construction contractors and subcontractors should seek advice on the operation of this section with respect to any arrangements where the other party to a contract is insolvent.
  • As a side note, the exercise of a right of set-off which would be given effect to in a winding up does not amount to a preference unless excluded by reason of knowledge of insolvency under s 553C(2): Jetaway Logistics Pty Ltd v DCT[3].

[1] (1991) 171 CLR 609.

[2] [2016] VSCA 247.

[3]  (2009) 262 ALR 727.

Disclaimer – the information contained in this publication does not constitute legal advice and should not be relied upon as such. You should seek legal advice in relation to any particular matter you may have before relying or acting on this information. The Lavan team are here to assist.