In the recent decision of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Ltd  FCAFC 228, the Full Court of the Federal Court of Australia considered and comprehensively resolved the often asked and much vexed question of whether a creditor can raise a claim for set-off under section 553C of the Corporations Act 2001 (Cth) (Act) in resisting and defending an unfair preference claim.
The question was reserved to the Full Court as a special case for determination by Derrington J. The special case was heard before Allsop CJ, and Middleton and Derrington JJ.
Allsop CJ, with whom Middleton and Derrington JJ agreed, examined the history of the relevant statutory provisions and the key authorities in the area in intricate detail, ultimately concluding that statutory set-off under section 553C of the Act is not available to creditors in defending a liquidator’s claim for recovery of an unfair preference under section 588FA of the Act.
The factual background to the underlying case is unremarkable.
MJ Woodman Electrical Contractors Pty Ltd (Company) operated an electrical and communications installation and servicing business based in Sydney, New South Wales. Metal Manufacturers Pty Ltd (Creditor) supplied goods to the Company.
The Company was placed into liquidation on 28 March 2019. During the relation back period, the Company paid the Creditor $190,000 in respect of unsecured debts owed to the Creditor for the supply of goods. However, at the time the Company went into external administration, the Company still owed the Creditor an unsecured debt of $194,727.23 (also relating to the supply of goods by the Creditor to the Company).
The liquidator of the Company (Liquidator) commenced proceedings to recover the $190,000 as an unfair preference under section 588FA of the Act. The Creditor claimed that it was entitled to set-off the $194,727.23 owed to it against the amount claimed by the Liquidator.
Derrington J then referred the question of the availability of section 553C set-off as a ‘special case’ to be considered by the Full Court of the Federal Court under rule 38.01 of the Federal Court Rules 2011 (Cth).
However, the broader legal background to the case is interesting in that:
On the one hand, the purpose of the unfair preference provisions in the Act is to achieve equality of access by unsecured creditors to the available assets of the insolvent company, by correcting unequal distributions and restoring (so far as possible) a pari passu distribution.
On the other hand, section 553C operates as an exception to pari passu distribution. If there have been mutual credits/debts or other mutual dealings between an insolvent company and a creditor who wants to submit a proof of debt in the liquidation, then pursuant to section 553C:
In order for section 553C to operate, the following matters must be established:
This last element of mutuality is critical, and broadly requires that the credits, debts or claims under consideration must arise from mutual dealings between the same parties in the same capacities.
The controversy since the decision in Re Parker has been whether a section 553C claim can be made to counteract and defeat an unfair preference claim.
The issue for the Full Court, as correctly identified by Allsop CJ, was to determine as a matter of statutory construction whether section 553C can operate as between a creditor’s potential liability to a liquidator for an unfair preference and that creditor’s claim for a debt owed to it by the company in liquidation.
It is important to note at the outset that it is not possible to easily summarise or to do justice to the decision of Allsop CJ, which conducted a thorough review of the history, object and purpose of section 553C and the unfair preference provisions, as well as the numerous cases that have considered these mechanisms over time.
However, Allsop CJ made the following key findings:
Allsop CJ concluded in light of the above findings that:
After a long period of uncertainty, this decision provides important (and comprehensive and well-reasoned) appellate authority that set-off under section 553C is not available as a defence to unfair preference claims.
This will come as welcome news to liquidators contemplating or prosecuting unfair preference claims, but may be less welcome to creditors seeking to defend such a claim.
If you have any questions about the effect of this important decision on a potential unfair preference claim or generally, please contact the experienced Lavan team.