Game, Set And Match - Full Court Of The Federal Court Confirms Set-Off Not Available In Unfair Preference Claims

In the recent decision of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Ltd [2021] 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.

Background

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:

• there have been a number of decisions since the decision in In the Matter of ACN 007 537 000 Pty Ltd (in liq) & Parker [1997] FCA 1264 (Re Parker) which have held that a set-off claim under section 553C of the Act is or may be available in respect of a liquidator’s unfair preference claim;
• however, a number of these decisions “side stepped” the ultimate issue by finding that in any event the defendant creditors had notice of the insolvency of the company such that they could not claim a set-off under section 553C (even if such a claim was available);
• there has also been strong criticism of the arguments as to the availability of section 553C in unfair preference claims by leading academics and Judges; and
• the outcome of the above has been significant uncertainty in relation to whether a claim for set-off can be made to counter an unfair preference recovery claim.

The issue

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:

• an account is to be taken of the company’s claim against the creditor and the creditor’s claim against the company;
• the claims are then set-off against one another; and
• only the balance is admissible to proof against the company or is payable by the company, as the case may be.

In order for section 553C to operate, the following matters must be established:

• the creditor’s claim is provable in the winding-up;
• both the company’s claim and the creditor’s claim existed at the date of the winding-up;
• both claims are capable of being converted into monetary amounts; and
• the element of ‘mutuality’ exists in relation to the two claims.

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.

The decision

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:

• first, the claim against the creditor in respect of the unfair preference is not a claim by the company in liquidation.  It is instead a right of recovery belonging to the liquidator, which is held for the benefit of all creditors and the administration of the insolvent company’s estate;
• secondly, the right of recovery is a right that accrues to the liquidator after the date on which the company goes into external administration.  As at the time of the payment to the creditor there is no contractual, legal, equitable or statutory right of any kind (vested or contingent) in the company to call for repayment.  In fact, a sum that is ultimately payable under section 588FF to disgorge an unfair preference is not and cannot be due, even contingently, before the relevant date, or indeed before the relevant order of the Court;
• thirdly, there is evidence within the Act to suggest that Parliament did not intend for section 553C to operate in the context of an unfair preference claim.  Section 588FI provides that an order under section 588FF will operate to put the company in the same position as if the transaction had not been entered into, such that the creditor can then prove for the preferred debt.  This is inconsistent with section 553C having any scope to operate in respect of an unfair preference claim; and
• fourthly, if section 553C were to be available, it would lead to the outcome that the proceeds of the preference recovery action would conceptually go first to pay (via set-off) the preferred creditor in priority to true priority creditors such as employees of the insolvent company.  Such an outcome would offend the notion of fairness that underpins mutuality in section 553C as well as the statutory order of priority of certain creditors (which itself was built on notions of protecting the vulnerable), and would not conform with the overall policy of the Act.

Allsop CJ concluded in light of the above findings that:

• there is a lack of mutuality between the creditor’s claim against the company and the creditor’s liability pursuant to court order to pay back an unfair preference, as the claims are not between the same parties in the same capacities or interests;
• further, the claims did not both exist at the relevant date as there is no right or equity (vested or contingent) in the company, or duty or obligation (vested or contingent) in the creditor, to recover or repay the preference as at the relevant date;
• given these matters, the essential elements of section 553C cannot be made out in respect of an unfair preference claim; and
• the unavailability of section 553C is consistent in an overall sense with the other provisions of the Act (such as section 588FI) as well as the underlying purposes of the set-off and unfair preference provisions.

Lavan comment

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.