Three Strikes And You’re Out - High Court Definitively Concludes Set-Off Not An Option In Unfair Preference Claims

In the recent decision of Metal Manufactures Pty Ltd v Morton (as Liquidator of MJ Woodman Electrical Contractors Pty Ltd (In Liq)) [2023] HCA 1, the High Court of Australia finally put to bed the debate as to whether a creditor can set-off an obligation to repay an unfair preference payment against a debt owed to the creditor by the company in liquidation.

A five Judge bench of the High Court unanimously concluded that statutory set-off under section 553C(1) of the Corporations Act 2001 (Cth) (Act) is not available to creditors against a liquidator’s claim for recovery of an unfair preference under section 588FA of the Act.

The majority judgment of Kiefel CJ, Gordon, Edelman and Steward JJ carefully considered the wording and purpose of the provisions of the Act relating to statutory set-off and the recovery of unfair preferences, before concluding that a liability under a court order made pursuant to section 588FF(1)(a) to repay an unfair preference cannot be the subject of a valid set-off against pre-existing amounts owed by the company to the preferred creditor for the purposes of section 553C.  Gageler J agreed with these conclusions and added some additional comments as to why (in addition to the reasons set out by the majority) there was no mutuality between a liability under a court order made pursuant to section 588FF(1)(a) and a pre-existing debt owed to the preferred creditor.

Background

The factual background to the matter is set out in our previous publication on the decision of the Full Court of the Federal Court which was then appealed to the High Court.  That publication can be found here.

However, the key facts are as follows:

• MJ Woodman Electrical Contractors Pty Ltd (the Company) was placed into liquidation on 28 March 2019;
• during the relation-back period, the Company paid Metal Manufacturers Pty Ltd (the Creditor) $190,000 in respect of unsecured debts;
• when the Company went into external administration, it owed the Creditor $194,727.23;
• the liquidator of the Company commenced proceedings against the Creditor to recover the $190,000 as an unfair preference under section 588FA of the Act;
• the Creditor argued that it was entitled to set off any liability to repay the $190,000 against the $194,727.23 owed to it by the Company pursuant to section 553C of the Act.

The Full Court of the Federal Court delivered a comprehensive and well-reasoned judgment concluding that set-off under section 553C was not available as a defence to an unfair preference claim.

The Creditor subsequently obtained special leave to appeal this decision to the High Court.

The Arguments

In summary, the Creditor raised the following arguments before the High Court:

• the trading transactions between the Company and the Creditor during the relation-back period constituted mutual dealings;
• these mutual dealings gave rise to both the amounts owing by the Company to the Creditor as well as the unfair preference payments;
• the unfair preference payments gave rise to a contingent liability on the part of the Creditor to repay those payments which existed as at the moment the Company went into external administration;
• it did not matter that not all of the elements required to crystallise the liability to repay the unfair preference had occurred before the Company went into external administration as:
  • there is authority that a contingent liability (which is contingent as at the time a company goes into external administration) can be the subject of statutory set-off; and
  • in line with that authority, all of the facts necessary to crystallise the contingency (in this case being the facts required to prove/establish the unfair preference claim) existed as at the time the Company went into external administration;
• the debits and credits in relation to these amounts were in fact between the same parties (namely the Company and the Creditor) because even if the Creditor was obliged to repay the unfair preferences on application by the liquidator of the Company (Liquidator), those amounts would be received beneficially by the Company; and
• as a result of the above, the necessary elements of section 553C of the Act were satisfied such that statutory set-off should apply.

The Majority Decision

The majority of Kiefel CJ, Gordon, Edelman and Steward JJ made a number of important findings as part of their analysis of the relevant statutory scheme.  The key findings are as follows:

• a company in liquidation retains beneficial ownership of its assets and does not hold these assets on trust for creditors and members.  This is also true in respect of property gathered in and controlled by a liquidator.  As a result, it is correct that a company in liquidation is the beneficial owner of repayments of unfair preferences made to the company pursuant to section 588FF(1) of the Act.  However, this ownership is subject to the “special interest” of creditors to have the assets of the company gathered together and then distributed;
• section 553C of the Act plays an important role in that it assists in ascertaining whether there is an asset available in respect of (i.e. an amount recoverable from) a creditor of the company, or a claim by that creditor in the winding up.  It reflects the intention of Parliament to allow for a set-off of mutually incurred credits, debts, or dealings to identify the net balance which can be claimed either by or against the creditor.  It is framed in very wide terms, but it is subject to two important limits.  First, there is a temporal limit which requires that for a claim to be able to be set off, there must either be an existing liability prior to liquidation or there must be an existing obligation prior to liquidation which might mature into a liability/debt owing.  Secondly, there must be true mutuality in that the claims must be between the same persons in the same capacities and/or interests, and must sound in money; and
• a liquidator’s right to seek recovery of an unfair preference under section 588FF is a cause of action conferred on the liquidator as an officer of the court and is not exercisable by the liquidator as an agent of the company.  As a result, there is no contingent claim on the part of the company prior to liquidation.  The contingent claim can only arise once the company is in liquidation and once a liquidator has been appointed.

Having made these findings, the majority observed that the Creditor’s case relied on the presence as at the date of the commencement of the winding up of an inchoate or contingent right to sue under section 588FF(1) which was capable of growing or maturing into a money claim by the Company against the Creditor that could then be set off against the amount owed by the Company to the Creditor.  However, the majority noted that this suffered from a fatal flaw in that as at the moment just before the Company went into liquidation, the Company owed money to the Creditor, but the Creditor owed nothing to the Company – the inchoate or contingent capacity of the Liquidator to sue the Creditor under section 588FF could not and did not exist before the Company actually went into liquidation.  As a result, the temporal element of section 553C was not satisfied and the right of the Liquidator to sue under section 588FF was not eligible to be set-off against the pre-existing amount owed by the Company to the Creditor.

The majority then went on to note a number of other reasons why set-off was not available in relation to a claim for the repayment of an unfair preference:

• there was no relevant mutual dealing giving rise to the relevant debits and credits as section 553C requires the mutual dealings to have occurred before the winding up, and the ‘dealings’ giving rise to the contingent liability to repay the unfair preference straddled the period before and after the commencement of the winding up;
• the authorities re contingent claims being amenable to set-off do not apply here.  A liquidator’s right to sue under section 588FF(1) could never be characterised as a claim “payable to the company” for the purposes of section 553C;
• as at the commencement of the winding up, there was no contingent liability on the Creditor to repay the unfair preference.  At most, the Liquidator held an expectancy (unsupported by any pre-liquidation right or obligation) that might at some point grow into a money claim of some kind, subject to the Liquidator’s decision to sue and the Court’s satisfaction that the elements of section 588FE(2) had been satisfied.  This type of expectancy is not sufficient to attract the operation of section 553C;
• as a matter of general construction, and having regard to the function and purpose of the regimes for dealing with voidable transactions and for the proof and ranking of claims, any liability arising from an order under section 588FF(1) cannot form part of the process for the identification of provable debts and claims for the purposes of section 553, and therefore cannot be the subject of a valid set-off under section 553C; and
• there had not been mutual dealings between the same persons in the same interests as the Liquidator’s right and interest in the claim against the Creditor are in the Liquidator’s capacity as an officer of the Court, with the Liquidator’s underlying interest being distinct from just a proxy for the Company’s interest in recovering a debt and being in the nature of a unique statutory ability to pursue a voidable transaction for the “special interests” of the creditors.

To remove all doubt, the majority confirmed that to the extent that the cases which contributed to the confusion around the application of set-off to unfair preference claims (such as Re Parker ¹, Buzzle Operations Pty Ltd (In liq) v Apple Computer Australia Pty Ltd ², Shirlaw v Lewis ³, Hall v Poolman ⁴ and Stone v Melrose Cranes & Rigging Pty Ltd [No 2] ⁵) are inconsistent with this analysis, they should now be considered to be wrongly decided.

The majority therefore dismissed the appeal.

Gageler J agreed with the majority’s judgment but added an observation that when a liquidator recovers an unfair preference, while the moneys do belong to the company, they must be dealt with only for the purposes of the winding up.  As a result, given its nature, the recovered amount is not one which could ever have been recovered by the company itself, or which could ever be paid to the company for the benefit of the company alone.  This further strengthens the point that there is insufficient mutuality of interests for section 553C to apply.

Lavan Comment

This important decision definitively ends the debate about whether set-off can apply in relation to a liability to repay an unfair preference, and will no doubt come as a relief to insolvency practitioners, creditors, insolvency lawyers and litigation funders alike.

In addition, the decision provides additional and very useful guidance as to how the statutory regimes for dealing with voidable transactions and for the proof and ranking of claims should be understood and applied, and will no doubt be of significant assistance in matters beyond unfair preference recovery claims.

If you have any queries about this significant decision or about statutory set-off or unfair preference claims in general, the experienced Lavan team is here to help.