By Arian Bahmiyari, Law Clerk at Matthews Folbigg in the Insolvency, Restructuring and Debt Recovery Group.
In the past, set-off has been used as a defence against unfair preference (and other insolvency) claims with some uncertain and inconsistent outcomes. This ends now in relation to unfair preferences with a major win in favour of liquidators and will most likely lead to a similar outcome with other insolvency proceedings.
In Metal Manufactures Pty Limited v Morton [2023] HCA 1 (“Metal Manufacturers v Morton”), the High Court held that set-off is not available as a defence to a creditor being sued for an unfair preference by a liquidator. The High Court found that the debt owing by the company in liquidation had no mutuality with the unfair preference claim by the Liquidator in the winding up.
What is set-off in insolvency?
Section 553C(1) of the Corporations Act 2001 (Cth) (“Act”) provides that in the winding up of a company amounts owing between a creditor and the company in liquidation may be set-off, “where there have been mutual credits, mutual debits or other mutual dealings”.
Subsection (2) excludes this right of set-off where the creditor had notice of the debtor company’s insolvency.
What is an unfair preference?
An unfair preference is defined in s 588FA of the Act as a payment made to a creditor by an insolvent company which has the effect that the creditor receives more than they would if the payment hadn’t been made, and the creditor had to prove for the debt in the winding up along with all of the debtor company’s other creditors. Under s 588FE of the Act only payments within the relation back period are susceptible to being clawed back by the liquidator. This period is normally 6 months before the commencement of the winding up, although each administration needs to be considered carefully (see s 91 of the Act). Unfair preferences are one of a number of voidable transactions that a liquidator will investigate as part of the winding up of an insolvent company.
How is set-off used as a defence to unfair preference claims?
In the Full Federal Court’s decision in that was on appeal, Chief Justice Allsop provided a hypothetical example that illustrates how set-off was used as a defence and how it would result in injustice. In this scenario, a creditor had two separate debts of $100 each (total $200) owed by an insolvent company and during the relation-back period, the insolvent company made a payment of $100 to the creditor.
If the liquidator sought to recover the $100 payment as an unfair preference, the debtor would seek to set-off against this claim the remaining debt of $100 owed by the insolvent company. If successful, this would reduce the liquidator’s claim to $0.
The question for the High Court was whether this was a legitimate use of the law of set-off.
Background of the case
In Metal Manufacturers v Morton, Metal Manufacturers Pty Ltd (“the Creditor”) was paid $140,000 and $50,000 by MJ Woodman Electrical Contactors Pty Ltd (“the Debtor”). The Debtor went into liquidation and its Liquidator sought to recover both the payments as an unfair preference. The Creditor had a balance owing to it by the Debtor (after the challenged payments) of $194,727.23. The Creditor therefore sought to set-off this $194,727.23 against the Liquidator’s $190,000 preference claim, extinguishing the unfair preference claim and leaving the Creditors $4,727.23 as a provable debt.
The Creditor argued that:
- when it received the unfair preferences, there was a future and contingent right for the Liquidator to recover the payments. This right was based upon its debtor/creditor relationship and was therefore part of the mutual dealings between it and the Debtor;
- according to the High Court’s decision in Gye v McIntyre (1991) 171 CLR 609, mutual dealings included dealings “capable of giving rise to” a claim that could be set-off in the future;
- any unfair preference recovered was recoverable by the Liquidator as a debt due to the company and was therefore mutual in that it involved the same parties (ie the Debtor and the Creditor); and
- at the time winding up commenced, the Liquidator’s unfair preference claim may or may not be made, but the mere contingent possibility was sufficient to establish the right to set-off.
The decision
The High Court dismissed the creditor’s appeal and held that:
- immediately before the commencement of the winding up there was nothing that could have been set off between the two parties, as the Debtor owed money to the Creditor, but the Creditor owed nothing to the Debtor. The claim for the unfair preferences only came into existence upon the winding up of the Debtor; it was a new and distinct claim that was not mutual to any dealings between Creditor/Debtor for goods and services;
- the ‘contingent’ and ‘future’ right could not have existed prior to the commencement of the winding up. Rather, there were a series of conditions required for the Liquidator’s claim to come into existence, including the making of the claim and the court being satisfied that the elements of s 588FE(2) had been met; and
- although the unfair preference was payable to the insolvent Debtor, there was no mutuality between the parties. The unfair preferences were paid by the Debtor to the Creditor. The unfair preference was a claim brought by the Liquidator, who did not bring the claim as an agent of the Debtor but rather in his or her own right as Liquidator. The unfair preference payable by court order pursuant to s 588FF(1) could never be “payable to the company” for the purposes of s 553C(1).
The Court’s decision will prevent any further claims of set-off in relation to the amount claimed by a liquidator pursuant to an unfair preference claim.
There remains a question as to whether set-off is now unavailable in other types of insolvency proceedings. For instance, in a claim for insolvent trading against a director, is the director now prevented from seeking to set-off any amount owing to him by the insolvent company against the Liquidator’s claims? Given the reasoning of the Full Federal Court and the High Court in Morton, in any case where the claims are dependent upon the change in status of a company and the appointment of a liquidator, set-off against pre-winding up claims must be regarded as doubtful. Nevertheless, it will be important to see how these issues are considered in other matters.
Matthews Folbigg Lawyers has a specialist team dedicated to Insolvency, Restructuring and Debt Recovery.
If you would like more information or advice in relation to recovering unfair preferences or other voidable transactions, recovery from debtors, or in relation to Insolvency, Restructuring or Debt Recovery practice and procedure, please contact Stephen Mullette or Jeffrey Brown on (02) 9806 7459 or (02) 9806 7446, or email stephenm@matthewsfolbigg.com.au or jeffreyb@matthewsfolbigg.com.au.
