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The Uncertainty Ends: Set-Off Defence Denied to Unfair Preference Defendants

In a decision delivered on 16 December 2021, the Full Court of the Federal Court appears to have finally put to bed one of the larger controversies affecting recovery proceedings brought by liquidators of insolvent companies.

After a company is wound-up in insolvency, it is frequently the case that the liquidator will pursue claims for unfair preferences which were paid by the insolvent company in the six months prior to the commencement of its winding-up. A liquidator is entitled to claw back payments made by an insolvent company in that preceding six month period so that one creditor is not preferred and, instead, all creditors will share equally in the funds which the insolvent company had in its final months.

Once a company is in liquidation, claims for and against its creditors are subject to s. 553C(1) of the Corporations Act, which provides that where there have been mutual credits, mutual debts or other mutual dealings between an insolvent company that is being wound up and a person who wants to have a debt or claim admitted against the company, an account is taken of all debts and credits and those are set-off against the other – leaving only a single amount owing to, or from, the creditor to the company in liquidation. Section 553C(1) applies automatically, as and when a company is placed in liquidation.

A growing body of law had recognised the application of the set-off available under s. 553C(1) to unfair preference claims. So for example a company may have been paid an unfair preference of $50,000.00 prior to winding-up, recoverable by a liquidator, but was still owed $100,000.00 by the company in liquidation. Applying s. 553C(1) would result in the liquidator’s claim to recover an unfair preference of $50,000.00 fail, and the creditor owed the balance $50,000.00 which it would prove in the liquidation.

The decision of Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228 held that a creditor still owed money by a company in liquidation, may not set that debt off against an unfair preference claim brought by the liquidator. To do so, the Court held, would be contrary to the proper intent of the unfair preference provisions, and does not involve a ‘mutual’ debt at the date of liquidation – because an unfair preference claim is pursued after liquidation, and by a liquidator in his or her personal capacity.

Creditors who are still owed money by an insolvent company will now have to pay up an unfair preference claim without recognition of what they are still owed. Statutory set-off has been an increasingly common defence raised in unfair preference claims, but is now likely to be given short shrift by liquidators and the Courts, leaving defendants with fewer arguments to raise in defence of such a claim. Under ordinary principles applying to the interpretation of Commonwealth legislation, all Courts will be expected to follow the decision of the Federal Court in Morton.

A matter left unresolved by the Morton decision is whether the s. 553C(1) set-off applies to a claim brought by a liquidator to recover losses from a director who has engaged in insolvent trading. Many of the policy and interpretive principles discussed by the Court in Morton could be said to apply as well to insolvent trading claims as they do to unfair preference claims. But previous decisions applying s. 553C(1) to insolvent trading claims were not overruled by the Court in Morton, and the Court seemed prepared to distinguish the different recovery proceedings in their interaction with s. 553C(1).

Until an Appeal Court determines whether or not the s. 553C(1) set-off applies to insolvent trading claims, debate over its appropriateness will likely continue. But that debate as it applies to unfair preference claims should finally be silenced by the Federal Court’s Morton decision.