Case Study on the Right of Creditors to Set-off to Unfair Preference Claims: Metal Manufacturers Pty Ltd v Morton (As Liquidator of MJ Woodman Electrical Contractors Pty Ltd (In Liq)) (2023) 496 ALR 711

A recent decision of the High Court of Australia (High Court) has set an important precedent when it comes to the availability of statutory set-off to unfair preference claims that provides certainty to liquidators and creditors.

In the unanimous decision of Kiefel CJ, Gageler, Gordon, Edelman and Steward JJ, it was found that creditors do not have the ability to set-off under s 553C of the Corporations Act 2001 (Cth) (Act) against an unfair preference liability.

Facts

Metal Manufactures Pty Ltd (Metal Manufactures) was paid $50,000 and $140,000 by MJ Woodman Electrical Contractors Pty Ltd (MJ Woodman). MJ Woodman then went into liquidation. Both payments to Metal Manufacturers were made in the six months prior to the winding up of MJ Woodman (relation-back period).

The Liquidator of MJ Woodman (Liquidator) sought to recover both payments from Metal Manufactures under s 588FF(1)(a) of the Act on the basis that each payment was an unfair preference under s 588FA of the Act.

MJ Woodman owed Metal Manufactures $194,727.23 as a separate and distinct debt (separate debt) from the unfair preference liability which was claimed by the Liquidator. This separate debt exceeded the total amount of the two payments claimed by the Liquidator to be unfair preference payments.

Metal Manufactures contended that it has a right under s 553C(1) of the Act to set-off its potential liability to repay the alleged unfair preferences against the separate debt that it was owed by MJ Woodman. The question to be answered was:

‘Is statutory set-off, under s 553C(1) of the Act, available to Metal Manufactures in this proceeding against the Liquidator’s claim for the recovery of an unfair preference under s 588FA of the Act?’

The Full Court of the Federal Court of Australia said “no” to this question, and Metal Manufactures appealed that decision to the High Court.

Case put by Metal Manufactures

Metal Manufactures claimed that it was entitled to set-off its potential unfair preference liability against the separate debt it was owed by MJ Woodman because there had been a mutual dealing between Metal Manufactures and MJ Woodman. That mutual dealing was said to include the alleged unfair preference payments made by MJ Woodman during the relation-back period.

Metal Manufactures submitted that, as at the date of commencement of MJ Woodman’s winding up, liability had not yet sprung into existence and that it was sufficient that it existed as a contingent liability, which might in the future mature into an actual liability. This could then be set-off against the separate debt that MJ Woodman owed Metal Manufactures.

Findings

The High Court held that the statutory ability for creditors to set-off under s 553C is not available against an unfair preference liability. Their decision was made on two grounds:

1. The credits, debts or dealings must subsist before the commencement of the winding up

s 553C(1) requires that mutual credits, mutual debts or other mutual dealings be credits, debts or dealings arising from circumstances that subsisted in some way or form before the commencement of the winding up. That is because under the statutory scheme, s 553C(1) exists in aid of s 553, which is concerned with debts and claims, whether present or future, certain or contingent, ascertained or sounding only in damages, arising from circumstances that had occurred before the commencement of the winding up. The purpose and function of s 553C is to permit a reckoning of amounts owing to and by the company during the relation-back period prior to the appointment of the Liquidator.

Permitting a preferred creditor to set-off its liability under s 588FF(1)(a) with the liability owed to it by the company would undermine the purpose of the recovery of unfair preferences pursuant to 588FF(1)(a). That purpose being to restore to the pool of distributable assets those payments made under voidable transactions. A set-off, in contrast, would leave that pool diminished. Such an outcome would not have been intended by the legislator.

2. There must be mutuality of credits, debts or dealings

Metal Manufactures could not identify any mutual debts, dealings or interests between the parties.

There were not mutual debts. Immediately before the commencement of the winding up, there was nothing to set-off between Metal Manufactures and MJ Woodman. MJ Woodman owed money to Metal Manufactures, but Metal Manufactures did not owe anything to MJ Woodman. The Liquidator’s capacity and right to sue under s 588FF(1) also did not exist before the commencement of the winding up. Thus, there was no relevant mutual dealing between the parties before the commencement of the winding up.

There was no mutuality of dealings either. Under the statutory scheme for liquidations, any liability arising from an order under s 588FF(1)(a) cannot form part of the process for the identification of provable debts and claims for the purposes of s 553. Therefore, the liability 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 s 553C. The liability created by s 588FF(1)(a) arises upon the application of the Liquidator, who does not do so as an agent of MJ Woodman but does so as an officer of the Court. As such, the dealings were not between the same persons.

Additionally, there was no mutuality of interests. A consideration of the benefit of equitable interests in a transaction is an example of when two parties can enjoy mutuality of interest. The claimed set-off would purely be for the benefit of Metal Manufactures. Pursuant to the statutory scheme, the sum of the unfair preference payments must be made available, amongst other things, for the making of priority payments and for distribution to creditors in accordance with the pari passu principle (i.e. proportionately equal distribution amongst the unsecured creditors).

Precedent set

This is an important precedent set for liquidators and creditors. The ability to set-off in claims such as this has long been the subject of conflicting Court authority, however, the High Court’s reasoning has now made it abundantly clear. Liquidators can now pursue unfair preference claims with a sense of certainty, while creditors have clear guidelines to follow when dealing with a company heading towards to liquidation. Creditors therefore must be cautious in their dealings with any company that they suspect to be insolvent and when responding to unfair preference claims

Should you require advice or assistance regarding any of the matters raised in this article, please contact Vas Marinos on 8210 1293 or vmarinos@normans.com.au or Tom Cheesman on 8210 1291 or tcheesman@normans.com.au.