Merry Xmas liquidators from the Federal Court of Australia

The dreaded Statutory Set-off

This debate has been rolling around since perhaps 1996. Who says the wheels of justice turn slowly?

Is a statutory set-off, under s 553C(1) of the Corporations Act 2001 (Cth) (Act), available to the defendant in this proceeding against the plaintiff’s claim as liquidator for the recovery of an unfair preference under s 588FA of the Act? This has given liquidators the willies for several years, and now in the judgment of Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228 delivered on 16 December 2021, the Full Court of the Federal Court of Australia has confirmed in a single word what the position is: “No”.

Cases in the recent past, such as Re Washington Diamond, Lister v Hooson, In re a Debtor, Shirlaw v Lewis, Re Parker, Hall v Poolman [2007] NSWSC 1330; 65 ACSR 123, Buzzle Operations Pty Ltd (In Liq) v Apple Computer Australia Pty Ltd [2011] NSWCA 109; 81 NSWLR 47 and to a lesser extent, Smith v Boné [2015] FCA 319; 104 ACSR 528 had all decided that a set-off was available to a creditor who was pursued by the liquidator for an unfair preference or an insolvent trading claim, but because the creditor was still owed a debt by the company in liquidation, it could apply that debt as a set-off against the liquidator’s claim. These cases have been the bane of liquidators ever since.

Unfair preference claims fall within the “voidable transactions” provisions of the Act, whereas the s553 set-off provision does not. In decades past, liquidators had simply (and understandably) applied s553C to determine debts owed or owing by creditors/debtors when considering proofs of debts. It simply was not an issue in an unfair preference claim. That changed in the early part of this century.

 Background

Section 553C of the Act provides:

(1) Subject to subsection (2), 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:

(a) an account is to be taken of what is due from the one party to the other in respect of those mutual dealings; and

(b) the sum due from the one party is to be set off against any sum due from the other party; and

(c) only the balance of the account is admissible to proof against the company, or is payable to the company, as the case may be.

(2) A person is not entitled under this section to claim the benefit of a set-off if, at the time of giving credit to the company, or at the time of receiving credit from the company, the person had notice of the fact that the company was insolvent.

Ordinarily, pursuant to s588FI of the Act, where a creditor pays an unfair preference amount back to the company, that creditor can then prove in the liquidation for the debt repaid.

The Full Federal Court held that “Section 588FI sits incongruously and uncomfortably with any proposition that an obligation to repay an unfair preference is to be set off against a second debt of the company to the preferred creditor the subject of the order. Indeed, for the above reasons it can be seen as inconsistent with s 553C being engaged in the manner propounded by the creditor[1].

The Feeling is mutual, or not…

Chief Justice Allsop, who delivered the principal judgment, went to great lengths and historical analysis to reach his monosyllabic conclusion.

The NSW Court of Appeal had earlier held[2] that the voidable transaction provisions do not create any right of action in the company. Nor do they allow the liquidator to recover. They enable the liquidator, as the official charged with the task of collecting and administering the insolvent estate, to seek the assistance of the court in augmenting that estate for the benefit of creditors by countering the effects of pre-liquidation transactions of certain kinds.

“When I refer to augmenting the insolvent estate for the benefit of creditors, I intend to recognise the reality that, although in a simple s 588FF(1)(a) case, the order is an order for the payment of money “to the company”, the right by virtue of which the money is received is a right of neither the company nor the liquidator; that the company has no capacity to mount a recovery action; and that the benefit of the recovery inures wholly for the benefit of the persons who will participate under the winding-up.”[3]

The Full Federal Court found that the creditor’s claim for an offset was “to take one description of the rights of ownership of the company for one purpose and use it mechanically for another purpose.

“That the funds are beneficially those of the company for one purpose does not answer the question of mutuality for the purposes of s 553C, in its statutory context. For the purposes of reciprocity and the statutory purpose within s 553C, the funds are received in virtue of the interest and right, and for the benefit of the creditors and those charged with the administration. This is not in the same interest as the company was liable for or the creditor entitled to receive the second debt of the company to the creditor.”[4]

The Full Federal Court found that the answer came to down to the concept of “mutuality” of the two debts sought to set-off:

“In such circumstances, the debts are not, and cannot be, mutual. One debt was owed by the company in its own right to the creditor arising out of historical events in the ordinary course of business dealings. The other obligation to pay is payable by the creditor to the company not as its pre-existing creditor, but pursuant to an order of the court obtained by the liquidator pursuant to his or her rights and exercising his or her statutory duties. Whilst in one sense the payment is received by the company beneficially, it is not payable to, or received by the company in virtue of its own interest or right, or for its own benefit, but in the interest or right, or for the benefit (through the liquidator) of all creditors and for the estate’s administration, under a statutory regime. The creditors of the estate have no beneficial interest in the funds received, but the funds are paid and received in virtue of their and the administration’s interest and right and for their and the administration’s benefit, under the statutory regime.

“The words of s 553C are to be read in the context of the Act as a whole in a way that conforms with its operation, set in the context of an orderly administration, built on the foundation of genuine mutuality, recognising the importance of the vindication for the general body of creditors of remedies to cure efficaciously the effect of a preferential transaction, of equality of distribution, and of the statutory regime of administration. [155] A conclusion of mutuality for the purposes of s 553C as propounded by the creditor would see a result described at [31] above, including the consequence that proceeds of a preference recovery action under s 588FF would go first to pay (by a set-off) an erstwhile preferred creditor in priority to priority creditors, such as employees of the insolvent company. Such a conclusion offends the notion of fairness that underpins mutuality in s 553C and the statutory order of priority of certain creditors, built in respect of some (in particular employees) upon the protection of the vulnerable.” [5]

Middleton J added that “the ultimate conclusion is that the relevant legislative provisions deny the character and quality of mutuality to the debt of the company to the creditor and the obligation of the creditor to pay the company under s 588FF.” [6]

In his one paragraph judgment, Justice Derrington very honourably stated “There is nothing which I might add which could possibly improve upon what his Honour [Allsop CJ] has written and anything I did would surely diminish it.” Hear! Hear!

Conclusions

In conclusion, can a creditor on the receiving end of an unfair preference claim from a liquidator apply to set-off their existing debt owed by the company against the liquidator’s claim? No.

Is the matter off to the High Court? The debate has certainly raged long enough to create confusion. Stay tuned.

[1] At [135]

[2] Fortress Credit Corporation (Australia) II Pty Ltd v Fletcher [2014] NSWCA 148; 87 NSWLR 728 at 749–750 [127] per Barrett JA

[3] Fortress at [129]

[4] At [151]

[5] At [153]

[6] At [218]