Insolvency Set-Off Does Not Protect Creditors Against Unfair Preference Claims

• Published date: 03 February 2022
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Corporate and Company Law, Insolvency/Bankruptcy
• Law Firm: Herbert Smith Freehills
• Author: Mr Paul Ap'thy and Emily Hunyor

In its recent decision in Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228, the Full Court of the Federal Court of Australia (the Court) held that statutory set-off, under section 553C(1) of the Corporations Act 2001 (Cth) (the Act), is not available to a creditor in respect of a liquidator's claim against that creditor for the recovery of an unfair preference under s 588FA of the Act.

The availability of set-off to defend against unfair preference claims has been a matter of some uncertainty in cases where the defendant creditor continues to be owed amounts by the company at the date of liquidation (even after receiving the payments that are alleged to comprise the unfair preference). Creditors have in some such cases asserted a right to set-off any amounts payable by them to the insolvent company to disgorge the unfair preference against the amounts still owed to them by the company in liquidation.

In determining that set-off was not available in such circumstances, the Court (Allsop CJ, Middleton and Derrington JJ agreeing) held that there was a lack of mutuality between the company's indebtedness to the creditor and the liability of the creditor to pay the company at the suit of the liquidator, meaning that one of the essential requirements of s 553C was not fulfilled. This lack of mutuality arose from:

• the different interest in which the company: (i) owes money to the creditor (under a normal trading liability pre-liquidation) and (ii) receives money pursuant to a court order in an unfair preference action brought by the liquidator for the benefit of all unsecured creditors (not merely for the company's own benefit) and
• the absence, at the relevant date, of any right or equity (vested or contingent) of the company to recover, or any duty or obligation of the creditor to repay, the preference.

Background

The case arose in proceedings by the liquidator of MJ Woodman Electrical Contractors Pty Ltd (the Company) to recover an alleged unfair preference received by one of its creditors, Metal Manufacturers Pty Ltd (the Creditor) prior to the liquidation.

The Company owed two separate debts to the Creditor. During the relation back period, the Creditor received payments amounting to $190,000 in respect to one of those debts - these payments were the subject of the unfair preference action taken by the liquidator under section 588FA of the Act. The Creditor claimed it was entitled to set-off any such amount that might be repayable by the Creditor as a preference against the other debt of $194,727.23 which remained outstanding to the Creditor.

Importantly, the Creditor did not seek to invoke section 553C to set off the debts that were the very subject of the asserted preference payments; it accepted that the circularity involved in doing so would entirely defeat the statutory purpose of the preference provision.

Derrington J, being the trial judge hearing the unfair preference case in the Federal Court of Australia, reserved the question of the availability of set-off under section...