High Court of Australia rules on Set Off Defence

To set-off, or not to set-off? That is the aged old question which has been plaguing the insolvency law space for years.

To the delight of insolvency practitioners around Australia, and to the disadvantage of creditors, the High Court of Australia has recently determined that the set-off defence is not available as a defence to creditors of an unfair preference claim.

The High Court in Metal Manufactures Pty Ltd v Gavin Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd (in liquidation) & Anor[1] dismissed an appeal instructed by the Metal Manufactures Pty Ltd from the Full Federal Court concerning the set-off defence found under 553C(1) of the Corporations Act 2001 (Cth) (Act).

Background

The company, Metal Manufactures Pty Ltd (Metal Manufactures) received two payments totalling $190,000.00 (Payments) by MJ Woodman Electrical Contractors Pty Ltd (in liquidation)(MJ Woodman) in the six months prior to MJ Woodman going into liquidation (the relation-back period).

MJ Woodman also owed Metal Manufactures a debt of $194,727.23 arising from goods purchased from Metal Manufactures (the Debt).

The liquidator of MJ Woodman (Gavin Morton of Morton and Lee Insolvency)(Liquidator) sought to recover the Payments on the basis that they were unfair preferences pursuant to section 588FA of the Act.

Metal Manufactures sought to set-off the alleged unfair preference Payments in reduction of its potential liability owed to the Liquidator against the Debt, leaving a balance of $4,727.23 owed to Metal Manufactures.

What is an unfair preference claim?

Put simply, an unfair preference claim, is a voidable transaction, where an unsecured creditor receives a payment from a company in the relation back period (usually in the 6 month period prior to the date of insolvency). If that unsecured creditor has received an advantage over other unsecured creditors (received more than it would have if it had to prove its debt in the winding up), and the company was insolvent at the time of the payment, then the liquidator will likely claw back the payment as it is deemed to be an unfair preference payment pursuant to section 588FA of the Act.

What is a set-off ?

A set-off is as simple as, you owe me $1, I owe you $1, so let’s call it even.

Section 553C of the Act provides that where there have been mutual credits and mutual debts between a company being wound up and a creditor, the amounts can be set off against each amount. Whatever the balance is, a creditor is able to claim by way of proof of debt in the winding up of the company.

Prior to the High Court’s decision, this meant that a creditor could set-off an amount equivalent to that received as an unfair preference, against another debt which the creditor could prove in the winding up of a company.

High Court Decision

The High Court dismissed Metal Manufactures’ appeal and held that the Payments which were deemed to be unfair preference payments were not eligible to be set-off against the debt owed to the Metal Manufactures.

The High Court’s decision to dismiss the appeal was based upon dealings which were not mutual, for the following reasons:

1. Until such time as when MJ Woodman went into liquidation, the Liquidator had no claim against Metal Manufacturers that could be set off, meaning, Metal Manufacturers’ debt to MJ Woodman only came into existence after the liquidation commenced as a result of the Court making an order that the Payments were in fact unfair preference payments.

2. There was no mutuality between the parties, namely, one dealing between MJ Woodman and Metal Manufacturers (the Debt) and the other being between Metal Manufacturers and the Liquidator (the unfair preference payment as determined by the Court).

3. The beneficial interests in the claims were not mutual. The payment of the Debt is for the benefit of Metal Manufacturers, however, the payment of the unfair preference claim is not for the benefit of MJ Woodman, but it is to claw back those monies so that creditors of MJ Woodman receive a dividend in accordance with the ranking of those debts in the liquidation.

At [45]-[47] of the majority reasons of Kiefel CJ, Gordon J, Edelman J and Steward J, it was held:

“s 553C(1) requires that the 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…

… before the commencement of the winding up there was nothing to set off as between [Metal Manufactures] and MJ Woodman; [MJ Woodman] owed money to [Metal Manufactures], but [Metal Manufactures] owed nothing to [MJ Woodman]… [the] capacity held by the liquidator to sue under s 588FF could not and did not exist before then. It could only be made following the commencement of the winding up… As such, it was not eligible to be set off against the pre-existing amount owed to [Metal Manufactures].

 It follows that [Metal Manufactures] could not identify a relevant mutual dealing”.

Implications following the Decision

This decision is clearly good news for liquidators, who now have one less hurdle to overcome when bringing a claim against creditors concerning unfair preferences. However, it is one less defence available to unsecured creditors.

This decision ultimately reinforces the purpose of the unfair preference regime, which seeks to ensure that all unsecured creditors are treated fairly and equally.

A copy of the judgment can be found here.

Salerno Law regularly advise and act for creditors and insolvency practitioners in respect of unfair preference claims and all things insolvency related. Should you be the recipient of a potential unfair preference payment and require legal advice, please contact our experienced insolvency lawyers, Alexander Phillips and Summer Irvin of our Queensland office.

Author Summer Irvin

[1] [2023] HCA 1