Set off vs unfair preference claims – uncertainty resolved

By an Amended Special Case, Derrington J reserved for consideration by the Full Court of the Federal Court the following question: “Is statutory set-off, under s 553C(1) of the Act, available to the [appellant] in this proceeding against the [first respondent’s] claim as liquidator for the recovery of an unfair preference under s 588FA of the Act?” By majority, the Court of Appeal (Kiefel CJ, Gordon, Edelman and Stewart JJ) held that s 553C(1) of the Act does not entitle the creditor to such a set-off.

Background

The Appellant was paid $50,000 and $140,000 by MJ Woodman Electrical Contractors Pty Ltd (MJ Woodman), within the six months prior to the winding up of MJ Woodman. The liquidator of MJ Woodman sought to recover both payments from the Appellant under s 588FF(1)(a) of the Act. It was accepted that the Appellant was owed a separate and distinct debt of $194,727.23 from the liability said to arise under s 588FF(1)(a) by MJ Woodman.

The Appellant contended that pursuant to s 553C of the Act it had a right to set off the potential liability to repay the alleged unfair preferences against the separate debt owed to it. If the set-off was allowed, the liquidator would not be able to obtain an order for payment under s 588FF(1)(a), because the separate debt exceeded the amount of the alleged unfair preference.

Full Court’s Decision:

In Morton v Metal Manufactures Pty Ltd (2021) 289 FCR 556 at 560 [5], per Allsop CJ (Middleton and Derrignton JJ agreeing), the Full Court held that the answer is ‘no’; the set-off should not be available under s 553C(1). In separate reasons in Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufactures Pty Ltd [No 2] [2022] FCAFC 1, the Full Court also ordered that the issue of costs in the special case be remitted for determination by the docket judge.

High Court of Australia’s Decision:

The High Court held that:

1. the decision of the Full Court was correct;
2. the costs order should not be disturbed; and
3. the costs of the appeal should be in the cause.

Reasoning of the High Court of Australia:

The High Court judgment reflected an evaluation of the statutory scheme and particularly the High Court’s emphasis on the ‘importance’ of the purpose of s 553 of the Act. In the reasons of the majority at [13], the High Court considered the observations of Campbell JA in WD Pty Ltd v Sutton (2011) 82 NSWLR 336 at 363 [105], that:

The High Court judgment reflected an evaluation of the statutory scheme and particularly the High Court’s emphasis on the ‘importance’ of the purpose of s 553 of the Act. In the reasons of the majority at [13], the High Court considered the observations of Campbell JA in WD Pty Ltd v Sutton (2011) 82 NSWLR 336 at 363 [105], that:

‘s 553 ensures that all legal obligations to which a company is subject are ascertained and then valued “at a common date”, so that they can be taken into account in the winding up.’

What followed was that no debt or claim, subject to one possible exception, that arises after the commencement of winding up will be admissible as proof against the company in liquidation.

Key features of the statutory scheme

The High Court at [30] observed that there were five features of the statutory scheme deserving emphasis:

1. “the liquidator is given power and responsibility to identify and gather in the assets of the company for distribution to creditors and contributories;
2. the liquidator is also obliged to distribute those assets by the making of priority payments and then on a pari passu basis by paying creditors and contributories;
3. a bright line is drawn to enable the liquidator to determine what debts are payable by the company and what claims must be met against it; here it is those arising from “circumstances” which existed “before” the date of winding up;
4. in aid of the duty to gather in the assets of the company, the liquidator may recover preference payments as a debt owed to the company; and
5. in determining what debts are payable and what claims must be met, a set-off must take place between what is due as between the company and another person arising from “mutual credits, mutual debts or other mutual dealings“.

High Court’s scrutiny of the appellant’s case in respect of mutual credits, debts, and dealings

The High Court observed at [45], that the appellant’s case turned upon the presence, at the date of the commencement of the winding up ‘of an inchoate or contingent right to sue under s 588FF(1), which was capable of growing or maturing into a money claim that could then be set off against the amount owed by MJ Woodman to it’. However, the High Court considered that proposition ‘suffered from a fatal flaw’. That is, s 533C(1) requires:

‘the mutual credits, debts or dealings be credits, debts or dealings arising from circumstances that subsisted in some way or form before the commencement of the winding up’.

The Court observed that the function and purpose of s 533C 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.

Furthermore, there was no mutuality of interest. Despite the appellant’s contention, the High Court held:

• that the consideration for ‘mutuality of interest’ ‘is not confined to determining whether both parties are beneficially or legally entitled to what they are owed’. Rather, the High Court affirmed the approach recently taken in the Western Australian Supreme Court of Appeal, that ‘a consideration of the benefit of equitable interests in a transaction is but an example of when two parties can enjoy mutuality of interest’.
• Accordingly, in the instant case the entire amount which the liquidator would recover under s 588FF(1)(a) could not be said to be “for his own benefit”, nor the benefit of MJ Woodman. Given the obligations and duties imposed by the statutory scheme, it could not be said that the interest the appellant had in being paid by MJ Woodman was the same as the interest of both the liquidator and the company in recovering the preferential payment.

Key takeaways

As the Full Court acknowledged at [60], this case is of significance to the practice of insolvency in Australia generally. Importantly, the High Court established at [55], that just because the statutory scheme of liquidation sufficiently provides for the winding up of a company without the need for equitable intervention, it does not follow that the interest of the company in receipt of a s 588FF(1)(a) payment is the same as that of the preferred creditor. Rather, the detailed scheme denies such mutuality of interest. Allowing the set-off would have undermined a purpose of recovery of unfair preferences, that being ‘to restore to the pool of distributable assets those payments made under voidable transactions’.

It is hoped that the uncertainty in this area has now been resolved for the benefit of liquidators and creditors of companies in liquidation.

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Authored by:
Scott Couper, Partner
Carma Holland, Graduate