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In a win for liquidators, the Full Court of the Federal Court of Australia this week found that a creditor cannot rely on set-off under the Corporations Act 2001 to reduce an unfair preference claim under section 588FA of the Corporations Act 2001 (Act).

The judgment, Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228, has significant consequences for liquidators prosecuting unfair preference claims.

matter raises questions for statutory set-off

The matter came before the Court as a special case under rule 38.01 of the Federal Court Rules 2011 (Cth) to give effect to the reservation of a question for the Full Court under s 25(6) of the Federal Court of Australia Act 1976 (Cth) brought forward by his Honour Justice Derrington.

The special case was supported by agreed facts that the defendant creditor received payments during the relation back period of $190,000.  Against those payments, the defendant sought to set-off claims totalling $194,727.23, which did not arise from the course of transactions occurring during the relation-back period and said to constitute the liquidator’s preference claim.

The question reserved by Derrington J for consideration of the Full Court was as follows: Is statutory set-off, under s 553C(1) of the 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?

creditor’s obligation could not be reduced by set-off says court

In the judgment of his Honour Chief Justice Allsop (with whom Justices Middleton and Derrington agreed) the answer to the reserved question was an unequivocal ‘no’.

The Chief Justice began by categorising the question as essentially one of statutory construction: properly construed according to their text and context, what was the meaning and content of section 553C, and of the unfair preference provisions in part 5.7B of the Act?

After careful consideration of the history of section 553C (and its predecessors), his Honour ultimately found that a creditor’s obligation to re-pay an unfair preference to a company in liquidation under section 588FF of the Act could not be reduced by way of set-off, as that obligation does not satisfy the requirement of mutuality.

In reaching that conclusion, the Court found that the obligation to disgorge preference payments was a new obligation arising after the liquidator, acting for the benefit of creditors, obtained orders of the Court.  There was no sense in which that obligation could be said to have been due, even contingently, prior to the company before the order was made.  Accordingly, that obligation could not be mutual with an old debt arising out of the company’s pre-liquidation dealings with creditors.

Moreover, allowing a creditor to rely on a statutory set-off would result in the creditor effectively receiving the set off portion of an otherwise successful unfair preference claim in priority to other creditors.  That, the Court said, would dislocate the statutory priority regime and there could be no genuine mutuality of debts in those circumstances.

key take-aways

The factual matrix in Morton is so familiar to insolvency practitioners as to be almost pedestrian.  Critically for practitioners, key takeaways from Morton include the following.

1. A creditor who has received an unfair preference cannot rely on section 553C of the Act to set off pre-existing debts owed to it by the company in liquidation.
2. A key purpose of the voidable preference regime is to protect the priority regime set out in the Act by ensuring that all unsecured, non-priority creditors are treated equally in accordance with the pari passu principle.
3. On the other hand, the underlying purpose of the law of set-off is to protect creditors who have genuinely reciprocal or mutual debts with the company in liquidation. That process should in no way interfere with the pari passu principle or otherwise ‘dislocate’ the order of priorities set out in the Act.

For more information, contact the Macpherson Kelley Insolvency team.