Set-off Denied for Unfair Preference Claims
- Published 22.12.2021
The FCAFC (the Court) recently confirmed in Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited (FCAFC 2021) (Morton) that the statutory set-off, under s553C(1) of the Corporations Act 2001 (Cth) (the Act), cannot be relied upon by a creditor to reduce an unfair preference claim under s588FA of the Act.
Section 553C of the Act describes the statutory set-off as being a situation '…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….'.
Prior to Morton, it has been held in several reported decisions, including Morton & Anor v Rexel Electrical Supplies Pty Ltd (QDC 2015) and Stone v Melrose Cranes & Rigging Pty Ltd, in the matter of Cardinal Project Services Pty Ltd (in liq) (CPS)(No 2) (FCA 2018), covered in our TurkAlert dated 30 May 2018, that a creditor that is liable to repay or disgorge a preference received by a company in liquidation may rely upon a right to set-off, under s533C of the Act, the pre-insolvency debt that is owed to it by the company. The result was that only the balance of the claim (if any) after deduction of the set-off amount can be claimed by the liquidator.
Accordingly, in a hypothetical illustration of the principle1:
- Creditor is owed $200 by company.
- Company pays creditor $100 during relation back period bringing debt owed down to $100.
- Company enters Liquidation.
- Liquidator sues creditor for $100 preference.
- Creditor defends claim for $100 on the basis it is owed $100 and invokes s553C set-off.
- Pre – Morton: Creditor's defence is successful. Liquidator loses unfair preference claim. The Court said that the consequence of this would be that the creditor is being paid in priority to priority creditors, such as employees of the insolvent company and such a "conclusion offends the notion of fairness that underpins mutuality in s 553C and the statutory order of priority of certain creditors…."2 .
- Post – Morton: Creditor's defence fails. Liquidator can claw back the $100 preference. Liquidator will ultimately pay that creditor a parri passu (cents in dollar) dividend based on a $200 debt.
In Morton, the liquidator brought proceedings against a defendant creditor under s588FA of the Act, seeking repayment of $190,000 that the company paid to the creditor during the relation back period. The creditor defended the proceedings claiming entitlement to set-off claims totaling $194,727.23 under s553C(1) of the Act.
The question of whether the creditor could set-off the alleged debt against the claimed unfair preference was reserved by the FCA for the Full Court's consideration.
On 16 December 2021, the Court ruled that the answer to the reserved question was 'no' - the creditor of an insolvent company has no statutory right of set-off against a liability to repay an unfair preference claim.
The decision came down to the lack of mutuality, as required by s533C of the Act, between the company's indebtedness to the creditor and the creditor's liability under a court order to repay the unfair preference at the liquidator's suit. The Court held that the creditor's interest in the alleged debt is a different interest to the company's interest as a payee of the unfair preference claim. Furthermore, the company's right to recover the unfair preference and the creditor's obligation to repay, does not arise until after the court order is obtained by the liquidator. Therefore, the creditor's obligation to repay does not have the necessary character and quality of mutuality to the debt incurred by the company, prior to the company's liquidation.3
- Set-off is no longer a defence to an unfair preference claim, and other defences are now more important.
- Review your position with respect to current disputes with liquidators where set-off is an issue.
- If there is a debt owed by the company in liquidation and you are sued for a preference consider whether the running account defence can be invoked, particularly having regard to the recent overhaul of the peak indebtedness rule in Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (in liq) (receivers and managers appointed) (FCAFC 2021) covered in our TurkAlert dated 12 May 2021.
- The secured creditor defence is now more important than ever. Creditors supplying on ROT terms should review their terms and conditions and the PPSR to ensure they are in a position to rely on this defence.
- As always, review credit limits and keep limits within set parameters.
- Consider current claims and assess whether there are now better prospects.
- The Morton decision may not make a great deal of difference to prospects. The set-off defence was always difficult to make out, given the need for a creditor to prove it had no notice of insolvency under s553C(2) of the Act.
- Whilst set-off is no longer a defence to a preference, we expect, since Badenoch, that creditors will be seeking to rely more heavily on the running account defence.
1 See  of the Judgment
2 See  of the Judgment
3 See  of the Judgment