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Can you claim statutory set-off as a defence to an unfair preference claim?

Thursday June 23, 2022

Can you claim statutory set-off as a defence to an unfair preference claim?

Can you claim statutory set-off as a defence to an unfair preference claim? Well, the Full Court of the Federal Court of Australia says no!


In the matter of Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228 (Allsop CJ, Middleton and Derrington JJ presiding), the Full Court unanimously held that a creditor was unable to rely on section 553C of the Corporations Act 2001 (the Act) as a set-off defence against an unfair preference claim brought by a liquidator.

What is an unfair preference claim?

An unfair preference is a transaction (such as a payment of funds or the transfer of assets) that has the effect of giving preferential treatment to one unsecured creditor over other unsecured creditors in a liquidation of a company. 

A good example would be a director of an insolvent company repaying unsecured family loans in full and not paying other unsecured creditors like the Australian Taxation Office.

In respect of company liquidations, the appointed liquidator/s have the power to pursue unfair preferences against unsecured creditors if the transaction/s occurred within six months prior to the relation back day, or four years prior to the relation back day in the event the creditor is a related entity of the company.

The relation back day is a date used by practitioners and the Courts to determine what date to relate-back from to pursue claims for possible voidable transactions.

The elements to establish an unfair preference claim are found within section 588FE of the Act, in summary being:

  1. The company was insolvent;
  2. There was a payment or transaction between the company and a creditor;
  3. This payment or transaction occurred during the relevant time period; and
  4. The creditor benefited from the transaction by receiving more than if the transaction was set aside and the creditor proved in the liquidation.

The reason for the above regime is to ensure there is equal treatment amongst unsecured creditors.

There are a number of defences available to an unsecured creditor to fend off or defend an unfair preference claim by a liquidator.

In the case of MJ Woodman Electrical, the unsecured creditor unsuccessfully attempted to raise a set-off pursuant to section 553C of the Act for a different debt that was owed to the unsecured creditor from the same company as a defence to an unfair preference claim.

Background

In the matter before the Full Court, an unsecured creditor was owed two separate debts by MJ Woodman Electrical Contractors Pty Ltd (in Liquidation) (the Company), one debt being in the sum of $190,000 and the other for $194,727.23.

Before the Company went into liquidation, it paid off the debt of $190,000 owed to the creditor during the relation back date. Once the Company went into liquidation, the liquidator attempted to claw back this payment.

In response, the creditor argued that the alternative amount owed by the Company to the creditor in the sum of $194,727.23 can be used as a set-off pursuant to section 553C of the Act to discharge the unfair preference claim by the liquidator.

Decision

The Full Court found that for a claim under section 553C of the Act to be established, the set-off must be in relation to “mutual credits, mutual debts or other mutual dealings.”

In order for mutuality to be established:

  1. The debts must exist between the same parties; and
  2. The debts must arise between the parties in the same right.

In this particular case, the Full Court held that the element of mutuality could not be established.  The debt of $194,727.23 was owed by the Company to the creditor and was a debt that exists between two parties in one right. However, the receipt of $190,000 by the creditor is an unfair preference payment which is a claim that is brought by the liquidator during his/her duty to recoup funds to distribute for the benefit of the creditors of the Company. 

The obligation on the creditor to pay back the $190,000 to the Company is a completely new right that is solely brought by the liquidator. As mentioned above, mutuality between two debts only arises when those debts are between the same parties and the same right.

The Court also made reference that section 553C of the Act is based on equitable principles of equality, therefore if the Court accepts that a set-off exists as a defence to an unfair preference claim, it would mean the funds obtained by the creditor would not be available to distribute equally to other unsecured creditors. This would ultimately disrupt the order of distribution amongst creditors in insolvent estates and in a way create a new type of creditor that ranks above other unsecured creditors.

Take away

The Full Court has provided greater clarity in respect of whether a creditor can use the statutory right of set-off against an unfair preference claim that is pursued by a liquidator.

The case reiterates that voidable transaction claims such as an unfair preference claim are rights of action that are expressly brought by the liquidator in his/her execution of the duty to gather or recover funds in the estate for the benefit of all unsecured creditors, and are not rights of action in the Company itself. 

If you would like to find out more, please contact our experienced insolvency team on 03 9629 7411.

This article was co-authored by Ali Dogan, Special Counsel and Dejan Vangev, Lawyer.


Author:
Ali Dogan