With the decision of Mansfield J sitting in the Federal Court in Parker [Re Parker (1997) 150 ALR 92] and seemingly reaching its zenith in the District Court of Queensland in the decision of Morton v Rexel [Morton v Rexel Electrical Supplies Pty Ltd  QDC 49], creditors have successfully sought to rely upon Section 553C of the Corporations Act 2001 (Cth) (Act) as a “set-off” defence to liquidators’ claims including for insolvent trading and unfair preferences . To suggest such decisions have caused debate in the halls of insolvency practices would no doubt understate the position.
Indeed it seems somewhat surprising that it has taken so long for an appellate Court – in this case the full bench of the Federal Court – to explicitly consider the matter. But it has now done so, respectfully in a particularly articulate and comprehensive manner by way of His Honour Chief Justice Allsop’s leading decision in Gavin Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd (In Liquidation) & Anor v Metal Manufacturers Pty Limited (MJ Woodman)  FCAFC 228 finding that the defence of set-off is not available to a defendant of a liquidator’s claim specifically for the recovery of an unfair preference.
SECTION 553C SET-OFF
Section 553C sets down that where there have been mutual credits, mutual debts or other mutual dealings between a company in liquidation and a creditor, sums owed and owing are – quite properly – to be set-off against each other, and only the balance is admissible to proof or payable to the company, as the case may be.
As touched upon above, in more recent years a number of Courts have sought to extend the application of the section to debts theoretically available to liquidators as a statutory claim, rather than a claim being the property of the company itself in contract, equity or otherwise.
That extension has led to some potentially counterintuitive outcomes including (in relation to unfair preferences specifically) a scenario put by counsel for the liquidator in Rexel (at ) whereby a debtor having recovered a portion of its debt within the relevant period would be ideally placed to obtain a complete set-off of the debt otherwise due as a preference, whilst a more forthright debtor having recovered the entirety of its similar debt would find itself without a set off available to it – hardly reflecting the parri passu regime which ultimately underpins the preference regime, and described by counsel in the aforementioned case as a “perverse outcome”.
That being the case, it seemed liquidators were reluctant generally to incur the expense of pursuing appeals – required to alter the precedent – and were content to settle matters with recalcitrant parties or otherwise rely on the Section 553C(2), which requires there to be no knowledge of insolvency in order for a party to rely upon the primary set-off provision.
Sensibly when the issue came before Justice Derrington at first instance, His Honour reserved the question for the Full Court – specifically:
“Is statutory set-off under Section 533C(1) of the Corporations Act 2001 (Cth) (Act) available to the defendant in this proceeding against the plaintiff’s claim as liquidator for the recovery of an unfair preference under Section 588FA of the Act?”
The liquidator’s position was predictable:
- the text and structure of the provisions and the Act disclose different spheres of operation for Section 533C and Section 588FA.
- the statutory purpose of the preference provision (Section 588FA) would be undermined by allowing the set-off under Section 533C.
- the accepted approach prior to 1992 in England and Australia was that there could be no set-off of a debt owed by a company in liquidation or bankrupt to a creditor against a liability of the creditor to repay or disgorge a preference.
- the extrinsic materials for the 1992 Act, most importantly the Harmer Report itself, do not suggest any change to that pre-existing position.
- there is an absence of mutuality between the land the creditor.
- the requirement under Section 533C that mutual obligations exist before the relevant date cannot be satisfied.
The Creditor submitted(@  et al):
- Set-off and 5.7B can operate together to permit a set-off of a separate debt against a preference claim.
- The parri passu purpose of the preference regime should not be considered superior to the equally worthy set-off regime both having been designed to achieve substantial justice between the parties.
- Mutuality remains notwithstanding the liquidator is the prosecuting party and has the right to claim personally.
- It is sufficient that there were mutual dealings between the company and the creditor – one debt due in favour of the creditor which remained unpaid at the commencement of the winding up; and the creditor pursuant to a contingent obligation to make a repayment to the company under a later preference claim in respect to a different underlying debt.
THE FULL COURT’S DECISION
The Court found there is no mutuality between what is owed by the company in liquidation to the creditor, and the liability of the creditor pursuant to a court order to pay the company at the suit of the liquidator. It fails the essential requirement of mutuality under Section 553C because the obligation is a new right, a new obligation “one to cure the dislocation to the order of priorities made by the payment, which discharged the debt…”.
Middleton J summarised the position thus (@ ):
The significant point …. is that the obligation to pay under s 588FF arises from an order of the Court sought upon the application of the liquidator. It is not an obligation owed to the company arising from a right it has against the creditor.
The Chief Justice recognised that such obligation is not one “owed to the company by virtue of a right it has against the creditor” but one owed to the liquidator “in his or her own right.”
A conclusion otherwise would quite properly “[offend] the notion of fairness that underpins mutuality in Section 533C and the statutory order of priority of certain creditors, built in respect of some (in particular employees) upon the protection of the vulnerable.” (@ )
Importantly, the Court found that in the absence of any right or equity (vested or contingent) in the company or duty or obligation (vested or contingent) in the creditor to recover or to repay the preference, there can likewise be no mutuality between the indebtedness of the company to the creditor and the liability of the creditor pursuant to the court order to pay the company at the suit of the liquidator(@ ).
Further, on the question of timing the Court noted (@):
The difficulty for the creditor’s submissions is that (directing oneself to the unfair preference) the liquidator is not enforcing a claim or right that forms part of the assets he or she was appointed to administer or that finds its place as a contingent right prior to liquidation.
RELEVANCE OF SECTION 588FI
Seemingly important to the Court’s conclusion was the wording of Section 588FI:
Creditor who gives up benefit of unfair preference may prove for preferred debt
(1)This section applies where:
(a)a transaction is an unfair preference given by a company to a creditor of the company after 23 June 1993; and
(b)at the request of the company’s liquidator, because of an order under section 588FF or 588FGAA, or for any other reason, the creditor has put the company in the same position as if the transaction had not been entered into.
(2)A court must not make under section 588FF, on an application relating to the transaction, an order prejudicing a right or interest of the creditor.
(2A)ASIC must not make an order under section 588FGAA that relates to the transaction and prejudices a right or interest of the creditor.
(3)The creditor may prove in the winding up as if the transaction had not been entered into.
The Court noted the decision of the Full Court in Quickfund (AUST) Pty Ltd v Airmark Consolidators Pty Ltd  FCAFC 70 @  which determined that the company could not possibly be put into the same position as if the transaction had not been entered into without [wholly] “replenishing the assets of the company and leaving the creditor with its two debts to be the subject of proof. Were Section 553C engaged the creditor would in effect be paid in relation to one debt to the extent of the preference repayment and the assets of the estate would not be replenished (notwithstanding the reduced burden of claim to prove by the creditor (@).
Liquidators Claims more Generally
In many respects the more fascinating aspect of the Full Court’s decision may lie with its obiter consideration of other claims by liquidators including insolvent trading, and the prospect of Section 553C applying to such claims.
In referring to the seminal decision of Re Parker the Court identified no inconsistency and did not seek to displace that decision.
Re Parker involved the application of Section 55V to a holding company in respect of the insolvent trading of its subsidiary.
Where there has been a contravention of Section 588V the legislation (Section 588W) provides for the recovery from the holding company “ass a debt due” .
His Honour noted two matters – firstly the aforementioned provisions (V and W) are not directed to the protection of the access of all creditors of the company to equality of distribution and:
Secondly, that feature of the provisions enables the character of the right of action by the liquidator of the subsidiary and the funds received (as a “debt due” to the [subsidiary]) to be seen as having arisen from a wrong (the contravention of s 588V) that was committed by the holding company against the subsidiary, at a time that may well be before the relation-back date for the winding up of the subsidiary and the relevant date for the operation of Section 533C in connection with that winding up.(@
His Honour sought to contrast Sections 588V and W with Section 588FF, finding a contrasting “statutory context” (@ ) and accepting Mansfield J’s assessment that the former provisions were directed at providing an action for the benefit of an insolvent subsidiary against a parent such that the action is for the benefit of the subsidiary company in the relevant sense, albeit the “perfection “ of the claim by winding up is required – but that this of itself does not prevent the set-off under Section 533C. Importantly His Honour notes:
The legitimacy of the set-off can be seen in the genuineness of the mutuality and in the good sense and fairness of seeing the two debts as mutual. The purpose of the substantive provisions is to protect the subsidiary and its creditors from the effects of the holding company’s contravention of the Act in allowing trading of the subsidiary to continue. In such circumstances, it may be reasonable to view the statutory debt as arising from the earlier contravention and so be contingent by the existence of a form of statutory equity in the subsidiary against the holding company, to be vindicated through any future liquidator. Looked at thus one can see a sense of equitable fairness in a characterisation of genuine mutuality. (@)
Whilst I (respectfully) have difficulty with the “perfection” argument, ultimately it is likely of no moment by reason of the quite proper delineation in statutory context and specifically the fact the preference provisions are singularly drafted to equalise the interests of the body of unsecured creditors so as to avoid a feeding frenzy of litigation prior to appointment.
In all the decision realigns the Universe on this singularly frustrating subject. No doubt there is an ongoing debate to be had vis a vis the utility of unfair preferences and parri passu in aligning the interests of unsecured creditors more generally, however for the time being order has returned.
1 (1997) 150 ALR 92.
2  NSWSC 1842.
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