Commonly, a creditor being sued by a liquidator to refund an alleged unfair preference is owed money by the company in liquidation.
Liquidators argue that under section 553(c)(1) of the Corporations Act 2001 (Act) a creditor is not able to set-off the outstanding indebtedness owed by the company to the creditor to reduce any liability of the creditor to refund any unfair preference. Similar arguments are made by liquidators in relation to insolvent trading claims.
A snapshot of the court decisions
In Morton v Rexel Electrical Supplies Pty Ltd  QDC 49, the District Court of Queensland applied the set-off section to an unfair preference claim, reducing the amount that had to be refunded by the creditor. The Court applied the controversial decision of Re Parker (1997) 150 ALR 92, where a holding company being sued for the insolvent trading of its subsidiary was able set-off debts owed by the subsidiary to the holding company.
In the Federal Court decision of Smith (in the capacity as liquidator) v Bone  FCA 319, a liquidator sought compensation against a director for insolvent trading. The liquidator argued that the set-off was not available under section 553C.
The liquidators in Smith v Bone did not make detailed submissions on the issue, but sought to preserve their position in the event of an appeal. The Court adopted the approach taken in Re Parker.
In Hambleton v Finn  QDC 61, the District Court of Queensland applied the decision in Rexel to an insolvent trading claim against a director.
Recent decision from the Federal Court
In Stone v Melrose Cranes & Rigging Pty Ltd, in the matter of Cardinal Project Services Pty Ltd (in Liq) (No2)  FCA 530, the creditor sought to rely on the set-off section in an unfair preference claim.
The liquidators accepted that the balance of authority permits the section 553C set-off to be utilised in voidable transaction claims, referring to the decision in Re Parker (an insolvent trading claim).
However, the liquidators in Stone argued the insolvency set-off is not available in unfair preference claims and that the Court should not follow cases such as Re Parker on the basis that they are plainly wrong.
In the circumstances where no detailed submissions were made by the liquidators as to the applicability of the set-off, the Court in Stone, in its judgment on 19 April 2018, took the same approach as in Smith v Bone and followed the decision in Re Parker and other authorities. The Court held the set-off in section 553C can be utilised in voidable transaction claims (including unfair preference claims).
Notice of insolvency
However, under section 553C(2) of the Act, a claim for set-off is not available under section 553C if, at the time of giving credit to the company, or at the time of receiving credit from the company, the person had notice of the fact that the company was insolvent.
In Stone, the creditor was ultimately unsuccessful under section 553C because, at the time it gave credit in respect of the outstanding indebtedness, it had notice of the company's insolvency within the meaning of section 553C(2) of the Act.
A person will have 'notice of the fact' that a company is insolvent if the person has actual notice of the facts that disclose that the company lacks the ability to pay its debts when they fall due, within the meaning of section 95 of the Act.
The liquidator does not need to show that the person actually formed the view that the company lacked that ability, however 'grounds for suspecting' insolvency will not suffice. What is required is proof of facts known to the creditor that warrant the conclusion of insolvency.
The relevant issue will be whether the creditor had actual notice of the facts that would have indicated to a reasonable person in their position that the company was unable to pay all of its debts as and when they became due and payable.
Liquidators may be losing the argument that the section 553C set-off cannot be relied upon by a creditor to resist an unfair preference claim.
Pending a decision by an appellate court, liquidators will no doubt contend that the decision of Re Parker is incorrect, and then argue that, in any event, the creditor cannot rely on the section 553C set off because of the fact the creditor had notice of the company's insolvency when granting the credit in respect of the outstanding indebtedness. This will be the liquidator's focus when trying to prevent their unfair preference claim from being whittled down by a creditor's claim for a section 553C set-off.
Whether the creditor had notice of the company's insolvency at the time of giving the credit to the company will depend on the nature of the transaction and the facts.
Of course, creditors will continue to seek to rely upon other potential defences to defeat or reduce an unfair preference claim.
Cooper Grace Ward is a leading Australian law firm based in Brisbane.
This publication is for information only and is not legal advice. You should obtain advice that is specific to your circumstances and not rely on this publication as legal advice. If there are any issues you would like us to advise you on arising from this publication, please contact Cooper Grace Ward Lawyers.