The Situation: Historically, creditors pursued by liquidators under the unfair preference regime could rely on a statutory set-off as a defence to the claim, reducing or eliminating their liability to repay what would otherwise be preference payments, on the basis that the liability for the unfair preference payment formed part of a running account between the creditor and the company.
The Development: In Metal Manufactures Pty Ltd v Morton as liquidator of MJ Woodman Electrical Contractors Pty Ltd (in liq)  HCA 1, the High Court of Australia held that debts owed to creditors cannot be set off against a liquidator's unfair preference claim during winding up.
Looking Ahead: This decision provides liquidators with much welcome certainty that any unfair preference claim will not be met for a claim of set-off based solely on the potential liability for the unfair preference.
Federal Court Proceedings
Before entering liquidation, MJ Woodman Electrical Contractors Pty Ltd ("MJ Woodman") made payments of AUD$50,000 and AUD$140,000 to Metal Manufactures Pty Ltd ("Metal Manufactures"). Both payments were made within the relation-back period. The liquidator of MJ Woodman sought to recover both payments from Metal Manufactures under s 588FF of the Corporations Act 2001(Cth) ("Act") on the basis that each payment was an unfair preference under s 588FA of the Act. MJ Woodman owed Metal Manufactures a separate debt of AUD$194,727. Metal Manufactures sought to set off this debt, pursuant to s 553C of the Act, against its potential liability to repay the alleged unfair preference payments.
The question of whether this set-off was possible was reserved by Justice Derrington for consideration by the Full Court of the Federal Court of Australia. The Full Court held that the statutory set-off was not available to Metal Manufactures.
Metal Manufactures appealed to the High Court. The High Court unanimously (Kiefel CJ, Gordon, Edelman and Steward JJ, Gageler J agreeing) upheld the decision of the Federal Court and dismissed the appeal.
High Court Decision
Metal Manufactures contended that it had a right, pursuant to s 553C of the Act, to set off MJ Woodman's separate debt against its potential liability to repay the two payments made to it during the relation-back period. If this set-off was possible, the liquidator would not obtain an order for payment under s 588FF.
Section 553C confers a right of set-off of 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, requiring that only the balance of any set-off be admissible to proof against the company.
Metal Manufactures contended that when it engaged in the mutual dealing with MJ Woodman, a future liability under s 588FF arose, and that s 553C entitled it to set off this potential liability against amounts owed to it by MJ Woodman when the liability crystalised as at the commencement of the winding up.
The court construed s 553C as containing a temporal element. In assessing whether there is mutuality, the rights of the parties are to be taken and ascertained as at the time of winding up. Importantly, and ultimately fatal to Metal Manufactures' claim, it was held that, when read in light of s 553, the mutuality must have existed between the parties before the commencement of winding up, so that any set-off can be taken into account in the winding up.
The court held that immediately before the commencement of winding up, Metal Manufactures' potential liability arising under s 588FF was only a 'mere possibly without more', which was insufficient to form the basis of a mutual dealing able to be set off in the way Metal Manufactures contended. There was therefore nothing to set off between the parties, as while MJ Woodman owed money to Metal Manufactures, Metal Manufactures owed nothing to MJ Woodman.
The court observed that it would be a "gross distortion" of the statutory scheme of liquidation if a creditor could avoid the repayment of an unfair preference by the happenstance that it was also owed money by the company in liquidation. Permitting such an outcome would undermine the purpose of the recovery of unfair preferences as well as the pari passu system of proportionate distributions of the available asset pool.
The Court also observed that liability for an unfair preference payment could not constitute a mutual credit, mutual debt, or mutual dealing with the pre-existing amount owed by the MJ Woodman to Metal Manufactures for two further reasons.
First, there was no mutual dealing because the unfair preference payments were made by MJ Woodman to Metal Manufactures, but the unfair preference liability is owed to the liquidator in their own right and as an officer of the court, not an agent of MJ Woodman.
Second, there was no mutuality of interest because the liquidators' right of recovery of the unfair preference payments is not akin to a trading transaction whereby goods or services have been previously supplied to MJ Woodman, but is a unique statutory ability to recover the proceeds of a voidable transaction.
Also see our related, recently publishedCommentary: "Stick to the Statute: No "Peaking" Around in Australia".
Two Key Takeaways
- It is now beyond doubt that liability for an unfair preference payment cannot be the subject of a valid set-off against pre-existing amounts owed to the preferred creditor.
- Properly construed, section 533C of the Act does not apply where the transactions that are alleged to constitute a running account straddle the period before and after commencement of the winding up.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.