Creditors cannot set off unsecured debts against unfair preference claims. What about other voidable transactions?

For some time, controversy has surrounded the question of whether unsecured creditors of an insolvent company can utilise set-off under s 553C of the Corporations Act 2001 (Cth) (Act) against unfair preference claims. In the recent decision of Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228 (MJ Woodman), the court made it clear that the recipient of an unfair preference cannot set off its unsecured debt against the preference claim.

Background

Section 553C of the Act

Section 553C allows the set-off of mutual credits, mutual debts or other mutual dealings between an insolvent company and its unsecured creditors. For example, where an insolvent company owes a debt to an unsecured creditor, this may be set off against an unrelated debt the creditor owes to the insolvent company.

Set-off against unfair preference claims pre-MJ Woodman

Before the decision in MJ Woodman, it had been thought that unsecured creditors could utilise set-off under s 553C in respect of unfair preference claims. That is, where a creditor had an unsecured debt provable in the liquidation, that unsecured debt could be set off against the quantum of any unfair preference claim against the creditor. Controversy has long surrounded the notion that a claim against an insolvent company could be set off against recovery by a liquidator.

The MJ Woodman decision and outcome

Context

The liquidator issued an unfair preference claim under s 588FA of the Act to Metal Manufacturers Pty Ltd for unfair preference payments of $190,000 received during the relation-back period. Metal Manufacturers claimed to be entitled to set-off debts totalling $194,727.23 owed to it by the insolvent company against the unfair preference claim.

Finding of the Full Court

The court in MJ Woodman held that unsecured creditors cannot claim statutory set-off where unfair preference claims are concerned. The central finding of the court was that there was a lack of mutuality between an unsecured debt owed by the company in liquidation to the creditor and an unfair preference claim owed by an unsecured creditor at the suit of the liquidator. The court’s two key reasons for finding a lack of mutuality were:

1. The right to seek repayment of an unfair preference is not a claim of the insolvent company but rather a claim accrued to the liquidator for the benefit of unsecured creditors (not the insolvent company)
2. The right of a liquidator to reclaim unfair preferences forms only when the liquidator brings a court application to set aside the unfair preference payment. Thus, there is no temporal mutuality between the creditor’s claim (which arises before the liquidator’s court application) and the liquidator’s claim.

As such, the court held that due to the lack of mutuality, the fundamental elements of s 553C could not be made out.

Applicability of the MJ Woodman decision to other voidable transactions

There is a range of other voidable transaction claims that accrue to a liquidator, for which set-off under s 553C has been previously applied. One example concerns uncommercial transactions under s 588FB of the Act.

Importantly, the court in MJ Woodman expressly refrained from commenting on whether s 553C would continue to apply to other voidable transactions. Despite this, given the reasons of the court in finding that s 553C set-off does not apply to unfair preference claims, it is arguable that s 553C does not apply to some other voidable transactions. That is because:

1. Voidable transactions do not create a cause of action of the company but rather enable the liquidator to seek orders of the court to augment the insolvent estate (see, for example, Fortress Credit Corporation (Australia) II Pty Ltd v Fletcher (2014) 87 NSWLR 728 at [127]). Thus, there may be a lack of reciprocal mutuality
2. There is likely to be a lack of temporal mutuality

Thus, whilst it remains to be seen, liquidators should closely consider whether s 553C may no longer apply to other voidable transactions. In particular, there are good arguments that set-off under s 553C should not apply to uncommercial transactions. This is because unfair preferences and uncommercial transactions share an essentially similar statutory regime. If set-off is found not to apply to uncommercial transactions, it may render uncommercial transactions worth pursuing where it might otherwise not have been viable. For example, where an insolvent company agrees to pay a price for services in an amount far exceeding the market value, liquidators may be able to pursue service providers with greater capacity for return.

Key takeaways for liquidators

1. While the case of Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (in Liq) (receivers and managers appointed) [2021] FCAFC 64 might have been seen as reducing the quantum of unfair preference claims available to a liquidator by removing the peak indebtedness rule, the MJ Woodman decision might have the effect of increasing the quantum of unfair preferences recoverable by a liquidator
2. Liquidators should review their files for any unfair preference claims they might have deemed uncommercial to pursue because of the applicability of s 553C – these claims may now be worth pursuing
3. Whether set-off applies to other liquidator claims will remain to be seen, but liquidators should consider challenging the applicability of s 553C to other voidable transactions, particularly uncommercial transactions
4. It is worth remembering that even in relation to set-off against other types of claims, where, at the time of giving credit to the company or at the time of receiving credit from the company, the defendant had notice of the fact that the company was insolvent, set-off will not apply (see s 553C(2) of the Act)