Ding Dong – Set-Off is Gone: Absolutely Set-Off is Definitely No Longer Available as a Defence to an Unfair Preference Claim: Decision Update

The High Court of Australia in Metal Manufactures Pty Limited v Morton [2023] HCA 1 has confirmed the view of the Full Court of the Federal Court of Australia that the "set off" defence under section 553C of the Corporations Act 2001 (Cth) (Act) is no longer available to claims by liquidators for an unfair preference claim made under section 588FA of the Act. 

This decision brings finality to claims brought by Creditor Defendants to such claims and no doubt brings much joy to liquidators across Australia.

As we pointed out in our Alert of 21 December 2021, reliance on this provision "has caused much controversy in the insolvency profession. Defendants of preference claims loved it, liquidators disliked it and the courts did not provide clear direction about its applicability – until now." 

We refer you to our earlier alert for the background prior to the MJ Woodman case.

SECTION 553C SET-OFF

Section 553C of the Act sets out that where there have been mutual credits, mutual debts or other mutual dealings between a company that is being wound up and a creditor seeking to have their claim admitted in the winding up, an account is to be taken of what each party owes the other. Those sums are 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. 

Subsection 2 of section 553C goes on to say that set-off is not available where the creditor is on notice of the insolvency of the company now in liquidation. 

Full Court of the Federal Court Decision

The issue was brought before Justice Derrington of the Federal Court on 24 March 2021, where His Honour reserved the question for consideration of the Full Court: 

"Is statutory set-off under s 553C(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 s 588FA of the Act?"

(Question)

On 16 December 2021, the Full Court handed down its decision and answered the Question "No": set-off was not available as a defence to an unfair preference claim. 

We again refer you to our earlier Alert with respect to the arguments put to the Full Court as to how the Question should be answered as well as the decision handed down by His Honour Chief Justice Allsop on behalf of the Full Court.

In the Full Court decision, His Honour, as well as going through an exhaustive analysis of the submissions made and the history before section 553C was enacted, spent some time on the fundamental issue of mutuality, as this goes to the very heart of the ability to set-off. His Honour found that there was a lack of mutuality between what was 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. Accordingly, His Honour concluded that the essential requirement of mutuality under section 553C of the Act was absent. His Honour eloquently put it as:

"[154] There is simply no mutuality between debtor and creditor in respect of the obligation of the creditor to comply with an order of the Court made under s 588FF on the application of the liquidator. It is a new right; and a new obligation; one to cure the dislocation to the order of priorities made by the payment, which discharged the debt, subject to the operation of the statute.  The obligation to pay under s 588FF is not owed to the company by virtue of a right it has against the creditor. It is an obligation found in a judgment or order of the Court of which the company is the recipient pursuant to a successful application brought by the liquidator in his or her own right."

High Court of Australia Decision

It was no surprise, given the importance of the issue, that the Creditor appealed to the High Court and was given special leave to do so. The Appeal itself was heard on 12 December 2022 and on Wednesday 8 February 2023, the High Court handed down its decision.

The submissions and outline of oral arguments filed by the Creditor and the Liquidator centered on the issue of mutuality. 

The Creditor set out in its Outline of Oral Argument 3 grounds around why mutuality was not lost here, being:

1. Mutuality not denied on the ground of lack of beneficial entitlement;
2. Mutuality not denied on the grounds of a contingent right or obligation at the date of winding up;
3. The Full Court of the Federal Court misunderstood the role of s553C(2).

On the other hand, the Liquidator in his Outline of Oral Argument (Liquidator's Outline) stated that the Full Court was correct to conclude that "applying a purposive test: 

• The focus is upon rights held by the company (not rights held by the liquidator as statutory officer); 
• The focus is upon rights which the company held prior to the date of liquidation (even if contingent), which are properly characterized as the source of the relevant monetary cross-demand; and 
• The focus is upon rights which the company holds in the same interests as its cross-obligations, so that the set-off does not distort the position of those in whose interests the relevant claim is brought".

Further the Liquidator's Outline also stated that the Full Court was correct to find that there was, for a number of reasons, no mutuality of interest and no mutuality of timing in this case.

The High Court in its judgment agreed with the position of the Liquidator and the decision of the Full Court and stated (emphasis added):

"[45] … Construed in the context of the statutory scheme of liquidation, s 553C(1) requires that the mutual credits, mutual debts or other mutual dealings be credits, debts or dealings arising from circumstances that subsisted in some way or form before the commencement of the winding up. That is because under that statutory scheme, s 553C exists in aid of s 553, which is concerned with debts and claims, whether "present or future, certain or contingent, ascertained or sounding only in damages", arising from "circumstances" that had occurred before the commencement of the winding up. That is why s 553C(1) refers to a "person who wants to have a debt or claim admitted against the company" and then provides that only the balance of any set-off is "admissible to proof against the company, or is payable to the company, as the case may be". As such, the function and purpose of s 553C is to permit a reckoning of amounts owing to and by the company during the relation-back period prior to the appointment of the liquidator.

[46] Here, immediately before the commencement of the winding up there was nothing to set off as between the appellant and MJ Woodman; the company owed money to the appellant, but the appellant owed nothing to the company. Moreover, the inchoate or contingent capacity held by the liquidator to sue under s 588FF could not and did not exist before then. It could only be made following the commencement of the winding up…"

The High Court also added two further reasons as to why the Liquidator's position should succeed: there had been no dealing between the same persons (at [52]) and there was no mutuality of interest (at [53]). 

Interestingly, the High Court also determined at [56] that the cases of Re Parker (1997) 80 FCR 1, Buzzle Operations Pty Ltd (In liq) v Apple Computer Australia Pty Ltd (2011) 81 NSWLR 47, Shirlaw v Lewis (1993) 10 ACSR 288, Hall v Poolman (2007) 65 ACSR 123 and Stone v Melrose Cranes & Rigging Pty Ltd [No 2] (2018) 125 ACSR 406 were wrongly decided, to the extent they are inconsistent with the High Court's reasoning in this case. 

That determination has the potential impact that set-off under section 553C in no longer available in relation to every kind of voidable transaction claim including unfair preferences, uncommercial transactions, unfair loans, unreasonable director-related transaction and creditor-defeating dispositions, as well as no longer being available in relation to insolvent trading claims against directors and holding companies.

Where to from Here?

It is now clear from the High Court decision that a defence of set-off is not available to creditors against a claim by a liquidator for an unfair preference. The position for liquidators, at least as far as this issue goes, is now clear and creditors will not be able to drag out unfair preference claims seeking to rely  on the set off principal.

The decision will be welcomed by liquidators and their lawyers alike who have always struggled with how such a defence was available. In turn, there should be benefits to the general body of creditors with one path to defending an unfair preference claim being closed and potential returns to the liquidation being higher.