…nature of debt owed by company to creditor v creditor’s obligation to repay unfair preference pursuant to court order – mutuality of debts
In Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Ltd  FCAFC 228, the question reserved for the Full Court of the Federal Court of Australia (Allsop CJ, Middleton and Derrington JJ) was whether a defendant who had a claim in debt against a company in liquidation could avail itself of the statutory right to set-off of debts under Corporations Act 2001 (Cth) (Act), s553C(1) – in respect of the liquidator’s claim against the defendant for recovery of an unfair preference paid out to the defendant.
The Full Court unanimously answered that it was not available: the unfair preference must first be repaid, then debts may be proven against the company in liquidation in the normal way. In the course of so deciding, Allsop CJ delivered a lengthy lead judgment tracing the history and operation of the right of statutory set-off, and in particular the necessity for “mutuality” of debts if they are to be set off against one another under the Act.
The agreed facts were the subject of a special case (or case stated). The company in liquidation owed two debts to the defendant for the supply of goods, one of which debts amounted to $194,727.23. The defendant had received payments during the relation back period amounting to $190,000.00 in respect of the other debt owed by the company (the defendant acknowledged that it could not set-off an unfair preference against the very debt in respect of which the unfair preference was paid – that would defeat the purpose of the unfair preference provisions in the first place!)
The liquidator sought repayment of the $190,000.00 as an unfair preference under s588FA of the Act. The defendant sought to avail itself of the right of set-off of debts under s553C(1). The liquidator acceded that if the defendant was correct, the proceedings should be dismissed.
The Full Court held that set-off was not available to the defendant as s553C explicitly required that sums to be set-off against one another be “mutual credits, mutual debts or other mutual dealings”. This necessary quality of mutuality requires that the sums be owed to and by the company in the same interest. In the present case, the $194,727.23 debt owed by the company to the defendant was owed in one capacity (the company as debtor), whereas the receipt of money by the company on repayment of an unfair preference by the defendant occurred in another capacity (the company as payee pursuant to a court order under s588FF, in the context of the liquidator gathering in the insolvent estate).
Unlike the pre-existing obligation on the company to pay its trade creditor, the obligation on the defendant to repay an unfair preference to the company is a new right created by the court, in exercise of a statutory power, on the making of the relevant order. Such repayment is not received by the company in the same interest as its obligation to pay the defendant creditor, but rather for the benefit of the creditors in insolvency generally and under the control of the liquidator (at - and -).
Further, at the relevant date of the winding up resolution/order there was no right or equity (vested or contingent) in the company to recover the unfair preference, nor any corresponding right or equity (vested or contingent) in the defendant to repay the preference, to be set-off. The obligation to repay the unfair preference only arises later, after the liquidator is appointed and successfully applies to the court for a repayment order under s588FF (at -).
Statutory text and legislative history
Allsop CJ traced the statutory history of the text of s553C back through Australian and English insolvency and bankruptcy law. His Honour observed that, under the similarly-phrased provisions which had preceded the current text, it had never been the case that an unfair preference paid to a creditor could be set-off against a debt owed to that creditor by the company, and there was no basis for concluding that the present enactment had intended to alter that position.
As to whether an eventual obligation to repay an unfair preference constituted a contingent debt for the purposes of s553C, His Honour held that it did not, and drew a distinction between a transaction which is “contingent at [the relevant date] and [is] of a kind which will ultimately mature into pecuniary demands susceptible of set-off” (Gye v MacIntyre  HCA 60; 171 CLR 609), and a court order for repayment of an unfair preference under s588FF (at - and ).
Considering the consequences of a debt and a repayment of an unfair preference being able to be set-off, His Honour observed that if this were permitted, it would have the effect of distributing the company’s assets – not by reference to the overall position of the insolvent company and the claims of all creditors, but rather by reference only to the size of an unfair preference payment compared to a given creditor’s other debt(s) owed.
In effect, this would render such a creditor a super-priority creditor, able to be satisfied before even the costs of administration and the repayment of priority creditors, including vulnerable priority creditors such as employees (at  and ). This would dislocate the working of the Act and disturb the proper order of the administration of an insolvent estate, and any interpretation of s553C which allowed an unfair preference to be set-off against a debt would ill conform to the policy of the Act in protecting priority creditors (at ).
Such a seemingly arbitrary dislocation and failure to remediate an unfair preference would require “[t]he clearest statutory text”, and there is no such clear text present in the Act (at ). As a result, with no set-off being available, the defendant would be required to first repay the unfair preference (thereby making good the insolvent estate) and then prove its two debts against the company in the normal way, and, if successful, join with other unsecured creditors in pari passu distribution of the company’s remaining assets.
Dr David J Townsend is a barrister at 3rd Floor Wentworth Chambers, Sydney.