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Setting off an unfair preference payment: what are the rights of a creditor?

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The Full Court of the Federal Court of Australia has held in a unanimous decision that a creditor of an insolvent company is not entitled to a statutory set off in response to a liquidator’s claim for the recovery of an unfair preference.

Background

Metal Manufacturers Pty Ltd was a creditor of MJ Woodman Electrical Contractors Pty Ltd, having provided goods on credit and giving rise two debts: one in the sum of $190,000 and another in the sum of $194,000.  MJ Woodman went into liquidation.

In the lead up to the liquidation, MJ Woodman paid Metal Manufacturers $190,000, in satisfaction of one of those debts.

This payment occurred during the “relation back period”.  This is a period of time prior to a specified event occurring (such as a liquidator being appointed) where, subject to the provisions of the Corporations Act, transactions can be “clawed back” as an “unfair preference” payment.  These are payments that are voidable due to putting one creditor at an advantage (by receiving more money than they would receive in a liquidation) over the other creditors where the debtor company is insolvent.

The liquidator of MJ Woodman sought to claw back the $190,000 paid to Metal Manufacturers as an unfair preference, under section 588FA of the Corporations Act.

In response, Metal Manufacturers argued that it was also owed an outstanding debt of $194,000, and that even if the $190,000 already paid was entitled to be clawed back by the liquidator, it had an entitlement to “set-off” any repayment of $190,000 as an unfair preference payment against the $194,000 it was also owed.

Whether or not a creditor was able to rely on such a set-off under s.553C(1) of the Corporations Act, against a liquidator’s claim for recovery of an unfair preference under s.588FA, was the question reserved for the Full Court of the Federal Court of Australia.

In a unanimous decision on 16 December 2021, the Full Court of the Federal Court of Australia delivered their answer: No.

What did the Court say?

The Full Court did not accept the creditor’s argument that it was able to set-off its obligation to repay the unfair preference, due to the company owing a debt to the same creditor, primarily because it was considered that there is a lack of “mutuality” between the two.

That is, the company’s debt to the creditor relates to one interest, and the creditor’s obligation to repay the unfair preference relates to another.

When repaying the unfair preference, the creditor is not doing so as a creditor of the insolvent company, but instead as a payee in an action brought by the liquidator, whose duty it is to gather all of the assets of the insolvent company, for the benefit of all unsecured creditors, as well as the administration of the company.

The Full Court looked to the purpose of section 553C, noting that the provision works as a form of “statutorily imposed accounting” and that the unfair preference provisions ultimately aim to achieve fairness.

It was also noted that founded in equity were the concepts of mutual set-off and pari passu (“equal footing”) that means all unsecured creditors in insolvency processes are entitled to a share by reference to the proportion of their respective debts in the available assets of the company.

Through this lens, should the creditor have been successful in their claim, the funds that should have otherwise been available to all the unsecured creditors would consequently not have been able to have been distributed equally.

As such, the Full Court concluded that the essential requirements of section 553C had not been met by the creditor’s argument. 

What does this mean for you?

Creditors need to take care when receiving payments from companies that may be insolvent.  That payment may be subject to a claw back by a future liquidator.

This case has made it clear that it will not be an answer for the creditor to say that they are also owed other debts.

The reality of insolvency law is that unsecured creditors must stand in line for their proportional share, if any, of the remaining assets available to the liquidator after secured creditors and liquidation fees have been paid.

McCabes is experienced in advising clients in relation to their rights and obligations in matters relating to insolvency.  Please reach out to our Litigation and Dispute Resolution Group if you have any questions.

Contributors

Luke Dominish
Associate
Saliha Rafiqi
Lawyer

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