Can I trigger an unfair preference claim? – Insolvency/Bankruptcy/Restructuring

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Australia: Can I trigger an unfair preference claim?

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The full Federal Court, in Morton’s recent decision as liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228 considered the provisions of Section 553C of the Companies Act 2001 (Cth) (“the Act”) and whether the right of set-off was available as a defense against claims of unfair preference purchased by a liquidator in accordance with the provisions of Section 588FA of the Act.

What provisions are included in s553C of the Companies Act?

S553C Notes:

(1) Subject to subsection (2), when there have been mutual credits, mutual debts or other relationships between an insolvent company in liquidation and a the person who wants to have a claim or claim against the Company admitted:

  • account must be taken of what is due from one party to the other under these mutual commitments relationships; and

  • the sum owed by one of the parties must be set off against any sum owed by the other party; and

  • Only the account balance is receivable against the Company or is payable to the Company, as the case may be.

(2) One the person shall not be entitled under this section to claim the benefit of set-off if, at the time of extending credit to the Company, or at the time of receiving credit from the Company, the the person had been advised that the Company was insolvent.

What is the ultimate effect of the s553C?

The underlying principle of s553C is to help ensure that a creditor is not required to repay a debt owed to a company in full, but only receives a proportionate distribution of a debt owed to it by the company in circumstances where there had been mutual relations between the parties.

Simply put, if Company A owes Company B $5,000, Company B owes Company A $2,500 and a mutual relationship can be established, according to Section 553C, Company A has the right to “offset” the $2,500 owed to it by Company B with Company A effectively now only obligated to pay Company B $2,500.

This mutuality is the key to allowing Company A to invoke the right to set-off.

It has often been a point of contention as to whether this mutual right of set-off was available in circumstances where an unfair preference was sought by a liquidator in the event of a liquidation of a company and, in that circumstance, the court federal plenary is directly invited to consider, via a particular case, the following question:

Is statutory compensation, under s. 553C(1) of the Act, available to the defendant in this proceeding against the plaintiff’s claim as liquidator for the recovery of an unfair preference under the Section 588FA of the Act?

What was the court’s decision?

The court determined that no, this defense was not available in the circumstances where a liquidator sued the beneficiary of a preferential payment pursuant to Section 588FA of the Companies Act.

The main rationale for the court’s decisions was that the obligation to repay a preferential claim to a liquidator is an entirely new obligation arising from the legal obligations required of a liquidator.

There is no connection between the incurring of a debt in the normal course of business by a debtor to a company and the obligation to repay a lien claim in circumstances where a company is placed in liquidation.

Consequently, since there is no reciprocity in the way the opposing debts are born, there is no right of set-off available. This now provides certainty to liquidators claiming preferential payments and removes the ambiguity around compensation arguments often made by a party defending a preferential claim.

What does this mean for the party who must defend a privileged claim purchased by a liquidator?

The compensation argument is no longer available to a party that is the beneficiary of a preferential payment as defined by s588F of the Act. Other defenses are available, including checking account and good faith defense to claims of preference.

Clients should be aware that, although this argument has now been settled, it is still worth seeking advice from a qualified insolvency expert in cases where they are subject to a claim of preference.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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