On 16 December 2021, the Full Court of the Federal Court of Australia decisively held in Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited  FCAFC 228 (Morton) that a creditor could not claim a set-off against an unfair preference claim brought by a liquidator under Part 5.7B of the Corporations Act 2001 (Cth) (the Act).
In this insolvency case note we review the recent findings and implications of the leading judgment of Chief Justice Allsop in Morton.
The Morton judgement also sets parameters and principles that may be usefully applied in claims for set-off under section 553C in relation to other voidable transactions under Part 5.7B of the Act, including uncommercial and insolvent transactions and unreasonable director-related transactions.
These will be addressed in a forthcoming Craddock Murray Neumann case note.
Set-off and the Morton decision
The Morton decision addressed a question reserved for consideration by the Full Court under section 25 of the Federal Court of Australia Act 1976 (Cth) as follows:
‘Is statutory set-off, 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 s588FA of the Act?’
The simple answer to this was a unanimous no, with a detailed analysis of the history and purpose of the sections set out in the leading judgement of Allsop CJ, with which Middleton and Derrington JJ agreed.
Prior position on set-off and preference claims
While historically authorities held that the right of set-off under section 553C of the Act was not available to unfair preference claims, the past decade has seen competing lines of authority developing that appear, at least on the surface, to question this notion.
For example, in the case of Buzzle Operations Pty Ltd v Apple Computer Australia Pty Ltd  NSWCA 109, Young JA suggested that a section 553C set-off may be available in relation to the repayment of an uncommercial transaction under section 588FE(3), although the case was not decided on this issue.
Earlier, in Hall v Poolman  NSWSC 1330; (2007) 65 ACSR 123, a set-off was recognised in respect of a liability owed by the director to the company for insolvent trading under section 588M. By way of observation, it was also suggested that as at the date of the winding up, the creditor was contingently liable for as yet unclaimed preference payments, implying that a set-off could apply.
Justice Edelman in Hussain v CSR Building Products Ltd (2016) 246 FCR 62,  FC 392 at , suggested that the position might nevertheless remain that section 553C did not apply to unfair preference payments and pointed to the need for a more sophisticated analysis of the legislation and case authorities to determine their application and effect in the context of voidable transactions and set-offs under the Act.
Relevant facts of the case
The defendant, Metal Manufacturers Pty Ltd (Creditor) had received $190,000 in payments for a debt owed to it during the relation back period from MJ Woodman Electrical Contractors Pty Ltd (Company). However, the Company had also received a further $194,727.23 worth of goods from the Creditor on credit, creating a further debt owed to the Creditor.
The Creditor sought to have the liquidator’s unfair preference claim of $190,000 set-off against the further debt owed by the Company to the Creditor of $194,727.23.
The reasoning on set-off in Morton
The broad reasoning of Chief Justice Allsop, with which Justices Middleton and Derrington JJ agreed, was:
Unfair preference claims – historical approach
- The historical purpose of unfair preference claims in the legislation, as developed through both English and Australian law and grounded in equity, has been to avoid payments made in preference of one or more creditors which would otherwise upset the statutory order of distribution among creditors under the principle of pari passu.
- The pari passu principle requires equality of distribution among creditors of equal rank, after priority creditors and the costs of administration are paid, as now provided for in section 555 of the Act.
- To allow a set-off of a debt owed to the creditor by the unfair preference payment, would frustrate the purpose of the provision by dislocating the statutory order of distribution among creditors.
- Historically, and under a correct construction of the statutory provisions, the right to seek avoidance by the Court and thereby to recover an unfair preference payment is at the suit of the liquidator according to the statutory regime, after the relevant date and for the benefit of the creditors. It is not a debt owed to the company as such.
Set-off: requirement of mutuality – historical approach
- The object of the statutory set-off is also one grounded in equity and is to achieve substantive fairness and do justice in ascertaining the assets and claims upon the estate, by recognising: “genuine mutual debts and credits and mutual dealings between the creditor and the debtor”.
- Mutuality means that the claims sought to be set-off must be held by the same parties, and additionally, must be held for their own benefit and interest, arising directly or contingently from circumstances arising before the relevant date.
- A set-off is available to a creditor in respect of its claim against a company where the liquidator is seeking to enforce a right of the company against the creditor, which existed or arose from circumstances existing prior to the relevant date.
- In the case of an unfair preference payment which a liquidator seeks to recover, there is no mutuality of debts between the parties because it cannot be said that the liquidator’s claim is a debt owed by the creditor to the company as at and before the relevant date, given that it was not a debt owed to the company but was payable to the liquidator for the benefit of creditors.
- The lack of mutuality between the right to a remedy resting in the liquidator and the debt for which the preference payment was made, applies equally to other debts owed by the company to the creditor.
Corporations Act 2001 (Cth) – preference claims and lack of mutuality
- The Act retains the policy of the historical legislation and the fundamental remedial purpose of an unfair preference claim by a liquidator: ‘to remedy the dislocation of the statutory priorities of distribution’.
- The Act reinforces the position that an unfair preference claim cannot be set-off against a different debt owed by the company to the relevant creditor, particularly given the incongruity of doing so in the context of section 588FI. That section provides that where a creditor puts the company in the same position as if an unfair preference payment has not been entered into, the creditor may prove in the winding up of the company.
- The Court brought further clarity to the nature and effect of the avoidance of transactions provided for by sections 588FE of the Act, in the context of the flexible remedies under section 588FF:
‘the notion of voidableness aligns with the pre-existing conception of void against the liquidator. That is, there is no “avoidance” brought about by the insolvency. Rather, at the election of the liquidator, a proceeding can be brought by the liquidator under s 588FF and the character of the transaction being voidable is relevant only to the availability of relief in the proceeding…
The consequence of the status of voidableness is not to undo or set aside the transaction or its constituent documents thereby putting the parties (debtor and creditor) into their antecedent legal position and thereby creating rights in the debtor company or obligations in the creditor, based on the avoidance. Rather, satisfaction of the Court of the character of the transaction as voidable is the condition for the remedial powers of the Court in s 588FF(1) to be exercised on the application (only) of the liquidator.’
- A relevant point of difference under the Act, is that while the right of action remains with the liquidator, and not the company, an order can be made for a remedy under section 588FF by payment to the company rather than the liquidator, contrary to the historical position. This does not affect the lack of mutuality between any debt owed by the company to the creditor, nor any remedy provided by the Court under section 588FF.
Key take outs from the Morton case: unfair preference payments and set-offs
The decision in Morton clarifies the operation of the Act concerning provisions for unfair preference payments and set-offs, offering liquidators certainty that for these claims section 553C will not apply.
Further, the decision provides a detailed examination of the principles of mutuality and in equity, which affect upon the application of a section 553C set-off to other voidable transactions claims under section 588FE of the Act. In doing so, Allsop CJ addresses many of the case authorities which have caused controversy and confusion in the application of the set-off provisions to various voidable transaction claims.
Importantly, however, the decision in Morton does not undermine the authorities where the Courts have found that “a debt owing to the company” arising as result of an insolvent trading claim, whether that debt is owed by a director or director(s) (sections 588G and 588M) or a holding company (sections 588V and 588W), can be set-off under section 553C against debts owed by the company to those parties.
If you need legal advice regarding unfair preference payments and set-offs in an insolvency matter, please contact us for a confidential discussion about your situation.
CMN’s Insolvency lawyers and litigators regularly assist liquidators and creditors in relation to disputed unfair preference claims and are familiar with negotiating the challenges and intricacies involved. Our lawyers are as also skilled and experienced in managing disputes regarding other claims under Part 5.7B of the Corporations Act 2001 (Cth), including other voidable transactions and insolvent trading claims. Our Dispute Resolution and Insolvency team advises and acts for a wide range of parties in disputes ranging from routine to complex.
*It should be noted in the Morton case that an application for special leave has been filed in the High Court, though as at the date of this article (April 2022) the special leave application has not yet been determined.