Australian High Court banishes statutory set-off, sets up liquidator recoveries in unfair preference decision

In a landmark case, the High Court of Australia this month unanimously determined in Metal Manufactures Pty Limited v Morton [2023] HCA 1 (Morton) that set-off is not available against a liquidator’s unfair preference claim.

The effect of the decision is that a creditor is not entitled to deduct any outstanding claim that it might have against a company from its liability to repay that company’s liquidator any unfair preference.

This ends two decades of uncertainty on this issue, and will change the scope and strategic approach to liquidators’ recovery actions going forward.

Background

Metal Manufactures Pty Ltd (Metal Manufactures) supplied goods to MJ Woodman Electrical Contractors Pty Ltd (MJ Woodman) on credit. Prior to its insolvency, MJ Woodman had two debts of AUD $190,000 and AUD $194,727.23 (Second Debt) owing to Metal Manufactures. The AUD $190,000 debt was repaid to Metal Manufactures during the six-month relation back period, and this was assumed to be an unfair preference pursuant to section 588FA of the Corporations Act 2001 (Cth) (Act) in the course of proceedings. In response, Metal Manufactures argued that its obligation to pay back AUD $190,000 as an unfair preference ought to be set-off against the Second Debt still owed to it by MJ Woodman, in accordance with the legislative right of set-off under section 553C of the Act.

Key points of the judgment

The High Court held:

1. The dealings lacked the essential requirement of mutuality for section 553C of the Act to apply – specifically, that there be “mutual credits, mutual debts or other mutual dealings” between a creditor and the insolvent company. This was on the basis that:
   1. the indebtedness of MJ Woodman to Metal Manufactures and the potential liability of Metal Manufactures for the unfair preference claim lacked mutual parties. The first was between a creditor and the company, and the second was between the creditor and the company’s liquidator (who is not characterised as an agent of the company, but rather an officer of the court for the purpose of an unfair preference claim); and
   2. the beneficial interest in the claims was also not mutual, as payment of the debt would be for the benefit of Metal Manufactures, whereas recovery of the unfair preference claim would benefit MJ Woodman’s creditors.
2. Section 553 of the Act limits the pool of claims which are provable in a winding up to those debts payable by and claims against the company, “the circumstances giving rise to which occurred before the [winding up].” In this instance, set-off was not available because any amounts owing as an unfair preference only arise upon the making of a court order after the commencement of the winding up.

Impact of the decision

The High Court’s decision provides much-needed clarification regarding the practical operation of set-off under section 553C of the Act, which can no longer be relied upon as a defence to unfair preference claims.

This is welcome news to liquidators – with a significant obstacle to the recovery of unfair preference claims being removed. This will result in enhanced returns for the general body of unsecured creditors – due to both the unavailability of the substantive set-off defence itself, as well as the time and cost savings that will come from liquidators no longer having to litigate the set-off issue in protracted court proceedings without a settled position on whether section 553C of the Act applies to an unfair preference claim.

On the other hand, creditors will now need to look to other defences (such as the running account defence and the secured creditor defence) in responding to an unfair preference claim.

There is also the potential that, following the High Court’s reasoning in Morton, set-off may no longer be available to reduce liability for other voidable transactions claims, such as uncommercial transactions and creditor-defeating dispositions, and in insolvent trading claims. Arguably, as in Morton, the core requirement of mutuality would be lacking in those circumstances as well.