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High Court confirms that set off defence does not apply to preference claims made by companies in liquidation

On 8 February 2023, the High Court of Australia confirmed in the case of Metal Manufacturers Pty Limited v Morton as liquidator of MJ Woodman Electrical Contractors Pty Ltd (in liquidation) [2023] HCA 1, that the statutory right of set-off cannot be used as a defence to a liquidator’s preference claim.  The decision by the High Court is considered a win for liquidators and insolvency practitioners by removing the possible defence by creditors and providing liquidators with clarity on the recoverability of funds when deciding to pursue preference claims against creditors.

Background of the case

The case involved the liquidator of MJ Woodman Electrical Contractors Pty Ltd (MJ Woodward), who sought to recover two payments of $50,000.00 and $140,000.00 made to Metal Manufacturers Pty Limited (“Metal Manufacturers”) in the six months prior to its insolvency, on the basis that the payments were unfair preferences under s 588FA of the Corporations Act 2001 (Cth) (“the Act”).

Metal Manufacturers’ defence to the claim was a right of set-off arising from a mutual debt owed to it by MJ Woodman which exceeded the amount of the preference claim brought by the liquidator. The right to set-off relied on by Metal Manufacturers arises under s 553C of the Act.  

What is a preference claim?

An unfair preference is a voidable transaction which occurs when a creditor has received payment or some other consideration from a company at the expense of other creditors. For example, a creditor may receive an unfair preference if they receive a larger sum than what they would receive by way of payment from a liquidator in the event of that company’s liquidation. A preference claim can usually only be brought where the transaction is made by the company knowingly in, or on the verge of, liquidation or insolvency.

A preference claim is generally pursued by liquidators of an insolvent company to claw back unfair preferences to creditors for the purpose of disbursing them amongst all of the creditors of the company in accordance with their entitlements at law.

Decision by the High Court

The High Court found that the payments made to Metal Manufacturers were made at a time when MJ Woodman was already insolvent or on the verge of insolvency. As such, the payments constituted unfair preferences that disadvantaged other creditors of the company. The High Court ordered that the payments be repaid to the liquidator, to be distributed amongst all of MJ Woodman’s creditors.

Further, the High Court held that Metal Manufacturers was not entitled to set-off its potential liability against an allegedly mutual debt owed to it by MJ Woodman on the basis that there is a lack a mutuality between the indebtedness of the insolvent company to a creditor and the liability of a creditor to a preference claim brought by a liquidator. This finding by the High Court confirms the position that s 553C of the Act is not a defence available to creditors in response to a preference claim brought by a liquidator.

Section 553C of the Act states that if there are mutual credits, debts, or other dealings or claims owing between an insolvent company in liquidation and a creditor, only the balance of the account is payable to the company (or the creditor, as the case may be), thereby establishing a right of set off. In the circumstances of this case, if section 553C was upheld, Metal Manufacturers would have been able to set off its liability to the preference claim against another liability owing to it by MJ Woodman which existed prior to its liquidation. If that occurred, the preference claim would have resulted in no recovery of funds by the liquidator for redistribution amongst other creditors of the company in accordance with their legal entitlement.  

Effect of the decision

The implications of this decision are significant, both for businesses and creditors alike. On the one hand, it is a clear warning to creditors that they need to be mindful of the timing and quantum of payments they receive from a company approaching insolvency. Even if these payments are made in the ordinary course of business, they may still be challenged by a liquidator as voidable transactions due to unfair preference. This is particularly important for creditors who work with businesses that operate on thin margins or have limited cash flow, as they may be more susceptible to insolvency.

On the other hand, the decision is a significant win for some creditors and liquidators. It sends a clear message that creditors can expect to be treated fairly in insolvency proceedings, and that unfair preferences will not be tolerated and will be unwound to put the estate of the company in the position It would have been in had the preferential transaction not occurred. It also allows liquidators to identify potential preference claims with greater certainty, and to provide clear advice on the prospects of recovering such claims when reporting to other creditors.

Overall, the High Court’s decision in the case is a significant development in the law of insolvency, providing clarity on a previously contested and uncertain area of law.

Please contact a member of our commercial law team for further information and advice. 

Important Disclaimer: The content of this article is general in nature and for reference purposes only.  It does not constitute legal advice and should not be relied upon as such.  Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.



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