A liquidator appointed to an insolvent company will often seek to recover, as an unfair preference payment, any payments made by the insolvent company to its creditors during the relevant relation back period prior to the liquidator’s appointment. More often than not, those creditors will have lodged a proof of debt with the liquidator with respect to debts owed to the creditor prior to the liquidator’s appointment. As a consequence of the decision of the Queensland District Court in Morton v Rexel Electrical Supplies Pty Ltd  QDC 49 (“Morton”), such creditors are increasingly arguing that the debt owed to them should be set off against the preference payment received from the insolvent company such that the amount of the liquidator’s preference claim is reduced by the amount of that debt.
Morton and Set-off
In Morton, the liquidator appointed to the insolvent company pursued an unfair preference claim against the creditor for payments the creditor had received from the insolvent company during the relation-back period totalling $197,469.16. The creditor defended the claim on a number of grounds including that the sum of $92,323.88, being monies owed to it by the insolvent company, should be set-off against the preferential payments pursuant to section 553C of the Corporations Act 2001 (Cth) (the “Act”).
Pursuant to section 553C of the Act, subject to there being no knowledge of the company’s insolvency on the part of the party seeking to rely on the section, where there have been mutual credits, mutual debts or other mutual dealings between an insolvent company that is being wound up and a person who wants to have a debt or claim admitted against the company:
- an account is to be taken of what is due from the one party to the other in respect of those mutual dealings; and
- the sum due from the party is to be set off against any sum due from the other party; and
- only the balance of the account is admissible to proof against the company, or is payable to the company as the case may be.
In Morton, the Court determined that the creditor could rely on section 553C of the Act to raise as a set-off amounts owing to it against the amount of the preference claim made against it by the liquidator.
Arguments against the decision in Morton
The decision in Morton has been heavily criticised. In particular, the correctness of the decision has been criticised for the following reasons:
- it is not only contrary to, but defeats the very purpose of the Act;
- the preference claim does not exist, whether as a vested or contingent right of action, before the date of winding up; and
- there is no mutuality between a creditor’s debt and the preference claim for the benefit of the company’s creditors.
A summary of the above arguments is set out in the following paragraphs.
Contrary to the purpose of the Act
The purpose of the preference provisions in the Act is to benefit the general body of creditors. To allow a set-off under section 553C defeats that purpose as it enables a particular creditor to retain what would otherwise be a voidable preference payment that would be available for distribution to the general body of creditors. The decision in Morton effectively leaves general creditors worse off.
Existence of debts
When interpreting section 553C of the Act, the Courts have held that the mutual debts referred to in section 553C must pre-date the commencement of the winding up. The debts referred to in section 553C of the Act must exist prior to the commencement of the winding up.
In the case of actions for the recovery of unfair preference payments, it is difficult to identify any pre-existing obligation prior to the commencement of the winding up. A voidable transaction such as an unfair preference payment is not readily referable to any obligation or contingent liability prior to the commencement of the winding up.
Even if a decision is made to wind the company up, the liquidator may decide not to pursue recovery of any unfair preference payments. In those circumstances, it is difficult to see how any potential preference claim gives rise to any obligation such that section 553C of the Act would be enlivened.
According to the High Court in Gye and McIntyre (1991) 171 CLR 609, mutuality of debts requires the debts to be:
- between the same persons;
- held by each of them respectively in the same interests; and
- commensurable, in the sense that each of the debts sounds in a monetary claim.
In the case of an action for the recovery of an unfair preference payment, it is arguable that (a) and (b) above are not satisfied. Firstly, the debts that are to be set-off against each other are not between the same person in circumstances where the transaction constituting the unfair preference payment is a right of action that vests in the liquidator, not the insolvent company to which the liquidator has been appointed.
Secondly, the debt owed by the insolvent company is owed in its own right whereas any entitlement to receive payment in respect of an unfair preference claim inures wholly for the benefit of the persons who will participate in the winding up of the insolvent company.
While the decision in Morton is not binding on either a single judge in the Queensland District Court or the Federal Court of Australia, in circumstances where the resolution of the Court’s decision in Morton requires consideration of national legislation, before a Court will depart from that decision, that decision must be shown to be plainly wrong.
Accordingly, until such a time as the decision in Morton is overruled by a superior Court, it is likely that creditors will continue to argue that they are entitled to set-off debts owed to them by insolvent companies against any preference claims that may be brought against them by liquidators appointed to those insolvent companies.
Marino Law has extensive experience acting for liquidators, administrators, lenders, financiers and creditors in the administration of all corporate insolvency appointments. Our highly experienced lawyers regularly advise clients in the following areas of corporate insolvency:
- voluntary administrations;
- enforcement of securities; and
- statutory demands.
Should you require assistance in any of the above areas, please contact one of our highly experienced lawyers.