Lack of mutuality becomes distinct in Federal Court case law.
For some time, there has been a question whether Section 553C (Insolvent companies—mutual credit and set-off) of the Corporations Act 2001 could be used as a defence against a liquidator’s preference claim.
For those unfamiliar, preferences are payments or asset transfers that give a creditor an advantage over other creditors.
Any payments or transfers made to a creditor within a certain period before a company is placed into liquidation, may in certain circumstances, be recovered by a liquidator. Preferences are usually payments of money, although a variety of transactions could be deemed ‘preferential’ such as transfers of physical assets (e.g. stock, equipment, or motor vehicles).
A liquidator must successfully prove a preference claim by establishing the following (section 588FA of the Corporations Act):
- The company (in liquidation) and the creditor were parties to the transaction.
- The creditor is an unsecured creditor.
- The transaction took place within six months before the winding up commenced (or four years for payments to related parties).
- The company was insolvent at the time or became insolvent because of the transaction.
- The payment resulted in the creditor receiving more than they would in a liquidation scenario.
Assuming a liquidator can establish these points, they have a fair chance of convincing a court the monies should be repaid (section 588FF of the Corporations Act)—however, creditors have certain defences available against such a claim. Notably, the onus of proving a defence is on the creditor—not the liquidator (Levi v Guerlini (1997) 24 ACSR 159).
In recent times creditors have defended preference claims via section 553C of the Corporations Act. It provides where a party is both a debtor and a creditor of the liquidated company, the debtor/creditor can offset the debts owed to and from the liquidated company and either receive from (i.e. make a claim for) or pay the company the debt’s balance. For set off to occur there must be “mutuality” in regard to the debts owed to and from the insolvent entity.
Essentially, creditors seek to offset the monies the company owes them as an unsecured creditor against any claim by a liquidator’s preference claim.
Most liquidators have argued that this offset is unavailable as there is no mutuality between the respective parties. That is, a creditor can’t claim the offset for monies the company owes against a liquidator’s as they are different parties.
In the recent decisions in Morton as Liquidator of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufacturers Pty Limited [2021] FCAFC 228[1] this debate has been answered.
The basic facts of the case are:
- The defendant creditor received $190,000 in preference payments during the relation-back period.
- The defendant creditor claimed a set-off of $194,727.23 for monies owed by the company as an unsecured creditor.
- The liquidator claimed that section 553C of the Corporations Act does not apply.
In short, the court decided that unsecured creditors cannot claim a statutory set-off against unfair preference claims under section 553C of the Corporations Act.
A summary of the judgment reasons include:
- A lack of mutuality existed between the company’s indebtedness to the creditor and the creditor’s liability pursuant to court order to pay the company’s liquidator.
- The lack of mutuality arises from the different interest in which the company owes and receives money to/from the creditor and as a payee under a court order the liquidator initiates to execute their duty to gather in the insolvent company’s estate (and its administration) for the benefit of all unsecured creditors.
- The lack of mutuality also arises (at the relevant date) from the absence of any right or equity (vested or contingent) in the company or duty or obligation (vested or contingent) in the creditor to recover or to repay the preference, respectively. Therefore, the essential requirements of section 553C of the Corporations Act are absent.
Liquidators welcome this decision as it unequivocally clarifies the position.
If any professional advisors and/or their clients require assistance on assessing the merits of a preference claim received and potentially settling such claims—we are here to help.
[1] Decision delivered on 16 December 2021.
