A Worrells partner was recently appointed as liquidator of two companies that traded in the same industry. Each company had a common director and a range of clients which they each serviced from time to time. A number of their clients were also creditors of one or other of the companies. Thus at the date of the liquidation of the companies, these clients were both owed money by and owed money to one of the companies.

Where the party is both a debtor and a creditor of the liquidated company, the debtor/creditor is entitled to offset the debts owed to and from the liquidated company and either receive from (i.e. make a claim for) or pay to the company the balance of the debts. This set-off essentially takes place at the time of liquidation, see section 553C of the Corporations Act. The Bankruptcy Act has very similar provisions at section 86.

For set off to occur there must be “mutuality” in regard to the debts owed to and from the insolvent entity.

CORPORATIONS ACT 2001 – SECT 553C
Insolvent companies–mutual credit and set-off

(1) Subject to subsection (2), 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:

(a) an account is to be taken of what is due from the one party to the other in respect of those mutual dealings; and
(b) the sum due from the one party is to be set off against any sum due from the other party; and
(c) only the balance of the account is admissible to proof against the company, or is payable to the company, as the case may be.

There are two circumstances which will affect the right of set off.

Set off is not allowed where the company was insolvent at the time that either side of the transaction was performed and the obligation forming part of the mutual and off-setting debts was created, and the party claiming set off had notice of the insolvency. This limitation is imposed to preclude circumstances where a creditor, having knowledge of the debtor’s insolvency, contracts to buy goods or services from the insolvent company with the intention of claiming a set off. Such an approach is contrary to the policy of the Act as it would provide an unfair advantage to that creditor.

The other circumstance where set off is not allowed is where there is a lack of mutuality. In the recent liquidations referred to above, a number of clients were a debtor of one company and a creditor of the related company. In these circumstances there is no mutuality, so no set-off, and this is true despite the common director and the close trading relationship which existed between the two liquidated companies. Accordingly the liquidator was unable to allow any set off. The effect of this was that debts due to the one company had to be paid in full and a claim lodged for amount due in the other company.