Creditors are no longer entitled to utilise the right of set off pursuant to Section 553C against their outstanding debt owed in a liquidation as a defence against an unfair preference claim commenced by a liquidator.

What is Mutual Set-Off?

A Mutual Set-Off occurs when a company and a creditor have mutual dealings with each other during the ordinary course of business.  For example, a creditor may supply goods to a company whilst the company at the same time may supply finished goods to the creditor as a customer.  The amounts owed to either party can be reduced by Mutual Set Off depending on the amount supplied to the creditor when admitting the claim in a liquidation.

The Corporations Act 2001 (“the Act”)

Section 553C of the Act states there were there have been mutual credits, debits or dealings between a company that is being wound up and a creditor who wants to have their claim admitted in the liquidation, an account is to be taken of what is due from one party to the other.  Further, the sum owed to one party is to be deducted from the sum due from the other party and the balance of the amount owing to the creditor is to be admitted in the liquidation.

In addition to the above, Section 553C(2) of the Act states that a creditor is not entitled to a set-off at the time of mutual dealings if they have knowledge that the company is insolvent.

In the Matter of MJ Woodman Electrical Contractors Pty Ltd (In Liquidation) (“MJ Woodman”) & Anor v Metal Manufacturers Pty Limited (“Metal Manufacturers”) (2021)

The Liquidator of MJ Woodman commenced proceedings against Metal Manufacturers for receiving unfair preference payments totalling approximately$190,000 during the relation back period.  The Metal Manufacturers sought to rely upon Section 553C of the Act as a defence to the unfair preference action, given it was owed approximately $194,000 in the liquidation. 

In summary, the Full Federal Court determined that the creditor cannot rely on Section 553C of the Act for the following reasons:

• To apply Section 553C of the Act, there must be mutual dealings between the insolvent company and a creditor;
• The mutual dealings must exist prior to a company being placed into liquidation;
• Given the payment of an unfair preference claim is served on the creditor via a Court Order pursuant to Section 588FF of the Act, the unfair preference claim is deemed to be a recovery action that is only available to a liquidator in exercising their statutory duties; and
• An unfair preference claim pursued by a liquidator does not exist prior to a company being placed into liquidation.

Conclusion

A creditor cannot rely on Section 553C of the Act to defend an unfair preference action commenced by a liquidator given that a Court Order to settle an unfair preference claim is a new obligation pursuant to Section 588FF of the Act.  Further, the ability to pursue an unfair preference claim is only available to be utilised by liquidators pursuant to the Act and this obligation does not exist prior to a company being placed into liquidation.

This gives a liquidator confidence in knowing creditors cannot rely upon Section 553C of the Act as a defence to an unfair preference claim.