Unfair preferences & the set-off defence

Under section 588FA of the Corporations Act 2001 (Cth) (Act) an unfair preference is defined as a transaction, such as payment of an outstanding debt, between a company and an unsecured creditor which results in that unsecured creditor receiving more than it would have received if it had to prove in the winding up of the debtor company.  It is unfair because the payment results in the net value of the assets of the debtor company being reduced, to the detriment of the body of unsecured creditors as a whole.  One of the rarer defences is the Set-Off to an unfair preference claim.

The Set-Off defence in operation

Under section 553C of the Act where there have been mutual dealings between an insolvent debtor company and a creditor who wants to have a debt or claim admitted against that insolvent company, an account is taken of:

• what is owed by the insolvent company to the creditor;
• what is owed by the creditor to the insolvent company; and
• the sums due are set-off with only the balance of the account admissible to proof against the insolvent company, or payable to it, as the case may be.

There must be mutual dealings between the parties.

At its simplest, both the creditor and the insolvent debtor company must both be buying and selling goods or services from each other.  However, mutual dealings can extend beyond debts to include, for example, a contingent liability (such as a possible claim in damages) capable of maturing into a pecuniary demand.

It is because of the need for the existence of mutual dealings between the parties that the set-off defence is rather rare.

The effect of the set-off is that the creditor’s payment received from the insolvent debtor company is set off against money owed by the creditor to the insolvent debtor company.

However, the creditor is unable to claim the benefit of the set-off if, at the time of giving credit or receiving credit from the insolvent company, the creditor had notice that the debtor company was insolvent.

Examples of the Set-Off defence in operation

The Federal Court in Re Parker held the term mutual dealings should be construed widely.  In that case, mutual dealings was accepted to extend to the situation where a holding company, being sued for insolvent trading by the liquidator of a subsidiary of the holding company, was able to off-set that post-liquidation statutory debt claim against a debt owed to it, by the subsidiary and incurred pre-liquidation.

Some liquidators have argued the set-off defence is not available in unfair preference claims.

However in Stone v Melrose Cranes & Rigging Pty Ltd the Federal Court accepted, consistent with Re Parker, that a set-off defence applies to unfair preference claims, not just voidable transactions claims.

The major stumbling block for many creditors is the issue of notice of the debtor’s insolvency.

Jetaway Logistics Pty & Ors v Deputy Commissioner of Taxation held that it is for the liquidator to establish the defending creditor had notice of the insolvency, being proof of the facts known to the creditor which warranted a conclusion of insolvency.

It will be sufficient if, from what was known by the creditor at the relevant time, the only inference reasonably open was that the company was insolvent.

Takeaways

When raising a set-off defence, it may be difficult to rebut notice of insolvency where a creditor has for example, granted significant indulgences as they apply to conforming with usual trading terms, received numerous post-dated cheques or there have been consistent failures to comply with repayment arrangements.

Links and further references

Cases

In the matter of: ACN 007 537 000 Pty Ltd (in liquidation); Robert Colin Parker [1997] FCA 1264

Stone v Melrose Cranes & Rigging Pty Ltd, in the matter of Cardinal Project Services Pty Ltd (in liq) (No 2) [2018] FCA 530

Jetaway Logistics Pty Ltd & Ors v Deputy Commissioner of Taxation [2009] VSCA 319

Legislation

Corporations Act 2001 (Cth)

Further information about unfair preferences

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Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

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