Background to Metal Manufactures v Morton
In the six months before the commencement of its winding up, MJ Woodman Electrical Contractors Pty Ltd (MJ) made payments of $50,000 and $140,000 to Metal Manufactures Pty Limited (MM). MJ was wound up in insolvency and its liquidator soon commenced proceedings against MM seeking to recover these payments as alleged unfair preferences under s 588FF of the Corporations Act. Against this claim, MM raised a number of defences including a defence of set-off under s 553C of the Corporations Act. MM asserted that it was not liable to pay the claimed amounts because it was still owed $194,727.23 by MJ at the time of liquidation and entitled to rely on that debt to set-off the liquidator's claimed amount under s 553C of the Corporations Act.
The use of the s 553C defence to the unfair preference claim was an issue of legal contention. There were various single judge decisions allowing the defence, and a number of other single judge decisions against it. To resolve this doubt, the primary judge referred the question of whether s 553C applied as a unfair preference defence to the Full Court of the Federal Court as a special case. In 2022, the Full Court found set-off was not available against a liquidator's unfair preference claim. MM appealed to the High Court by special leave.
The High Court’s decision on set-off
The High Court unanimously held that the Full Court was correct in concluding that set-off under s 553C was not available to MM in respect of the unfair preference claim under s 588FF.
The High Court explained that s 553C set-off has two key elements:
1. It has a timing element: to be available the circumstances giving rise to the set-off must have occurred before the winding up commenced.
2. There must be mutual dealings. This requires three sub-elements to be satisfied:
(a) The credits, the debits or claims to be set-off must be between the same persons.
(b) The benefit or burden of them must lie in the same beneficial or equitable interest.
(c) The dealings must ultimately sound in money.
The High Court found that the requirement there be mutual dealings did not exist because the liquidator's claim did not exist before the winding up commenced (see the timing element above). Rather, the liquidator's claim was created by the winding up. As the High Court explained" 'immediately before the commencement of the winding up there was nothing to set off as between… [MM] and MJ Woodman; the company owed money to [MM] but [MM] owed nothing to the company' (at [46]) and '…any liability arising from the making of an order by a court [for an unfair preference] cannot… be the subject of a valid set-off against pre-existing amounts owed by the company to the preferred creditor for the purposes of s 553C' (at [50]).
The High Court also determined that there was not mutuality of persons or interests. The High Court pointed out that the liquidator's claim for an unfair preference was not a claim by MJ so that there was not mutuality of persons. Likewise, the Court held that because a liquidator sues for an unfair preference in the special capacity as an officer of the Court, and not as an agent for the company, there could be no mutuality of interest. It therefore followed that there could be no s 553C set-off.
Other matters
In coming to the conclusion that set-off did not apply to a liquidator's preference claim, the joint judgment [at 56] referred to two earlier cases. One of which decided that set-off could be used to defend a liquidator's insolvent trading claim (Re Parker) and one which decided it could be used to defend another type of voidable transaction, 'uncommercial transactions' (Buzzle Operations). The judgment said that 'to the extent' that those cases were inconsistent with the reasoning applied by the court to unfair preferences, they should be considered to have been 'wrongly decided'. There remains an issue then as to whether those cases are in fact inconsistent. The Full Federal Court had held that they could be distinguished from a claim relating to a preference.
In the course of reasoning, the High Court also found that the 'statutory regime for the administration of a company in liquidation is both an exhaustive and sufficient measure for the distribution of a company's property which does not necessitate or justify the intervention of equity' (at [6]). This statement bears some significance and the prospect of assisting to define the development of insolvency law into the future. In particular, this clarification makes it clear that neither a liquidator or company holds its property on trust for creditors. Logically, it must also mean creditors are not, and should not claim to be, beneficiaries of a trust under the winding up provisions in the Corporations Act.
Another interesting passage in the judgment relates to the underlying function and purpose of the proof and ranking of claims regime in Division 6 of Part 5.6 of the Corporations Act (of which s 553C is included) being different to the function and purpose of the regime for dealing with voidable transactions. The High Court explains that proof and ranking of claims is 'directed at identification of which debts and claims must be addressed by the liquidator' whereas the voidable transaction scheme is about 'the liquidator's duty and capacity to recover preferential payments and… ensure equality in the making of distributions to the same class of creditors' (at [51]). Understanding these policy drivers should assist to Courts in applying the various provisions contained within those divisions of the Corporations Act into the future.
Key takeaways
While the headline take away is clear: s 553C does not provide a defence to an unfair preference claim, the following key points may also be noted:
- the rights and obligations of liquidators, creditors and other interested parties are defined by the Corporations Act;
- under the statutory scheme, neither the company nor the liquidator holds the company's property on trust for its creditors and members;
- in exercising their powers to reclaim unfair preferences, liquidators are acting as officers of the Court;
- set-off under s 553C is not available against unfair preference payments under s 588FF because the obligation to repay unfair preference payments arises after the commencement of the winding up;
- section 553C cannot apply to unfair preference payments because the key features of mutuality of persons and interests do not exist; and
- with regard to the reasoning of the Court, set-off as a means of defence to any preference claim must be regarded as hopeless.
Consequences of the decision
The decision in Morton clears up an interesting legal question and in doing so provides liquidators and creditors with greater certainty as to their positions relating to unfair preference claims. This legal certainty is welcome because it enables parties to make properly informed commercial decisions relating to the conduct and settlement of preference claims.