Summary

Insolvency practitioners pursuing unfair preference claims should give consideration to a recent Queensland District Court judgment which has endorsed the application of section 553C of the Corporations Act 2001 (Cth) (Act) - which enables an insolvent company and a creditor to set-off their mutual debts against each other - to unfair preference claims.

In practice, this means that a creditor who has received preferential payments may seek to offset any pre-liquidation debt they are owed against the amount of the preferential payments. From an insolvency practitioner’s perspective, this could significantly reduce or nullify the quantum of any unfair preference claim it may have against a creditor.

The Facts

Morton & Anor v Rexel Electrical Supplies Pty Ltd [2015] QDC 49

  • The creditor provided electrical products to the debtor company. On 31 January 2012, the creditor rendered an invoice totalling $215,421.80 (the January invoice).
     
  • On 23 March 2012, the debtor company paid $16,224.07. A few days later, the creditor reminded the debtor company that the amount outstanding was $244,558.15 (as further invoices had been rendered by the creditor).
     
  • On 4 April 2012, the parties agreed to a 7-instalment payment plan over April and May 2012. The first 5 instalments were paid. The final 2 instalments were never paid.
     
  • On 14 August 2012, the debtor company’s creditors passed a resolution winding up the debtor company. The appointed liquidator pursued an unfair preference claim against the creditor for the payments it received from the debtor company during the relation-back period totalling $197,469.16.
     
  • The creditor defended the claim on a number of grounds including that the sum of $92,323.88 - being monies owed to it by the insolvent company - should be set-off against the preferential payments pursuant to section 553C of the Act.

Application of Section 553C of the Act to Unfair Preference Claims

The issue was whether section 553C of the Act applied such that the creditor could set-off $92,323.88 against the preferential payments.

The liquidator argued that a creditor’s ability to rely on the set-off provisions in a case such as the present would frustrate the purposes of the unfair preference provisions. The liquidator pointed to the peculiar result that would follow in the case of a creditor who is paid its entire debt by preference payments and the disadvantage this creditor would suffer in comparison to a creditor who is paid only part of their debt by preference payments.

For example, if a creditor was owed $100,000 and was paid the entire amount by preference payments, it would have to disgorge the entire amount and have no amount outstanding by which it could set-off the preference payments. Alternatively, if another creditor was owed $100,000 and paid $30,000 by preference payments, the creditor could set-off the outstanding $70,000 against the $30,000 preference payments and not have to disgorge any amount to the liquidator.

Despite the liquidator’s submissions, the Queensland District Court found that the potential unsatisfactory outcomes raised by the liquidator did not justify disregarding the plain language of section 553 of the Act. It was held that the set-off provision in section 553C of the Act applies to unfair preference claims.

Set­Off Not Available to Creditors with Notice of Insolvency

The Queensland District Court highlighted a key qualification to section 553C of the Act - namely that a set-off will not be available to a party who, at the time of receiving a credit (which in the present case was the date each invoice was rendered), had notice of the fact that the company was insolvent.

In light of this qualification, it was found that for all invoices except the January invoice (of which $64,658.15 remained outstanding), the creditor had actual notice of facts that would have indicated to a reasonable person in its position that the debtor company was insolvent.

Reliance was placed on a telephone conversation between employees of the creditor and the debtor company in mid-February 2012 where the creditor was advised that the debtor company did not have the money to pay the January invoice. Accordingly, the Queensland District Court only set-off the amount of $64,658.15 (being the amount outstanding under the January invoice) against the unfair preference payments. The amounts outstanding under the other invoices were not set-off against the unfair preference payments because it was found that the creditor had notice of the debtor company’s insolvency.

Orders

The Queensland District Court ordered that the creditor pay the Liquidator the sum of $131,811.01. This represented the amount of the unfair preference payments totalling $197,469.16 less the amount of $64,658.15 (being the amount outstanding under the 31 January 2012 invoice) which was set-off pursuant to section 553C of the Act.

Key take­outs for insolvency practitioners

  • A preferred creditor may be able to offset any pre-liquidation debt against preferential payments if it can show it did not have notice of the company's insolvency.
  • If the preferred creditor has lodged a proof of debt in the liquidation, the issue of notice will be particularly relevant.
  • The result could either significantly reduce the quantum of any such unfair preference claim or nullify it entirely.