The ability of liquidators to claw back payments made to creditors for pre-appointment debts owed by a company is a powerful tool with a noble aim, that being to ensure no one creditor is preferred, and each is treated equally.
While the aim is noble, the consequences for a creditor in having to repay money it has received for goods and services rendered is a very bitter pill to swallow. The taste of that pill is even more rancid where the creditor who receives the demand is also owed a substantial debt from the company in liquidation.
To date, creditors have found it difficult to argue that the debt owed should cancel out (or offset) the preference claim.
However, in a blow to liquidators, and a potential boon to creditors, the Federal Court of Australia (FCA) In the matter of Stone v Melrose Cranes & Rigging Pty Ltd, in the matter of Cardinal Project Services Pty Ltd (in liq) (No 2)  FCA 530 has confirmed that the set-off defence under section 553C of the Corporations Act 2001 (Cth) (the Act) can be used by creditors who would otherwise be required to repay an unfair preference.
On 1 February 2012 the plaintiffs, Richard Andrew Stone and Peter William Marsen, were appointed as liquidators of Cardinal Project Services Pty Ltd (In Liquidation) (CPS), a wholly owned subsidiary providing environmental services in waste management and recycling.
In 2016, the Liquidators initiated proceedings against Melrose Cranes & Rigging Pty Ltd (Melrose) seeking orders under section 588FF of the Act that 18 payments from CPS to Melrose totalling $308,544.58 were voidable transactions and unfair preferences.
Melrose disputed the Liquidators' position and asserted, inter alia, that:
• they were unaware of the fact that CPS was insolvent at the time that each payments was made;
• they had acted in good faith;
• any payments made were not unfair preferences but were instead an integral part of the continuing business relationship (referred to as a running account defence); and
• they were entitled to a set-off in the amount of $80,774.23 which was the amount in which CPS was indebted to it at the date of the appointment of the administrators.
At trial, the Liquidators invited the Court not to follow a long line of cases that favoured Melrose's view that a set-off may be available in the context of a preference claim, on the basis that the cases are "plainly wrong", however they did not provide detailed submissions on the issue.
On 19 April 2018 after a seven day hearing, the FCA ultimately found that payments made to Melrose were voidable transactions pursuant to s588FE(2) of the Act, and that they were unfair preferences.
Accordingly the Liquidator's claim was successful and Melrose lost, but what is important for creditors is that the Court rejected the Liquidators' submission that a set-off under section 553C is not available to creditors in the context of a preference claim.
Her Honour Justice Markovic stated that the Court was not prepared to depart from the leading judgment in Re Parker (1997) 80 FCR 1 or any of the other authorities permitting a set-off to be utilised by creditors in voidable transaction claims.
However, Melrose could not avail the defence, because it was found that it had the requisite notice and knowledge of insolvency at the time of the payments.
Referring to the matter of Jetaway Logistics Pty Ltd v Deputy Commissioner of Taxation (2009) 26 VR 657 (Jetaway), Her Honour found that Melrose had 'actual notice' of facts which disclosed that CPS lacked the ability to pay its debts when they fell due within the meaning of section 95A of the Act.
The relevant evidence included Melrose being aware of multiple promises of payment that were not met despite persistent follow up and knowing the CPS had no prospect of having any funds to pay the debts. These circumstances, amongst other, should have indicated to the director that CPS was insolvent, and therefore Her Honour accepted that Melrose was not entitled to a set-off.
Given the finding of actual notice, it was unsurprising that Her Honour also found that Melrose could not make out its good faith defence.
The Court also held there was no running account, as there was no evidence of a 'mutual assumption' of payment, instead the agreements between the parties were on a project by project basis.
IMPORTANT TAKE AWAY POINTS
Despite a loss for Melrose, this decision represents a significant win for creditors, who can rely on the decision as further authority at the Federal Court level for the proposition that the set-off defence is available in an unfair preference claim.
However consideration should be given to the following take away points:
• In order to be entitled to a set-off, creditors must demonstrate that they had no notice of a company's insolvency;
• The onus of establishing such notice will be on the liquidator and the test is whether the creditor had actual knowledge that the company lacked the ability to pay its debts when they fell due.
• The requirement of 'actual knowledge' is juxtaposed to the test for a good faith defence which is easier to overcome because the liquidators need only show that there were reasonable grounds for suspecting insolvency ; and
• Even a creditor who is unable to rely on the good faith defence may yet succeed with its set-off defence.
Until this issue is considered by a higher court, we expect the controversy around its application to continue, but perhaps the tide is turning more sharply in the creditor's favour and as a result, liquidators may find an increased amount of creditors using the set-off defence in response to claims for repayment of unfair preferences.
*Allan Kawalsky, Partner, TurksLegal
Ph: (03) 8600 5000
*Katherine Higgins, Lawyer, TurksLegal
1 Richard Andrew Stone and Peter William Marsen were previously appointed as joint and several administrators of Cardinal
Project Services Pty Ltd pursuant to section 436A of the Corporations Act (Cth).
2 See section 588FE(2) and 588FA of the Corporations Act 2001 (Cth).
3 See Airservices Australia v Ferrier (1996) 185 CLR 483 where a majority High Court of Australia stated with regards to the running account defence that: “if the purpose of the payment is to induce the creditor to provide further goods or
services as well as to discharge an existing indebtedness, the payment will not be a preference unless the payment exceeds the value of the goods and services acquired”.
4 See In the matter of Stone v Melrose Cranes & Rigging Pty Ltd, in the matter of Cardinal Project Services Pty Ltd (in liq)
(No 2)  FCA 530 at .
5 Ibid, . See generally Re ACN 007 537 000 Pty Ltd (in liq); Ex Parte Parker (1997) 80 FCR 1, Morton v Rexel Electrical
Supplies Pty Ltd  QDC 49 and Buzzle Operations Pty Ltd v Apple Computer Australia Pty Ltd  NSWCA 109.
7 See section 553C (2) of the Act.
8 See Sutherland v Eurolinx Pty Ltd (2001) 37 ACSR 477.
9 See section 588FG of the Corporations Act 2001 (Cth).
July 2018 - FNSCRD505 - Respond to corporate insolvency situations - FNS51520 Diploma of credit management and FNSCRD401 - Assess credit applications and BSBRSK501 - Managing Risk