Setting off debts to avoid the liquidators’ clawback - voidable transactions v set-off

11 April 2023

When does a set-off – or the prospect of a set-off – defeat a voidable transaction claim by the liquidator of an insolvent company? This update outlines a recent decision of the High Court of Australia and summarises the position under New Zealand law.

The issue

Liquidators of insolvent companies are generally concerned with the net debt owed to the company by its creditors. In other words, if a company in liquidation owes money to a creditor, and is also owed money by the same creditor, the company can only recover the net amount. It cannot insist on payment of its debt in full in circumstances where it is unable to perform its corresponding obligation. The parties do not need to do anything to achieve this set-off. It happens by operation of law (referred to as an “insolvency set-off ”) pursuant to s 310 of the Companies Act 1993.

Liquidators also have the power to “claw-back” payments that were made by a company in liquidation prior to the appointment of liquidators, if they would result in a creditor receiving more than it would otherwise have received in the liquidation. This helps achieve a fair distribution of the company’s assets as between creditors. It avoids an outcome in which one creditor receives payment in full simply because the payment was processed immediately before the liquidation. However, it can leave blameless defendants in the unfortunate position of facing a claim, depending on how long the payment is made before the company goes into liquidation.

The High Court of Australia recently considered, in Metal Manufactures Pty Ltd v Morton (Morton)1, how these two principles interact: can a creditor, faced with a voidable transaction claim, assert a set-off of the claw-back amount against the other amounts that the company owes it?

What it means for set-offs and voidable transaction claims in New Zealand
The Morton decision

An electrical contracting firm, MJ Woodman Electrical Contractors Pty Ltd (the Company), was placed into insolvent liquidation. In the six months prior to the liquidation (i.e. during the “restricted period” for voidable transaction purposes), it made payments totalling AU$190,000 to Metal Manufactures Pty Limited (the Creditor).

The liquidators of the Company attempted to claw-back the AU$190,000 in payments. The Creditor opposed the application on the basis that the Company owed it a further AU$194,000 at the time of liquidation. It argued that, under an insolvency set-off , two debts were set-off against each other, such that the liquidator could not force the Creditor to pay back the AU$190,000 it had received.

The High Court of Australia, like the Federal Court before it, held that the insolvency set-off was not available in these circumstances. The Court reasoned that the insolvency set-off provisions of the Australian Corporations Act 2001 (Cth) (the Corporations Act) only applied to mutual debts, such as debts between the same people. The debts in this case were not mutual, because it was the liquidator, rather than the Company, that had the claim to claw-back the AU$190,000. The Court also held that an insolvency set-off only applies to debts that existed at the time of the winding-up, whereas the requirement to repay the AU$190,000 only arose once the liquidators commenced the voidable transaction process.

The High Court observed that its conclusion was consistent with the purpose of the voidable transactions regime, which is to preserve equality among distributions made to creditors. In the Court's view, it would be a "gross distortion" of this statutory regime if a creditor could avoid recovery of a preferential payment by the coincidence that it was also owed money by the insolvent entity, as it would permit them to use each dollar owed to set-off in full each dollar of liability arising from receipt of the unfair preference.

Set-off v voidable transactions in New Zealand

The New Zealand Courts have never considered this issue. In our view, the reasoning in Morton would be persuasive to a New Zealand Court if the issue arose.

What about set-off by agreement?

The New Zealand Courts have considered a different issue relating to set-off. In Trans Otway Ltd v Shephard, the company in liquidation and one of its creditors had, before the liquidation, agreed to set-off two debts they owed to one another. The first issue was whether a set-off arising by agreement constituted a “transaction” for the purposes of the voidable transaction regime. The Court of Appeal held that it did.2 It was, in substance, a payment of money by the company.

That issue was not appealed to the Supreme Court. However, a second question arose, whether, if it was a payment, it resulted in the creditor receiving more than it otherwise would have received in the liquidation. The Supreme Court observed that it would not result in the creditor receiving more, if the insolvency set-off would have operated regardless of the agreed set-off.3 In other words, a payment made by set-off cannot be clawed back if the set-off would have happened by operation of law in any event.

The Morton considerations (the lack of mutuality and the fact that the debts would not have existed at the time of the liquidation) do not apply in those circumstances.

So can set-off be a defence to a voidable transaction claim?

The answer is yes it can, but only in certain circumstances. In summary:

  • A set-off arising from a pre-liquidation agreement to set-off two existing debts can amount to a voidable transaction. A liquidator may claw-back the amounts that have been set-off, in the same way as if they had been paid in cash. This principle operates when the company in liquidation has agreed to the set-off. It will not apply when the set-off takes place by operation of law (e.g. the insolvency set-off).4 It is undecided whether it applies when the creditor unilaterally exercises a contractual right to set-off.5
  • It will be a defence to this type of claim if the creditor can show that the set-off did not create a preference in the liquidation, because the set-off would have happened by operation of law as part of the insolvency set-off in any event. This will be the case if the two debts would otherwise have existed at the time of the liquidation, and the creditor did not have reason to suspect that the company could not pay its due debts at the time of the set-off.
  • However, according to Morton, it is not possible to set-off a voidable transaction claim against other debts owed by the company in liquidation. The reason is that the two debts lack the requisite mutuality, and were not both owed at the time the insolvency set-off operated.

If you have any questions or require any other guidance, please contact our team or your usual Bell Gully adviser.

1 Metal Manufactures Pty Ltd v Morton [2023] HCA 12 Trans Otway Ltd v Shephard [2005] NZLR 678 (CA)3 Trans Otway Ltd v Shephard [2005] NZSC 76, [2006] 2 NZLR 2894 Finnigan v He [2010] 2 NZLR 668; Harlock v CIR [2013] NZHC 33895 Trans Otway Ltd v Shephard [2005] NZLR 678 (CA)

Disclaimer: This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.