Can a director’s liability for insolvent trading be reduced by a set-off against the company?

If a director can exercise a right of set-off against a company in liquidation for a debt owed to the director or for a liability of the company to the director (which may be unascertained in amount or contingent), it may help to cancel out or significantly reduce the director’s liability to the company for insolvent trading.

Section 553C(1) of the Corporations Act 2001 provides for a set-off where there have been mutual credits, mutual debts or other mutual dealings between an insolvent company that is being wound up and a person who wants to have a debt or claim admitted against the company. An account is to be taken of what is due from one party to the other in respect of those mutual dealings.

Under Section 553C(2) of the Act, a claim for set-off is not available under section 553C if, at the time of giving credit to the company, or at the time of receiving credit from the company, the person had notice of the fact that the company was insolvent.

Re Parker

In the controversial decision of Re Parker (1997) 150 ALR 92, a holding company was liable for the insolvent trading of its subsidiary under section 558V of the Act.

Mansfield J held that:

• the holding company’s post-liquidation liability for insolvent trading could be set-off under section 553C against the debt owed to the holding company by the subsidiary;
• although the liability for insolvent trading did not arise from any dealings between the two companies, it did not mean that the debt may not qualify for set-off under section 553C because the two debts were between the same companies;
• there was no reason to exclude statutory debts from the compass of provisions such as 553C;
• although mutual creditors and debtors will ordinarily result from prior dealings between the two parties, it is not necessarily so.

Smith & Bone

In the recent Federal Court decision of Smith (in the capacity as liquidator) v Bone [2015] FCA 319, a liquidator sought compensation against a director for insolvent trading. The director argued that he was able to set-off debts owed to him by the company in liquidation against his liability for insolvent trading.

The liquidator argued that a set-off was not available under section 553C because there was a lack of mutuality, as the insolvent trading claim was characterised as ‘misfeasance proceedings’.

The liquidators did not make detailed submissions on the issue, but sought to preserve their position in the event of an appeal. The Court adopted the approach of Mansfield J for the reasons given in Re Parker.

Comments

Recently the District Court of Queensland in Morton v Rexel Electrical Supplies Pty Limited [2015] QDC 49 applied Re Parker where the liquidator was seeking the recovery of unfair preference payments. The creditor successfully reduced the amount of the preference payments by the amount of some of the outstanding invoices owed to the creditor by the company in liquidation.

The position under section 553C(2) is as follows:

• A set-off is not available if, at the time of giving credit to the company in liquidation, the person had notice of the fact that the company was insolvent.
• A person will have ‘notice of the fact’ that a company is insolvent if the person has actual notice of the facts that disclose that the company lacks the ability to pay its debts when they fall due, within the meaning of section 95 of the Act.
• It is unnecessary for the liquidator to show that the person actually formed the view that the company lacked that ability however ‘grounds for suspecting’ insolvency will not suffice. What is required is proof of facts known to the creditor that warrant the conclusion of insolvency.
• The relevant issue will be whether the person had actual notice of the facts that would have indicated to a reasonable person in their position that the company was unable to pay all of its debts as and when they became due and payable.

Liquidators argue the decision in Re Parker frustrates the statutory recovery provisions relating to unfair preferences and insolvent trading. The counter argument is that section 553C is a statutory directive that operates at the time the liquidation takes effect. Its purpose is to achieve ’substantial justice’ and should be given ’the widest possible scope’.  From the liquidator’s perspective, the legal controversy regarding Re Parker awaits resolution by an appellant court.

If you would like more information about these issues, please contact Graham Roberts on +61 7 3231 2404 or Sarah Dewar on +61 7 3231 2976.