Set off first, ask questions later 8 min read
The Supreme Court of Queensland has refused to grant declarations sought by the Department of Employment and Workplace Relations that liquidators were required to distribute assets to priority creditors in accordance with s561 of the Corporations Act 2001 (the Act), and that a secured creditor was not entitled to assert a right of set-off with respect to these assets under s553C of the Act until after this distribution occurred.
The decision appears to clarify that the availability of set-off rights under s553C for the benefit of a secured creditor with security over circulating assets (or a 'floating charge') will prevail over any priority unsecured creditor entitlements under s556 and s561. For example, as occurred in this case, a creditor bank that loans funds to an insolvent debtor company and takes security over the company's bank account, is entitled to exercise its statutory right to set-off its debts against funds in the bank account without first distributing the funds to priority unsecured creditors in accordance with s561.
Key takeaways
- The priority afforded to priority creditors under s561 does not displace set-off rights under s553C, and does not operate until and unless there is a contest between a secured creditor and priority unsecured creditors over circulating assets. The statutory set-off is self-executing and occurs automatically for the benefit of the secured creditor before such a contest can arise, and before s561 can be engaged.
- The statutory set-off under s553C applies to secured debts and is not displaced by priority entitlements under s556 or s561.
- Liquidators and receivers do not hold circulating assets of the company on trust for priority unsecured creditors. The treatment of priority unsecured creditors with respect to circulating assets and floating charges is exhaustively dealt with by statute.
- A creditor cannot rely on the statutory set-off under s553C if they had actual notice of the facts of the company's insolvency at the time of giving credit to, or receiving credit from, the company. However, the threshold is high and requires that the creditor has actual notice of facts that would indicate the company is insolvent to a reasonable person.
Background
On 16 March 2022, Jason Bettles and James Robba (the Liquidators) were appointed as liquidators of Condev Construction Pty Ltd (Condev), which carried out a construction business in Queensland.
The lender had provided various loan facilities to Condev (the Facilities), secured by a fixed and floating charge over all of Condev's present and future assets and undertaking (the Security). The Facilities included a right of set-off in favour of the lender.
At the date of the appointment, the lender was owed approximately $6.3m. Between 18 March and 27 May 2022, the lender was repaid some of the Facilities through the sale of Condev's real and personal property, over which it had a fixed charge under its Security. The lender then purported to apply a set-off against a $5m term deposit account, over which it held a fixed charge, to repay the balance of Condev's debt.
Between May and December 2022, the Federal Government, through the Department of Employment and Workplace Relations, made payments to former employees of Condev in relation to entitlements under the Fair Entitlements Guarantee Act 2012 (FEG Act), which are afforded priority under s556 and s561 of the Act. The FEG Act operated to subrogate the Government into the position of the former employees as a priority unsecured creditor of Condev.
Following the lender exercising its statutory right of set-off under s553C, the realised value of the property of Condev was insufficient to meet all creditor claims against Condev, including priority and ordinary unsecured creditor claims.
In April 2023, the Government made an application seeking declarations that the Liquidators were required to distribute property of Condev which was subject to a circulating (or floating) security interest of the lender in accordance with s561 of the Act, and that the lender was required to repay funds to the Liquidators as it was not entitled to assert a right of set-off under s553C of the Act or at general law.
Legal issues
Could the secured creditor rely on its right of set-off?
The Government made various submissions in support of its contention that the lender was not entitled to rely on either the statutory set-off under s553C of the Act, or its general law set-off rights.
Does the statutory set-off under s553C apply to secured debts?
Yes. The court rejected the Government's submission that the statutory set-off does not apply in relation to secured debts.
The court noted the following with respect to the statutory set-off under 553C:
- it is self-executing, and occurs without a creditor needing to prove the liquidation of the company.
- it applies to a debt that would have been provable, had the creditor done so, and applies broadly to mutual credits, mutual debts and mutual dealings—notwithstanding that one or other of the debts or credits may be secured.
Did the Liquidators hold Condev's assets as trustee for the priority creditors as contingent beneficiaries?
No. The court rejected the Government's submission that the benefit of the Term Deposit was held by the Liquidators on trust for the priority creditors, and accordingly the statutory set-off could not be relied on as the Term Deposit and Facilities were not mutual credits and debts.
Citing the High Court's decisions in Metal Manufacturers Pty Ltd v Morton (2023) 275 CLR 100 and Federal Commissioner of Taxation v Linter Textiles Australia Ltd (in liq) (2005) 220 CLR 592, the court held that the proper view is that the company and Liquidator are not a trustee for priority unsecured creditors. Rather, the assets are held for the purpose of the company's own liquidation, and the realisation of assets and distribution of proceeds is done in accordance with the Act, which is exhaustive and leaves no room nor justification for the operation of general law principles relating to trustees in these circumstances.
Does the statutory set-off under s553C occur subject to any right created under s561?
No. The Government submitted that the statutory set-off under s553C occurs subject to the rights created under s561. The court rejected this submission and noted that s561 operates to give priority unsecured creditors a right to be paid from the circulating assets of the company in priority to the claim of the secured creditor with a security interest over the circulating assets, in circumstances where the company's available property for distribution to creditors is insufficient to meet payment of creditors other than secured creditors (the 'insufficiency threshold'). The priority is limited to the amount of the secured creditor's claim against the circulating assets, and priority unsecured creditors have no right to be paid in priority from any circulating assets not the subject of the secured creditor's claim.
The court held that in the absence of a contest between the claim of a secured creditor and priority unsecured creditor against circulating assets, s561 does not operate. The court held that there was 'no contest' between the lender (as secured creditor) and the Goverment as priority creditors because:
- the 'insufficiency threshold' for the engagement of s561 applies only once the liquidator has sufficient information, not at the date of appointment. By the time the Liquidators were able to form a view as to the insufficiency of assets to meet priority creditor claims for the purposes of s561, the lender's secured debt had been discharged by operation of the set-off and so no contest remained; and
- The lender applied the statutory set-off with respect to a fixed charge over a term deposit account. Therefore, it fell outside the scope of s561 in any event.
Did the secured creditor have notice that Condev was insolvent, precluding it from relying on the statutory set-off under s553C?
Under s553C(2) of the Act, a creditor cannot rely on the statutory set-off if they had notice of the fact that the debtor company was insolvent.
The Government submitted that the lender was not entitled to rely on the statutory set-off, as at the time it gave credit to Condev by granting the Facilities, or received credit from Condev in the form of the term deposit, the lender had notice of the fact of Condev's insolvency.
The test for whether a creditor has notice that a company is insolvent is not in dispute, as set out in Jetaway Logistics Pty Ltd v Deputy Commissioner of Tax (2009) 26 VR 657. Citing this case, the court held that in order to preclude the creditor from reliance on the set-off under s553C(2), it must be proven that, taken objectively, the creditor had actual notice of facts that would have indicated to a reasonable person the fact that the company was insolvent. Mere reasonable grounds for suspecting the fact of insolvency is not sufficient to preclude reliance on 553C.
Relevantly, the lender had notice of the following facts:
- Since 22 February 2022, it had received extensive information about Condev's balance sheet, including its tax statements and financial statements.
- Since 28 February 2022, The lender's own investigations showed Condev had operated at a significant net loss and breached key financial covenants, but its assets continued to exceed its liabilities.
- Since 12 March 2022, a news article describing the financial circumstances of Condev, which had been read by numerous of the lender's employees.
- On 13 March 2022, the lender received emails as to Condev's urgent requests for cash injections and financial support from developers.
- On 14 March 2022, it formed a view that its balance sheet was 'still reasonably strong', noting it had recently improved its cash at bank position.
In the circumstances, the court held that the information known to the lender was not sufficient to satisfy the test for notice of insolvency under 553C(2). The court considered that the information available was not sufficient to permit the lender to reach a conclusion that Condev was unable to meet its debts when they became due and payable.