A warning for companies entering solvent liquidation: you may not have a right to set-off unliquidated claims against debts you owe to creditors.    

That was the finding in a recent High Court decision where the liquidators of HY Tourism Ltd (in liquidation) (HY) asked the Court to determine the amount a creditor was able to prove in HY's liquidation. The case (Mason-Thomas v Three Dukes Home Ltd) is another development in the law on the interface between section 79 of the Construction Contracts Act 2002 (CCA) (which prevents set-offs) and section 310 of the Companies Act 1993 (CA) (which allows set-offs).  

Three Dukes Home Ltd's creditor claim

Three Dukes Home Ltd (Three Dukes) undertook construction work for HY and issued invoices to HY for that work. A dispute arose between HY and Three Dukes as to payment of some of those invoices, as HY said it had been overcharged and the works were defective. Three Dukes served a payment claim on HY for the unpaid invoices. HY did not pay, nor did it serve a payment schedule in response. Under section 23 of the CCA, HY's failure to provide a payment schedule meant that it became automatically liable to pay the full amount in the payment claim as a debt due and owing to Three Dukes.    

Three Dukes served a notice of adjudication on HY seeking payment of the unpaid payment claim. The adjudicator found HY liable to pay the amount of the payment claim, being $577,967, under section 23 of the CCA. While HY had a counterclaim for alleged overcharging and defective works, section 79 of the CCA says HY cannot raise its counterclaim in any proceedings for recovery of a debt under section 23 of the CCA.    

This is referred to as the "pay now, argue later" policy. HY needs to pay the adjudication amount now, and take separate proceedings to claim back any over-payment it thinks it has made to Three Dukes (the "argue later").  

HY's claim

HY then filed a High Court claim against Three Dukes claiming overcharging by Three Dukes. It sought judgment of $267,415. HY sought to stay the enforcement of the adjudication determination pending the High Court claim. HY's stay application was dismissed on the basis of the "pay now, argue later" policy.  

HY liquidation

HY did not pay the adjudication amount so Three Dukes applied, successfully, to liquidate HY. Three Dukes then lodged its proof of debt for $612,878 (the adjudication amount plus costs).  

Assessment of Three Dukes' claim in the liquidation

The director and shareholders of HY argued that the adjudication amount was not a liquidated sum able to be proved in the liquidation. Their argument was based on the fact that the adjudicator had simply awarded the amount of the payment claim without determining the parties' substantive rights. They argued that once a company is in liquidation, the "argue later" of the "pay now, argue later" policy applies and the parties' substantive rights must be assessed in order to determine the creditor's claim.    

The High Court disagreed and said the adjudication amount is a liquidated sum.  

Can HY set-off its unliquidated claim against Three Dukes' liquidated debt?

Section 79 of the CCA says that in any proceedings for the recovery of a debt (here, the adjudication amount), the debtor (here, HY) cannot set-off its counterclaim. This is one aspect of the "pay now, argue later" policy of the CCA. This is straightforward where the debtor is solvent and trading.    

However, once the debtor goes into liquidation, section 310 of the CA says that the liquidator must take account of any mutual credits or debts between the creditor and debtor in assessing the creditor's claim in the liquidation. Taken alone, this means that if HY has a set-off or counterclaim argument, Three Dukes' claim in the liquidation would be reduced accordingly.    

It has been suggested by the courts that section 310 applies automatically upon liquidation to set-off against CCA debts, notwithstanding section 79 of the CCA. This is because liquidation is the "later" and insolvency is the last chance for the claims to be heard. But, in this case the High Court said section 310 does not apply in a solvent liquidation such as this one. Key reasons for the Court's decision were:  

• Once a solvent liquidation is terminated, the company has the ability to pursue its unliquidated claim in the Court so it should not be allowed to "jump the gun" by setting off its unliquidated claim now.    
• If a losing party in an adjudication determination could go into solvent liquidation and apply section 310 to reduce the debt, it would be circumventing the "pay now, argue later" policy of the CCA.    
• It would be an abuse of process to allow HY to invoke section 310 because it had already had the chance to pursue its High Court claim and did not do so. It was particularly important that HY had not opposed the liquidation application.

Can the liquidators value HY's claim against Three Dukes anyway?

Another key principle of this case is that the High Court suggested that liquidators cannot value an unliquidated claim by the company against a creditor.    

Section 307 provides the process for liquidators to estimate the quantum of an unliquidated debt. We have seen this occur where a third party owes a liquidated debt to a company in liquidation but has a contingent claim against the company. In that case, the liquidators can assess the claim and determine its value.    

The HY liquidation concerned the reverse – HY owed a liquidated sum to Three Dukes and sought to set off an unliquidated counterclaim.    

The Court suggested that section 307 may not provide an ability for liquidators to value an unliquidated claim by the company itself, but did not conclude definitively on this. If this is the case, it would mean that liquidators faced with unliquidated claims by the company against a creditor would be required to pursue the claim in Court in order to obtain a liquidated value. This is palatable where there is a solvent liquidation, but in an insolvent liquidation it would be a big ask to require liquidators to expend money to pursue a claim to enable them to value the set-off against a creditor.