(See also Gye v McIntyre at 624).
19 The company will owe or be owed a contingent debt if, as a result of an existing obligation, the company will be liable to pay or be entitled to receive a sum of money on the occurrence of a future event which may happen, not which must happen (Community Development Pty Ltd v Engwirda Construction Co (1996) 120 CLR 455 at 459; Federal Commissioner of Taxation v Gosstray [1986] VR 876 at 878).
20 Clause 97 provided that it was upon the termination of the agreement that the plaintiff granted the defendant an option to purchase its fixtures, fittings, plant and equipment. However, I do not read the option given by clause 97(b) as an irrevocable offer, not resulting in a contract until it is accepted by a notice in writing by the defendant exercising the option. The better characterisation of clause 97 is that, pursuant to the contract then entered into, the plaintiff agreed to sell its fixtures, fittings, plant and equipment to the defendant if two conditions were satisfied, namely, that the franchise agreement was terminated, and the defendant gave notice of exercise of the option. Whether an option is better characterised as a conditional contract or as an irrevocable offer may turn on the terms in which it is expressed (GPT RE Ltd v Lend Lease Real Estate Investments Ltd (2005) 12 BPR 23,217 at 23,220 [25], 23,224 [51], 23,225 [56]). The better characterisation of the option in clause 97(b) is that it is a conditional contract for the sale and purchase of such of the plaintiff's fixtures, fittings, plant and equipment as the defendant chooses, if the defendant gives notice of exercise of the option after the agreement is terminated (Laybutt v Amoco Australia Pty Ltd (1974) 132 CLR 57 at 75-76).
21 The option was granted on entering into the franchise agreement. On entry into the franchise agreement, there was a contingent debt owed by the defendant to the plaintiff. The debt was contingent on the franchise agreement being terminated for any reason whatsoever, the defendant giving notice of exercise of its option to purchase such of the plaintiff's fixtures, fittings, plant and equipment as it chose, and the determination of the price in accordance with clause 97(b)(2) or (3). To adapt the language of Dixon J in Hiley v Peoples Prudential Assurance Co Ltd, at the commencement of the administration a liability had been contracted by the defendant, albeit contingently, that in the events that happened gave rise to money claims accruing during the course of the winding-up.
22 It follows that, subject to the operation of s 553C(2), the defendant is entitled to set off against its obligation to pay the purchase price for debts owed by the plaintiff company to it.
23 The defendant did not dispute this conclusion. It based its case on s 553C(2). However, it is necessary to consider two cases referred to by Dr Derham in The Law of Set Off at 530-533 [13.54]-[13.57], namely, Re Kidsgrove Steel, Iron and Coal Co (1894) 38 Sol Jo 252 and Paganini v The Official Assignee (New Zealand Court of Appeal, unreported, 11 March 1999). Both cases were analogous to the present and in both cases it was held that moneys payable pursuant to the exercise, after the commencement of the winding-up, of an option to purchase the insolvent company's assets, could not be set off against debts owed by the company to the optionee.
24 In Re Kidsgrove Steel, Iron and Coal Co Ltd, the company in liquidation was a lessee of a colliery and ironworks. It was a term of the lease that the lessor should have the option, at the termination of the lease, to purchase the lessee's plant and fixtures at valuation. The lessee company went into liquidation. Almost two years later, the lessor terminated the lease for non-payment of rent and, it would appear, exercised the option to purchase such of the plant and fixtures as were subject to the option. The lessor also agreed to purchase other items of plant and equipment from the liquidator. There could be no question of a set-off of moneys payable under such a contract with the liquidator, against the unpaid rent and claim for damages for breach of the lease (Hiley v The Peoples Prudential Assurance Co Ltd at 496). So far as the report discloses, the claim for set-off against moneys payable for assets purchased pursuant to the exercise of the option was dealt with in the following few sentences:
" But it was said that there was a great distinction between that purchase [viz the purchase of assets from the liquidator] and the purchase under the option, and the trustees [lessor] relied on the mutual credit clause in the Bankruptcy Act . Had they any contract to purchase at the time of the winding-up? No. That only arose when they exercised the option. The option seemed to his Lordship to make no difference as to set-off, and he held that there was no such distinction as was contended for, and no method of applying the mutual credit clause. If he was right Lee v Chapman's case had no application. "
25 The case is only briefly reported. The question whether the option created a contingent debt which could be set off once the contingency was satisfied through the exercise of the option was not considered.
26 In Paganini v The Official Assignee, the lessors had an option under the lease to purchase the tenant's chattels, plant and equipment at valuation on the termination of the lease. The tenant was wound up and on the next day, the liquidator agreed to sell the fixtures, fittings, chattels and stock in trade to the landlords for $50,000. The sale and purchase agreement between the liquidator and the landlords made no reference to the option, but stipulated that the parties would co-operate in resolving the issue of whether the landlords were entitled to set-off the purchase price against arrears of rent. The rent was in arrears by about the same amount.
27 On the facts disclosed in the reasons of the Court of Appeal, no question of set-off arose because the option was not exercised. The report of the reasons of the primary judge (Paganini & Anor v Official Assignee (1999) 8 NZCLC 261,811) records (at 261,813) that the landlords were asserting rights under the option clause of the lease and the liquidator was contending that if the landlord wanted the fixtures and chattels belonging to the tenant to remain on the premises, it must immediately come to terms and purchase them; that eventually an agreement for the sale and purchase of all items for $50,000 was reached; but that the exact nature of the arrangement immediately became controversial. The primary judge (Robertson J) said (at 261, 815) that the indebtedness of the landlords to the liquidator was incurred when the landlords were acting pursuant to an existing contractual right. Accordingly, the judgments at first instance and on appeal appear to proceed on the basis that the option was exercised, or at least, that it was common ground that the right of the landlord to set off the purchase price against unpaid rent should be determined on the assumption that the purchase price was payable pursuant to an exercise of the option after the commencement of liquidation.
28 It was held by the Court of Appeal, affirming the primary judge, that there could be no set-off because the debt for the purchase price arose after the commencement of liquidation and did not exist at the commencement of the liquidation (Court of Appeal reasons at [4], [6], [7]). The Court of Appeal concluded not only that mutual transactions giving rise to indebtedness must occur before the liquidation, but that the debt arising pursuant to the exercise of the option must arise before the liquidation (at [12]). The Court also said (at [13]):
" In this case the landlords must establish that their interest (to choose a neutral word) in the option qualified, at the time of the liquidation, as a 'debt' or an aspect of 'other mutual dealings' between them and their tenant. We do not see how they can possibly do that. Under the option they had the power in certain circumstances to require the tenant to sell. At the time of liquidation they had not exercised that power. Had they done so, but, for instance, the valuation had not been completed there would have been a compelling argument that they were indebted at the critical time and the fact that quantification had not been completed did not defeat the claim, ... But in this case they had not taken that step and accordingly they could not be said to owe the debt to the company or to have engaged in mutual dealings with it. Nor could the power under the option be read as coming within the provisions of s303 on admissible claims: the power is simply not a 'debt' or 'liability'. "
29 With respect, the reasoning in this paragraph is not easy to follow. The question was not whether the landlords' right to exercise their option to purchase the lessee's goods was a debt or liability provable in the liquidation. The question was whether the debt the landlords would owe on exercise of the option could be set off against arrears of rent. The liability of the tenant to pay rent under the lease, and the grant by it in the lease of an option to the landlord on termination of the lease, must have been mutual dealings made before the company's liquidation. It can readily be accepted that because the option had not been exercised at the time of liquidation, the landlords did not owe a debt to the company at that time. But the question is whether at the time of the liquidation there was a contingent debt. Whilst Hiley v Peoples Prudential Assurance Co Ltd was cited, the passage at 497 quoted earlier in these reasons at [18] was not.
30 A further reason for rejecting the claim for set-off was that there was no mutuality between the debt owed for rent and the debt arising pursuant to the exercise of the option because at the time the latter arose, the company no longer had a beneficial interest in its property (at [16]). This reasoning was based upon the decision of the House of Lords in Ayerst (Inspector of Taxes) v C & K (Construction) Ltd [1976] AC 167). However, that is not the law in Australia (Franklins Self-Serve Pty Ltd v Federal Commissioner of Taxation (1970) 125 CLR 52; Commissioner of Taxation v Linter Textiles Australia Ltd (in liq) (2005) 220 CLR 592).
31 The reasoning in the decisions in Re Kidsgrove Steel, Iron & Coal Co and Paganini v The Official Assignee has been queried by Dr Derham in The Law of Set Off at 531 [13.55]. I agree with his observations on those authorities. In my view, the reasoning in those cases is not consistent with that of Dixon J in Hiley v Peoples Prudential Assurance Co at 497, approved by the High Court in Gye v McIntyre at 624.
Notice of Insolvency when Credit Received
32 Counsel for the plaintiff did not rely on the decisions or the reasoning in Re Kidsgrove Steel, Iron & Coal Co or Paganini v The Official Assignee. Counsel was not disposed to dispute the proposition that there were mutual dealings between the parties which gave rise to debts owed by the plaintiff company to the defendant franchisor, and that a contingent debt was owed by the defendant franchisor to the plaintiff company at the relevant date. Rather, counsel submitted that even if there were such dealings giving rise to debts and contingent debts on both sides of the record at the relevant date, there could be no set-off because under the option, the defendant received credit when the option was exercised. The credit arose because, on exercise of the option, the defendant was entitled to such of the plaintiff company's fixtures, fittings, plant and equipment as it chose to purchase, but the purchase price was not payable until sixty days after the purchase price was determined. It was submitted that that credit was received upon the exercise of the option, when the defendant had notice of the plaintiff's insolvency. The plaintiff was already in administration. Whilst this might not itself be conclusive evidence of notice of insolvency, in the present case, the plaintiff, through its administrator, had abandoned its business. This was one of the grounds relied upon for terminating the franchise agreement. Hence, the plaintiff submitted, that s 553C(2) precluded the set-off because "... at the time of receiving credit from the company, the [defendant] had notice of the fact that the company was insolvent."
33 The defendant did not dispute that it had notice that the plaintiff was insolvent at the time it exercised its option. It follows that if the time of exercise of the option was "the time of receiving credit" within the meaning of s 553C(2), the defendant is not entitled to claim the benefit of the set-off.
34 Counsel for the plaintiff referred to McKinnon v Armstrong Brothers & Co (1877) 2 App Cas 531, but did so for the purpose of distinguishing it. That case is an example of the principle stated in Hiley that it is enough that there are mutual dealings which give rise to contingent rights and obligations that ultimately mature into pecuniary demands (SR Derham, The Law of Set-Off at 282-283 [6.65]). It does not assist in resolving the present question.
35 Counsel for the plaintiff also referred to Re Inglis; Ex parte The Trustees (1932) 5 ABC 255. It was another example of the set-off of mutual debts and credits where the claims of one party (in that case the bankrupt) only matured after bankruptcy. But it does not assist in resolving the present question as the credit given on both sides undoubtedly was given before notice of an act of bankruptcy.
36 Of more assistance are Old Style Confections Pty Ltd v Microbyte Investments Pty Ltd [1995] 2 VR 457 and Shirlaw v Lewis (1993) 10 ACSR 288. In Old Style Confections Pty Ltd v Microbyte Investments Pty Ltd, a company in liquidation was entitled to be paid monthly licence fees for the right to use a machine. The debtor under the licence agreement (the licensee) had received an award of damages against the company. Hayne J held (at 462-464) that the licensee was entitled to set off its right to damages against its liability to pay licence fees, even those accruing after liquidation. His Honour held that the transactions which constituted the giving and receiving of credit for the mutual dealings occurred before liquidation and before the licensee had notice of the company's insolvency. That is, for the purpose of s 553C(2), credit was not received from the company on each occasion a licence fee became payable.
37 In Shirlaw v Lewis (1993) 10 ACSR 288, the vendor of a business contracted to sell the business to a company, which company was authorised to carry on the business between the date of agreement and completion. The contract was made in April 1990. The sale agreement included a term entitling the vendor to terminate the licence and exclude the company from the business premises in certain events, whereupon: "the Vendor will purchase from the Purchaser all of the Purchaser's goods and saleable stock in trade used in the conduct of the Business and on the Premises on the date of termination of the licence at the value thereof at such date and the provision of Clause 3.1 hereof shall apply, mutatis mutandis, in order to determine such value and saleability and the manner of payment for such stock."
38 The vendor terminated the agreement. On 13 March 1991, the vendor retook possession of the premises. On 28 February 1991, a winding-up summons was filed and the company was subsequently ordered to be wound up. The winding-up commenced from the filing of the summons. The vendor received notice of the winding-up on 22 April 1991. The liquidator of the company claimed that the company was entitled to damages for conversion of the company's stock. The vendor had a claim for damages for breach of contract which substantially exceeded this claim.
39 Hodgson J (as his Honour then was) held (at 295) that the agreement for purchase of stock contemplated by clause 5.12 did not arise until 13 March 1991, that is, after the commencement of the company's winding-up. His Honour held that this was a void disposition under s 468, but that the retrospective avoidance of the disposition did not retrospectively make the disposal of the goods pursuant to a contractual right which existed as at 13 March 1991 a wrongful act of conversion (at 295). As to the claim of set-off, his Honour said:
"Since I have found that there was a disposition which would be void under s 468 unless validated, I would, in the first instance, approach any question of set-off, not on the basis that what may be set off is a claim for the price of the goods, but rather that what is being set off is a claim of the nature of the claim for unjust enrichment. However, it does seem to me that there have, in this case, been mutual dealings which were undertaken in the first instance through the contract for the sale of the business, well in advance of any question of insolvency or liquidation. What ultimately happened was the crystallisation of mutual obligations arising from these pre-liquidation dealings. It does seem to me that, on the authority of Gye v McIntyre , these mutual obligations as crystallised are matters which would be set off under s 86 of the Bankruptcy Act . Indeed, even if I had come to the view that there had been conversion, it could be contended that set-off would have been available. The taking of the stock was pursuant to a contractual obligation arising out of the pre-liquidation dealings. Gye v McIntyre makes it clear that liquidated claims can be set off against unliquidated claims; and it follows a fortiori, I think, that unliquidated claims can be set off against unliquidated claims.