In brief: A Supreme Court of Queensland judgment handed down today has provided greater certainty for secured creditors of companies that earn profits following the appointment of a receiver. The judgment dispels suggestions that the law was uncertain and means that secured creditors can continue to fund receivers confident that any trading profits will be distributed to them as secured creditors and not to priority creditors. Partner Michael Ilott(view CV) and Managing Associate Bruce Wacker (view CV) report.
- The liquidators' application
- Priority to assets subject to a circulating security interest
- The liquidators' assertions
- The established principle
- The court's judgment
- Certainty for secured creditors
THE LIQUIDATORS' APPLICATION
The Supreme Court's judgment1 concerned a manufacturer of automotive components that had gone into receivership and liquidation. Upon their appointment, the receivers continued to trade the business of the company – purchasing additional raw materials and manufacturing them into inventory for sale by the company. The receivers were successful in doing so and produced a significant cash surplus.
The company's liquidators contended that the priority creditors (mainly employees) were entitled to claim ahead of the secured creditors, not just to the assets that are the subject of a circulating security interest that existed at the receivers' appointment, but also to the proceeds of the raw materials that were purchased by the receivers and manufactured into inventory following their appointment.
The application was opposed by the first-ranking secured creditor, CMI Limited. Allens acted for CMI Limited.
PRIORITY TO ASSETS SUBJECT TO A CIRCULATING SECURITY INTEREST
Sections 433 and 561 of the Corporations Act 2001 (Cth) require a receiver to pay from property that is the subject of a circulating security interest that comes into their hands certain amounts that are payable to priority creditors (such as for employees' entitlements), in priority to any claims by secured creditors.
THE LIQUIDATORS' ASSERTIONS
The liquidators contended that assets acquired by the receivers following their appointment were property that is the subject of ss 433 and 561 of the Act for five reasons:
- the definition of 'floating charge'2 in the Act refers to a charge that at the time of its creation conferred a floating security. The definition therefore attracts attention to the nature of the charge at the time of its creation, rather than at the time the property comes into the hands of the receivers;
- the floating charge continues to attach to any surplus generated by the receivers. It is irrelevant that the charge had crystallised on, or before, the appointment of the receivers as the Act deems the charge to take effect as a floating charge;
- the position the liquidators contended for is consistent with the approach taken in various English authorities;3
- if the position was not as the liquidators contend, a receiver could utilise floating charge assets to trade the business at the expense of priority creditors' entitlements by making a payment equivalent to the value of assets on the receivers' appointment at a later date, without accounting for the additional profits that were created in the intervening period; and
- the liquidators' position is consistent with the purpose of the statutory scheme which is to prevent a secured creditor from "scooping the pool" of the company's assets.
THE ESTABLISHED PRINCIPLE
CMI Limited contended that the long-established principle is that the property that is the subject of the floating charge is to be identified and assessed as at the date of the appointment of the receivers and that there is no reason to depart from that long-held view.
This view was expressed by Justice Bryson in Whitton v ACN 003 266 886 Pty Ltd4:
The concept that a floating charge could exist over a book debt or any other asset which did not come into existence until after crystallisation and the fixing of all charges is not one which I am able to grasp. Any rights to preference under s 433 could extend only to property which was the subject of a floating charge before crystallisation on [the date of appointment of the receiver]…In my opinion the controller's liability neither increases with success nor diminishes with failure of any venture in which he utilises assets which have been subject to a floating charge.
CMI Limited argued that the five propositions put forward by the liquidators were incorrect or did not support the contentions advanced by the liquidators. CMI Limited stated that no cogent reason had been put forward to support a departure from the established principle.His Honour's reasoning was supported by that of a number of other Australian authorities, including a judgment of the Full Court of the Supreme Court of Western Australia.5 His Honour's reasoning has also been subsequently approved by a judge of the Federal Court of Australia.
THE COURT'S JUDGMENT
The court found in favour of CMI Limited.
Justice Mullins agreed with the established principle as it had been articulated by CMI Limited and was not persuaded that the liquidators' contentions required her to depart from that principle:6
To the extent that it is argued that the use of the expression "out of the property coming into his, her or its hands" in s 433(3) suggests assets received after the date of appointment of the receivers, those words need to be construed in the context of when s 433 applies, as expressly set out in s 433(2)(a). The property "coming into" the hands of the receiver must be property that falls within the designation in s 433(2)(a). That property is identified by the operation of s 433(2)(a) which operates at the date of the appointment of the receivers. The statutory entitlement cannot apply unless the identified property comes into the hands of the receiver...
The priority creditors do not have a statutory entitlement under s 433 of the Act to the receivers' inventory trading profit, as that profit was not an asset identifiable at the date of the appointment of the receivers.
Her Honour also held that none of the English authorities relied upon by the liquidators provide the support that the liquidators sought to draw from them.
CERTAINTY FOR SECURED CREDITORS
The judgment confirms that priority creditors will be given priority only to those floating charge assets that are in existence upon the appointment of the receivers.
As such, secured creditors can take comfort that cash advances made by them to enable a receiver to purchase materials or inventory to facilitate a trade-on of the business by the receiver will not be eroded by the claims of priority creditors.
The judgment reaffirms the position that most in the insolvency industry have considered to be the long-established principle.