It is anticipated that the Personal Property Securities Act 2009 (Cth) (PPSA) will apply from the beginning of May 2011 and with this date drawing closer banks and other deposit taking institutions need to understand how their rights of set-off will be affected once the PPSA commences.

This article only deals with rights of setoff as they exist between deposit taking institutions and their customers and does not contemplate rights of set-off as between purchasers, retailers and manufacturers of goods and assignees of accounts (eg. trade debts and receivables).

What is the PPSA and what does it govern?

The PPSA creates one national regime for security interests over personal property. The national regime will be made up of the PPSA, the Personal Property Securities Regulations (PPS Regulations) and the Personal Property Securities Register (PPS Register). The national regime also introduces substantive changes to the laws and practices that govern security interests.

The PPSA governs security interests in tangible and intangible personal property. Personal property for the purposes of the PPSA is any kind of property other than land, fixtures, water rights and certain licenses and authorities granted under Commonwealth, State or Territory laws. Funds held in a bank account (whether or not the account is a trading account, savings account or term deposit) are personal property.

When determining what types of interests are security interests, the PPSA uses a functional approach as opposed to the traditional or formal approach currently used. Once the PPSA applies a security interest will be any interest in personal property that is provided for by a transaction that in substance secures payment or performance of an obligation without regard to the form of the transaction or the identity of the person who has title to the property.

Rights of set-off

Banks generally have a right to set-off over their customers accounts. This right allows a bank to use funds available in their customers accounts to satisfy debts which are owed to them by their customers. However, the bank’s right of set-off does not by itself limit the customer’s ability to use the funds available in their account and, in the absence of contractual restrictions to the contrary, customers are free to withdraw or deal with those funds as they see fit.

The PPSA will not apply to legal or equitable set-off

Basic rights of set-off are not security interests for the purposes of the PPSA and are specifically excluded from its application (see section 8(1)(d) of the PPSA). Consequently, these rights are not subject to the provisions relating to attachment, perfection, priority and extinguishment in the PPSA.

In the PPSA environment a bank’s basic right of set-off in their customer’s account will co-exist with any security interests granted by the customer in that account. A common example of when this might occur is where a customer gives an all assets charge over its property in favour of another financier. The bank’s right of set-off and the financier’s charge over the account will exist together and even if the financier wishes to enforce its rights in the customer’s account the bank will be able to exercise its right of set-off notwithstanding the financier’s security interest.

Flawed asset arrangements

While the PPSA does not apply to bare rights of set-off, the PPSA can apply if the set-off right is coupled with socalled ‘flawed asset’ restrictions. Flawed asset provisions commonly restrict the customer’s use or withdrawal of the funds available in their account until such time as they have satisfied certain obligations. If the obligations have not been performed the bank is able to use these restrictions to ensure the deposit moneys remain available until such time as the bank is able to exercise its right of set-off. Such flawed asset arrangements will be security interests under the PPSA when they in substance secure the payment or performance of an obligation. The bank’s right of set-off coupled with restrictions placed on the customer’s withdrawal or use of the funds in the account will satisfy the PPSA’s functional definition of security interest.

Caisse case – a Canadian example

The recent Canadian Supreme Court’s decision in Caisse populaire Desjardins de l’Est de Drummond v Canada [2009] 2 S.C.R. 94 (Caisse Popularie) provides an example of when a right of set-off coupled with restrictive ‘flawed asset’ terms will amount to a security interest. 1

Caisse Popularie involved the provision of a line of credit from Caisse Populaire Desjardins de l’Est de Drummond (Caisse) to its customer Camvrac Enterprises Inc (Camvrac). As security for the line of credit Camvrac deposited $200,000 with Caisee in accordance with a Term Savings Agreement and Security Given Through Savings Agreement. These two agreements provided that:

  • Camvrac would deposit $200,000 with Caisse and that Caisse would have a right of set-off in the deposit in respect of Camvrac’s obligations under the line of credit  
  • the deposit would be for a term of 5 years  
  • Camvrac could not negotiate or transfer the deposit  
  • the deposit could only be given as security in favour of Caisse  
  • Caisse could withhold repayment of the deposit for as long as the line of credit was outstanding.  

Soon after the line of credit was made available to Camvrac, it defaulted on its interest payments and Caisee exercised its rights of set-off against the deposit.  

In determining whether Caisse’s right of setoff under the Term Savings Agreement was a security interest the majority of the court determined that it was. In reaching that decision the majority made the following comments:  

  • The issue is not whether the right of set-off alone is viewed as a security interest. It is whether the arrangements between the parties as a whole (including the right of set-off and the restrictions on withdrawal) create a security interest.  
  • If the parties mutual intention is to create a security interest to ensure that the right of set-off will be an effective remedy there is no reason to think that a security interest does not exist. It is the substance of the agreement that is important.  
  • The fact the deposit was for a 5 year term and subject to the restrictions on the transfer or granting of security in the deposit is vital to the determination of the existence of a security interest.  

Specific provisions of the PPSA applicable to banks who enter into flawed asset arrangements

Perfection by control

The PPSA provides that a bank can perfect its security interest under a flawed asset arrangement in respect of its customers account by control.

Priority of a bank’s interest against other parties who have a security interest in the account

Under the PPSA the method of perfection used by a bank for its security interest in an account will be critical in determining priority. Subject to the issues mentioned below in relation to employee entitlements, if a bank perfects its security interest by control it will be given a super priority over all other interests granted by the customer in the same account. In effect the bank’s right of set-off under the flawed asset arrangement will sit above all other perfected and unperfected security interests which the customer has granted to other parties in the same account (eg. the interests of another financier under an all assets charge).

Priority of the bank’s rights in an account against employee entitlements

How a bank perfects its security interests in an account can also be vital in determining issues of priority between and the bank and the entitlements of employees on insolvency. Under the consequential amendments to the Corporations Act 2001 (Cth) and Part 9.5 of the PPSA, the security interest of a bank in a customer’s account (other than a term deposit) will be subordinate to the entitlements of employees. This will be the case even if the bank has perfected its interests in the account by control. A bank’s perfected security interest in respect of a term deposit will rank ahead of employee entitlements.  

However, the statutory subordination of a bank’s security interest in an account (other than a term deposit) as against employee entitlements can be overcome if the bank can satisfy both of the following:

  • the bank has control of the account (this will beg established if the bank is the depositee), and  
  • the bank has made an effective registration on the PPS Register and that registration discloses in accordance with the PPS Regulations that the bank has control of the account.