The Western Australian Court of Appeal has ruled that giving security to a Bank does not destroy mutuality for the purposes of statutory set-off if the security allows the debtor to use assets to pay its debts in the ordinary course of business.
The Western Australian Court of Appeal overruled the finding of a trial judge that the effect of the Personal Property Securities Act 2009 (Cth) (PPSA) was to deny a counter party to a construction contract the right to set-off claims simply because the insolvent builder had assigned to its bank, by way of security, amounts payable to it under the contract.
The Court also expressed the view that section 553C of the Corporations Act (which allows set-off) does not provide an exclusive code for when set-off is allowed in company liquidations.
First instance decision
Hamersley Iron Pty Ltd (Hamersley) and Forge Group Power Pty Ltd (In Liquidation) (Receivers and Mangers Appointed) (Forge) were parties to engineering, procurement and construction contracts for the West Angelas Power Station and the Cape Lambert Power Station. Forge appointed voluntary administrators and its secured creditor appointed receivers and managers. The receivers and managers caused Forge to sue to recover money allegedly owing to Forge by Hamersley under the contracts. Hamersley defended the claim relying on, amongst other things, set-off rights arising because of claims for damages. Hamersley relied on section 553C of the Corporations Act, amongst other rights.
In June 2017, Justice Tottle of Supreme Court of Western Australia determined preliminary questions in the proceedings between Hamersley and Forge. One of the issues determined was whether Hamersley was entitled to rely on set-off, under the general law or under section 553C of the Corporations Act.
Tottle J determined that section 553C operated exclusively once a company entered into liquidation and that section 553C set off did not apply because the attachment of a PPSA security interest destroyed mutuality of interest (one of three essential ingredients for section 553C to operate).
The decision of the Western Australian Court of Appeal has reversed Justice Tottle's first instance decision on section 553C. The Court held that section 553C did apply in the circumstances of the case and despite the attachment of the bank's security interest to the account.
The Court identified the critical question in assessing whether section 553C applied to be whether Forge was entitled to receive the payments from Hamersley for its own benefit rather than only for the benefit of the secured bank. Put another way, did the bank's security entitle it to receive the money from Hamersley rather than Forge.
The answer to that question turned on two further questions:
Was the money payable to Forge an 'account' within the PPSA and thus a circulating asset?
This question was relevant because the nature of the asset as a PPSA account affected the rights of the secured bank under its security. The Court answered this question 'yes', upholding Tottle J's decision on that point.
Did the Bank's financing documents have the effect that Forge could no longer control the use of the money payable to it by Hamersley?
This question was relevant because the concept of 'control' potentially altered the rights of the secured bank. To answer the question, the Court dissected the relevant terms of the bank's security agreement and, with regard to the terms of that security agreement and facts of the case, determined the bank did not have control over the accounts.
Importantly, the Court held that the mere fact of attachment of a security interest over the circulating asset was not enough to make the account payable only for the secured party's benefit.
The Court concluded:
"It follows that, as at the commencement of the winding up, Forge's claims were, as a matter of substance, recoverable for the benefit of Forge rather than for the benefit of the bank. Any amounts paid by Hamersley to Forge under the Contracts could be used by Forge for its own benefit (by discharging its Permitted Financial Indebtedness) and was not available to the bank. Amounts payable by Forge to Hamersley under the Contracts could be used by Hamersley for its own benefit. Therefore, at that time, the dealings between Hamersley and Forge under the Contracts were mutual dealings within the meaning of s 553C of the Corporations Act, notwithstanding the bank's security interest."
Does section 553C establish an exclusive code for set-off?
The Court also expressed a view on what the position would be if it was wrong in its conclusion that s 553C was available. .
The Court held that if section 553C did not apply, then Hamersley was nevertheless entitled to assert available contractual and equitable rights of set-off, despite indications in earlier cases that section 553C establishes the only right of set-off available in company liquidations.
The Court concluded that at least in the circumstances of the case before it, there was nothing in section 553C or the policy that lay behind it, which would relieve the financier from 'equities' that would otherwise apply to the charged debt. This included the 'statutory equity' referred to in section 80(1)(a) of the PPSA. Section 80(1)(a) of the PPSA provides that the rights of a transferee (here the secured bank) are subject to the terms of the contract between the contracting parties.
The Court's decision brings clarity for the time being to the availability of set-off in insolvency where the accounts of the insolvent company are subject to circulating security interests. However, the amounts at issue in the case would justify consideration of an application to the High Court of Australia for special leave to appeal.