What you need to know
The Court of Appeal –that the existence of a general security interest does not of itself destroy mutuality between a company in liquidation and its creditors and as a consequence section 553C of the Corporations Act 2001 (Cth) (Corporations Act) can apply to allow a creditor to set-off its debts against amounts owed to the company in liquidation.
In a comprehensive unanimous decision, the Court of Appeal confirmed the following propositions:
- Section 553C of the Corporations Act operates to the exclusion of any contractual and equitable rights of set-off held prior to the commencement of liquidation.
- In the alternative, if mutuality is destroyed by the existence of a general security interest in debts or claims, then section 553C does not prevent a party from claiming set-off pursuant to existing contractual or equitable rights.
- In accordance with section 80(1)(a) of the Personal Property Securities Act 2009 (Cth) (PPSA), a financier with a general security interest will take its interest subject to the terms of the contracts and any equity, defence, remedy or claim arising in relation to the contract.
How we got here
In 2012, Hamersley Iron (as principal) engaged Forge (as builder) to provide certain services in relation to the construction of power stations at West Angelas and Cape Lambert in Western Australia. In July 2013 Forge entered into a general security agreement with its financier granting security over all of its personal property. The financier registered its security interest on the Personal Property Securities Register on 2 July 2013 and on 11 February 2014, the financer appointed Receivers to Forge following the appointment of voluntary administrators to Forge that day. Forge was subsequently placed into liquidation. Following the Receivers’ appointment, the financer did not give notice to Forge Group Power requiring it to open and maintain a controlled account into which Forge Group Power’s receivables (i.e. circulating assets under the general security agreement) were to be deposited for the financier’s benefit with the effect that Forge Group Power could use any receivables payable to it for its own benefit, provided it did so in accordance with the terms of the general security agreement.
Hamersley Iron alleged that its claims against Forge arising under the relevant construction contracts exceeded the debts and amounts owed by Hamersley to Forge and therefore it was entitled to set-off its claims and prove in the liquidation of Forge for the balance relying on section 553C of the Corporations Act.
The Receivers argued that:
- mutuality under section 553C was ascertained by reference to equitable interests; and
- there was no mutuality because the equitable interest in Forge’s claims against Hamersley arising under the relevant construction contracts rested with Forge’s financier as a consequence of Forge Group Power granting a security interest in favour of the financier over those claims, which security interest was registered on the PPSA.
At first instance, the Court accepted the Receivers’ position. The Court of Appeal overturned theand held that Hamersley Iron was entitled to apply section 553C in order to set-off debts and amounts that it owed to Forge under the construction contracts against debts and amounts that Forge owed under the relevant contracts. The practical effect of the Court of Appeal’s decision is that the financier does not end up with a windfall payment from Hamersley Iron and Hamersley Iron is entitled to prove in Forge winding up for the net amount.
The critical takeaways from the Court of Appeal decision are:
- Section 553C of the Corporations Act is capable of operating concurrently with the PPSA.
- A security interest that is a floating charge is treated in the same way as a security interest which attaches to a circulating asset where the grantor has title to the asset.
- The important issue when determining mutuality (and therefore whether the section 553C right of set-off is available to creditors and debtors) is not the source of the rights of the party but the substance of those rights. That is, for mutuality to exist, the critical question is whether the chargor (i.e. Forge Group Power in this case) has the right to use payments received for its own benefit (being payments which Hamersley Iron was required to make under the relevant construction contracts). If so, then mutuality exists and the statutory right of set-off is available to the creditor.
- Section 553C is not a code. If there is no statutory right to set-off pursuant to section 553C, a party can have recourse to any of its other rights arising under the contract, in equity or at common law.
- Any right to set-off (legal or equitable) accruing between parties prior to crystallisation of a floating charge is not destroyed by crystallisation and that right of set-off may be asserted by or against a receiver, as the case may be, irrespective of whether the claim the subject of the asserted right of set-off is brought after crystallisation.
- Unlike a floating charge, a fixed charge precludes the application of section 553C on the basis that once the charge becomes fixed, there is an absence of mutuality for the purpose of insolvency set-off.