Set-off rights extinguished by grant of security interest

The decision in Hamersley Iron Pty Ltd v Forge Group Power Pty Ltd (in liquidation) (receivers and managers appointed)[1] (Hamersley Iron) concerned a dispute between the rights of a secured creditor of Forge Group Power Pty Ltd (Forge) and the asserted set-off rights of a creditor of Forge, Hamersley Iron Pty Ltd (Hamersley).

In Hamersley Iron, Tottle J found that in an insolvency context, s 553C of the Corporations Act 2001 (Cth) is an exclusive code governing set-off rights, displacing the operation of s 80 of the Personal Property Securities Act 2009 (Cth) (PPSA).

Tottle J also determined an important question concerning the impact of the PPSA on set-off rights. To summarise his Honour’s findings on that question:

• the granting of a security interest in Forge’s collateral (including, relevantly, its claims against Hamersley) created a proprietary interest in that collateral in favour of the secured party by reason of the operation of the attachment rule in s 19(2) of the PPSA;
• the secured creditor acquired a proprietary interest in Forge’s claims against Hamersley from the date Forge granted a security interest in those claims;
• the subsistence of the said proprietary interest brought to an end the mutuality of interest between Forge’s and Hamersley’s respective claims; and
• as the necessary mutuality of interest was absent, set-off was not available.

Background

In 2012, Hamersley and Forge entered into two contracts pursuant to which Forge agreed to engineer, procure and construct two power stations. Subsequently, Forge entered into a General Security Agreement (GSA) with ANZ Fiduciary Services Pty Ltd (ANZ) which secured funds advanced to Forge and which was registered on the Personal Property Securities Register.

In February 2014, administrators were appointed to Forge by its directors, and subsequently receivers and managers were appointed by ANZ. The contracts with Hamersley came to an end shortly thereafter. Forge went into liquidation in March 2014.

The contracts contained set-off provisions, to the effect that Hamersley was entitled to deduct from amounts due to Forge any debt or claim (given an expansive definition which included claims for liquidated damages) it had against Forge.

Issues to be determined

One of the questions for determination was one of construction — namely, whether the contracts permitted Hamersley to “net off” amounts owing as between it and Forge. It was found that they did not, but the reasons for that conclusion are not the focus of this article and will not be explored in detail.

Rather, the focus of this article is the two further questions considered:

• first, whether Hamersley was able to rely at all on either its contractual or equitable rights of set-off; and
• second, the effect of the PPSA on Hamersley’s asserted rights of set-off.

The Department of Employment of the Commonwealth of Australia was granted leave to appear and made submissions supporting the contention that Forge’s claims were subject to a security interest in favour of ANZ.

Section 553C is an exclusive code governing set-off in insolvency

Although Hamersley’s contest was with (in effect) ANZ, Tottle J considered its claims in the context of Forge’s liquidation. This was important, because it formed the basis for the conclusion that s 80(1) of the PPSA was not applicable. That provision states that:
(1)The rights of a transferee of an account or chattel paper (including a secured party or a receiver) are subject to:

1. the terms of the contract between the account debtor and the transferor, and any equity, defence, remedy or claim arising in relation to the contract (including a defence by way of a right of set-off) …

Tottle J found that in winding up, s 80(1) was displaced by s 553C of the Corporations Act, observing that had parliament intended s 80(1) to permit contractual set-off in a winding up, it could have indicated this in clear terms.

While Hamersley pressed an argument that in circumstances where s 553C did not apply (where, for example, there was an absence of beneficial mutuality) it was permissible to rely on contractual or equitable rights of set-off, Tottle J disagreed, finding that s 553C was an exclusive code governing set-off in insolvency.

Mutuality of interest brought to an end by creation of security interest

In order for s 553C of the Corporations Act to apply, there must be mutuality of interest between the parties. The High Court explained in Gye v McIntyre[2] that “mutual” in this context means reciprocity rather than correspondence. Thus, it is concerned with the status of the parties and their relationship with each other rather than the nature of the claims, the underlying principle being that one person’s money should not be applied to pay another person’s debts.[3] In an insolvency context, set-off is determined by reference to equitable interests rather than bare legal rights.[4]

In reliance on these principles, the argument advanced against Hamersley was that ANZ was the beneficial owner of Forge’s claims and, as such, those claims could not be set-off against Hamersley’s claims. Central to the determination of this question was a consideration of the attachment rule in s 19(2) of the PPSA. It provides that:

Attachment rule

(2)A security interest attaches to collateral when:

1. the grantor has rights in the collateral, or the power to transfer rights in the collateral to the secured party; and
2. either:
   1. value is given for the security interest; or
   2. the grantor does an act by which the security interest arises.

Time of attachment

(3)Subsection (2) does not apply if the parties to a security agreement have agreed that a security interest attaches at a later time, in which case the security interest attaches at the time specified in the agreement.

(4)To avoid doubt, a reference in a security agreement to a floating charge is not a reference to an agreement that the security interest created by the floating charge attaches at a time later than provided under subsection (2).

Ultimately, Tottle J found that the attachment provided for in s 19 of the PPSA operated so that the mutuality of interest between Forge’s claims and Hamersley’s claims ceased to exist for three reasons.

First, the attachment rule conferred a proprietary interest in the collateral (Forge’s claims) upon the satisfaction of the conditions set out in s 19(2). There was nothing in the GSA to suggest that ANZ and Forge had agreed that the security interest would attach at a later time. Second, his Honour found that (contrary to Hamersley’s contention) the concept of crystallisation is made redundant by the PPSA, as is the floating charge. Third, the GSA provided that the security interest granted to ANZ was by way of a charge overall collateral save for revolving assets, and Forge’s claims were not revolving assets.

The attachment rule

Tottle J found that “attachment” in s 19 connotes the creation of a proprietary interest for the benefit of the secured party. His Honour concluded that this conclusion left no room for the operation of “crystallisation” of floating charges. This did not however (as Hamersley contended) have as its corollary the abolition of the general law distinction between fixed and floating charges. Parties are, his Honour observed, free to agree that attachment will take place upon the occurrence of some future event, such that attachment operated in a manner similar to the crystallisation of a floating charge.

Floating charges (and the concept of crystallisation) redundant under the PPSA

Tottle J observed that while the PPSA did not abolish the concept of the floating charge, it rendered that mechanism redundant for the purposes of taking security over circulating assets. Rather, the effect of s 32(1) of the PPSA is that a grantor is authorised to deal with collateral in the ordinary course of business, with a security interest attaching to the proceeds in a manner reminiscent of a floating charge.

His Honour surveyed the Canadian and New Zealand authorities, all of which supported the conclusion that the attachment of a security interest in collateral created a proprietary interest in that collateral, and that crystallisation is conceptually irrelevant. In particular, the decision of the Supreme Court of Canada in The Royal Bank of Canada v Sparrow Electric Corp[5] was authority for three relevant propositions. The first was that, under the Alberta analogue of the PPSA, a security interest over after-acquired property can be characterised as a fixed charge pursuant to which the secured party acquires a proprietary interest, subject to a licence to sell inventory. Second, the said acquisition is not contingent on a crystallising event, and third, it retains the character of a fixed charge for the purposes of resolving a contest with interests not covered by the Alberta personal properties legislation.

GSA effective according to its terms

Ultimately, Tottle J found that the conclusion that ANZ acquired a proprietary interest upon Forge granting the security interest as a matter of statutory construction was not essential to a finding as to the primacy of ANZ’s interest. His Honour found that the GSA operated to create a charge over Forge’s claims that attached by operation of s 19 of the PPSA, creating a proprietary interest by way of the equitable assignment of those claims. The creation of that interest also resulted in the cessation of mutuality between Hamersley’s and Forge’s respective claims.

The short reasons advanced by his Honour in support of this conclusion were that the GSA created a security interest in all collateral other than revolving assets, and Forge’s claims were not revolving assets. Section 18(1) of the PPSA provides that a security agreement is effective according to its terms.

Conclusion

Hamersley Iron illustrates that rights of set-off, perhaps thought to be preserved by s 80(1) of the PPSA, may in fact be illusory where the relevant claims are subject to a third party’s proprietary interest by reason of the attachment of a security interest granted in favour of that party. Creditors will, in the future, need to explore alternatives to reliance on contractual mechanisms, such as taking a registrable security interest themselves, should they wish to preserve their set-off rights.