This article was written by Jenny Zhao and Ray Aryal.
In the event of a contractual counterparty going into liquidation, whether or not a trade counterparty may claim set-off against debts owed to the insolvent counterparty can dramatically affect the commercial position of the account debtor. This was recently highlighted in the decision of Hamersley Iron Pty Ltd v Forge Group Power Pty Ltd (In Liquidation) (Receivers and Managers appointed)  WASC (2 June 2017).
What does this mean for you?
Parties should, by now, be aware that certain provisions of the Personal Property Securities Act (PPSA) override contractual terms agreed between parties. In particular, a transfer of an account or chattel paper in contravention of express contractual restrictions or prohibitions will nevertheless be legally effective even if the consent of the primary party has not been obtained.
The Hamersley v Forge case confirms what commentators have already concluded – in the context of a liquidation, a security interest created under the PPSA will render worthless any set-off rights that account debtors may have had against the transferor.
Hamersley Iron Pty Ltd (Hamersley) contracted with Forge Group Power Pty Ltd (Forge) to receive certain engineering, procurement and construction services (the Contracts).
Forge entered into a General Security Agreement (GSA) with a secured creditor, ANZ Fiduciary Services Pty Ltd (ANZ), under which Forge granted a charge over its contractual rights under the Contracts.
Forge subsequently went into voluntary administration and then into liquidation; receivers were appointed and Hamersley terminated the Contracts. Hamersley owed Forge monies for unpaid work, however Hamersley counterclaimed against Forge for damages and related losses. Hamersley's counterclaims in connection with the Contracts far exceeded what it owed to Forge.
Given the significant monetary difference, Hamersley sought to vigorously pursue available set-off rights against Forge in its liquidation.
The table below sets out an overview of Hamersley's respective commercial positions with, and without, the benefit of set-off in liquidation.
Hamersley pays Forge for approx. $77.3M for amounts relating to unpaid progress claims under each Contract
Hamersley pays nothing to Forge
Hamersley proves in the wind-up of Forge for approx. $633.3M
Hamersley proves in the wind-up of Forge for approx. $556M
Statutory set-off rights in liquidation
Generally in the context of a liquidation, parties will look to section 553C of the Corporations Act (Section 553C) which operates automatically to set-off "mutual credits, debts or other mutual dealings". The effect of Section 553C is that only the balance of an account is admissible to proof against the insolvent company, or is payable to the insolvent company (as the case may be).
In Hamersley's case, the Court found that a prerequisite to relying on automatic insolvency set-off – the presence of "mutuality" between Hamersley and Forge – was absent.
In particular, the Court found that "mutuality" between the parties was destroyed when Forge granted the GSA in favour of ANZ. In coming to this decision, the court noted that the security granted to ANZ created a fixed proprietary interest in favour of ANZ (in particular, in Forge's rights to receive monies from Hamersley under the Contracts). This meant that the debts which would have otherwise been owed between Forge and Hamersley were no longer owed between the same parties in the same right.
It is important to note that this decision was not unexpected, given that prior to the introduction of the PPSA, a "fixed charge" granted to a third party was similarly capable of destroying the mutuality between the primary contract parties. In this context, the Court made some significant observations about the nature of a PPSA security interest:
- Distinction between fixed and floating charges no longer relevant in context of PPSA
Hamersley proposed a technical argument that the security provided to ANZ over Forge's contractual rights to payment under the Contracts was, in substance, a "floating charge". Such a floating charge needed to "crystallise" or "attach" before it gives right to a legal proprietary interest sufficient to destroy the "mutuality" between Forge and Hamersley.
The Court rejected this argument. In line with recent authorities in New Zealand and Canada, the Court confirmed that the pre-PPSA distinction between a fixed and floating charge is no longer relevant. Importantly, a security interest effectively granted under the PPSA is a proprietary interest which operates to destroy "mutuality" between the original contracting parties.
Alternative rights to set-off
Hamersley raised a number of arguments to persuade the court that it had alternative rights to set-off its counterclaim against what was owed to Forge:
- Even if automatic set-off under Section 553C was unavailable, Hamersley could nevertheless rely on a parallel set of contractual and equitable set-off rights. Specifically, Hamersley sought to rely on a set-off clause in the Contracts.
The Court found that while the contractual and equitable rights to set-off may exist pursuant to the terms of the Contracts and the rules of equity, such rights are supplanted in the event of liquidation. In coming to this decision, the Court considered local and overseas authorities and confirmed that Section 553C is an exclusive code, meaning that it operates to the exclusion of any concurrent contractual or equitable set-off rights.
- Forge's rights to payment under the Contracts were "accounts" for the purposes of the PPSA, and section 80(1) says that the rights of a transferee of "accounts" are subject to the terms of the contract between the transferor (Forge) and the account debtor (Hamersley) and any claim arising in relation to that contract, including the rights of set-off. Therefore, even if Section 553C did not determine in Hamersley's favour, ANZ's rights under the GSA (as the transferee of "accounts") remained subject to Hamersley's rights of set-off as a result of section 80(1). Consequently, Hamersley's rights of set-off were preserved.
The Court confirmed the primacy of Section 553C by ruling that any of Hamersley's rights which may have been preserved under section 80(1) of the PPSA were not effective in Forge's liquidation. The Court also noted that:
- Section 80(1) of the PPSA generally ameliorates injustices to account debtors who may be deprived of their set-off rights when a transfer of an "account" is made contrary to contractual terms. However, the protection under section 80(1) was not intended to affect or displace the operation of Section 553C as an exclusive code in the event of liquidation. Parliament had reviewed and amended the Corporations Act following the commencement of the PPSA and had Parliament intended section 80(1) to permit contractual set-off not otherwise recognised by Section 553C it would have expressly done so.
- Although not required for the decision, the court noted that only some of Forge's payment claims against Hamersley were "accounts" for the purposes of the PPSA, to which section 80(1) could have applied. In particular, for a claim for payment of services to be an "account" for the purposes of the PPSA, there must be a legally enforceable obligation and a corresponding existing liability to make payment. The agreement must contain a "mechanism for ascertaining the amount to be paid and the payment date", and it is immaterial if court intervention is required for enforcement or resolution of a dispute as to the payment amount or date.
- Although not expressly argued, the Court also noted that section 81 of the PPSA would override any restrictions on the assignability of the contract between the account debtor and transferor.
- The set-off clause found in the Contracts was, in effect, a netting arrangement such that no money would, as a matter of construction, become owing to Forge if any money was owing to Hamersley under the same Contract. Section 553C, which requires the existence of actual mutual debts, was therefore inapplicable such that Hamersley was only able to claim the net amount from Forge in its liquidation.
The Court did not accept Hamersley's argument. In so deciding, the Court reviewed the language of the set-off clause and the contractual payment terms, in the context of what a reasonable business person in the shoes of the parties would have understood the relevant provisions to mean. The outcome was based on a specific interpretation of the contract clauses and the outcome may have been different if the terms were drafted differently.