In July 2017, we wrote about the case of Hamersley Iron Pty Ltd v Forge Group Power Pty Ltd (in liquidation) (receivers and managers appointed)[1], in which the Western Australian Supreme Court held that rights of set off enjoyed by an insolvent company’s contractual counterparties would not apply if the company had granted a security interest over the relevant contractual rights under the Personal Property Securities Act 2009 (PPSA).

The decision has been overturned by the Court of Appeal of the Supreme Court of Western Australia[2], such that the existence of a security interest will not necessarily of itself preclude the operation of statutory or contractual set off rights in favour of third parties.

The decision is significant because it potentially has a dramatic impact on the competing rights of secured and unsecured creditors in liquidation, and may prevent secured creditors from enjoying a windfall at the expense of unsecured creditors. It also places the emphasis firmly on the terms of the relevant security interest and underlying contract, which will now need to be considered in detail each time there is a claim for set off by the insolvent company’s contractual counterparties.

[1]               [2017] WASC (2 June 2017)

[2]               Hamersley Iron Pty Ltd v Forge Power Group Pty Ltd (in liquidation) (receivers and managers appointed) [2018] WASC 163

 

Background

By way of reminder of the key facts of the case:

  • Forge entered into various contracts with Hamersley to provide engineering and construction services;
  • Forge subsequently granted an “all assets and undertaking” security interest to ANZ Fiduciary Services Pty Ltd (ANZ), in connection with the Forge group’s debt facilities, which included the grant of a charge over all of Forge’s contractual rights under the contracts with Hamersley;
  • Forge went into voluntary administration and then liquidation in early 2014;
  • ANZ subsequently appointed receivers, and Hamersley terminated the contracts;
  • at the time of termination, Hamerlsey owed Forge approximately $77m under the contracts, but counterclaimed against Forge for damages incurred as a result of the liquidation and Forge’s non-performance for an amount of approximately $663m;

 

The ability to claim a right of set off in respect of those amounts was of critical importance to Hamersley, because:

  • if set off was available, Hamersley could refuse to pay anything to Forge, and prove in the liquidation for the balance owing to Hamersley of approximately $556m; and
  • if set off was not available, Hamersley would be liable to pay $77m to Forge, and whilst it could prove in the liquidation for the full amount of $663m it was claiming, the prospects of receiving any dividends as an unsecured creditor of Forge were negligible.

 

First instance decision

At first instance, the Supreme Court of Western Australia held that the statutory set off regime that applies when a company goes into liquidation under s553C of the Corporations Act 2001 is the only source of set off rights in those circumstances.  In other words, contractual and equitable set off rights cease to be enforceable once a company enters liquidation.

Further, the Court held that the mutuality of debts required for s553C to apply could not exist in circumstances where the company had granted a security interest over the relevant contractual rights. The grant of security over the contractual rights, including the right to receive payment, destroyed the mutuality of dealings between the company and the contractual counterparty, because it created a proprietary interest in the contractual debts in favour of the secured party.

 

Decision overturned on appeal

 The Court of Appeal of the Supreme Court of Western Australia upheld Hamersley’s appeal, and held that set off would operate as between Hamersley and Forge notwithstanding the grant of security by Forge.

The key points from the Court’s decision are:

  • the attachment of a security interest under the PPSA to a debt owed to the company does not necessarily destroy the mutuality of dealings between the company and the contractual counterparty;
  • the key issue to consider in assessing whether mutuality exists (which must be assessed at the time of commencement of the liquidation) is whether payments received can be used for the benefit of the company, or whether they are received for the benefit of the secured creditor;
  • on the facts of the case, the Court found that Forge was entitled to receive the benefit of payments made by Hamersley (as opposed to ANZ as its secured creditor bank); and
  • accordingly, the mutuality required for operation of s553C was satisfied notwithstanding the grant of security by Forge.

Importantly, the Court also found that s553C does not operate as an exclusive code. Therefore to the extent that the requirements for statutory set-off are not met, contractual or equitable rights of set-off might still provide a means by which set-off could be effectively claimed against the insolvent company.

The Court reached its decision that set-off was available based on both the operation of statutory set-off, or on the alternative basis of contractual set-off being available. This means that Hamersley would be entitled to asset contractual set-off even if the decision was wrong in relation to the operation of statutory set-off and mutuality of dealings.

What does the decision mean in practice?

The decision at first instance had the effect of potentially delivering a windfall to the secured creditor, because it would have enabled Forge’s liquidators to pursue Hamersley for payment of the amount owing of $77m for the benefit of the secured creditor.

The decision on appeal has the effect of causing the secured creditor to lose the benefit of those payments, which instead are set-off against the greater amount claimed by Hamersley as an unsecured creditor of Forge.

The decision required a detailed examination of the terms of the relevant security agreements and underlying contracts to identify whether Forge retained the “benefit” of payments from Hamersley, and therefore whether the mutuality required by s553C was established. Since s553C is a self-executing provision, insolvency practitioners in particular will need to take great care going forward in analysing whether the requirements for mutuality are met in the specific circumstances of each case, and will not simply be able to rely on the existence of a security interest as grounds for denying the operation of statutory set off rights.

Given the significance of the principles and the amounts in question, it would be surprising if an application for special leave to appeal to the High Court was not made.