Set-Off Rights vs the PPSA
In Hamersley Iron Pty Ltd v Forge Group Pty Ltd (In Liq), the Supreme Court of Western Australia held that the rights of set-off when dealing with an insolvent company can be overridden by a third party’s security interest. However, luckily for contracting parties, this decision has been overturned by the Court of Appeal.
Forge Group Power Pty Ltd (Forge) and Hamersley Iron Pty Ltd (“Hamersley”) were parties to two construction contracts. During the term of the contracts, Forge obtained finance from ANZ and granted ANZ a registered security interest over all its personal property.
After Forge entered voluntary administration and then liquidation, Hamersley terminated the construction contracts between the two parties. Forge subsequently sued Hamersley for unpaid work, which Hamersley made a counterclaim alleging that Forge had breached their contract. Hamersley claimed the loss and damages it suffered for breach of contract exceeded the amount of Forge’s claim.
Hamersley claimed that the money it owed to Forge in unpaid work could be set-off against the amount that Forge owed to Hamersley in respect of the breach of contract.
Forge claimed that Hamersley could not set-off the amount due to ANZ having taken a security interest over all of Forge’s property.
Set Off Rights under the Corporations Act
Section 553C of the Corporations Act allows set-offs ‘where there has been mutual credits, mutual debts or other mutual dealings between an insolvent company that is being wound up and a person who wants to have a debt or claim admitted against the company’.
Essentially, the Corporations Act supported Hamersley’s claim that it could set off the amount that it owed to Forge against the amount that Forge owed to it.
The trial Judge held that when Forge entered into the General Security Agreement with ANZ, Forge had charged its interest in the contract to ANZ and ultimately destroyed the mutuality between Forge and Hamersley. As such, Hamersley could not rely on section 553C of the Corporations Act to set off the amount owed, because in essence the Judge considered the amount that Hamersley owed to Forge was in substance owed to ANZ.
Because ANZ had registered its interest over Forge’s property under the Personal Property Securities Act (PPSA), ANZ had priority over Hamersley’s interest, including rights under the contracts. Therefore, Hamersley’s interest was one of an unsecured creditor and Hamersley could only claim whatever they could get at the end of the liquidation process (after having to pay for the unpaid works).
This decision was a concern as it would ultimately render set-off clauses in contracts and under the Corporations Act as useless and overridden by the PPSA. Fortunately, the decision was overturned on appeal.
The Court of Appeal unanimously overturned the trial Judge’s decision and found that an error was made in concluding the dealings between the parties were not mutual for the purpose of section 553C of the Corporations Act.
In making this decision, the appellate court held that mutuality is to be assessed at the commencement of winding up by looking at whether the benefit recoverable is for the benefit of Forge or for the benefit of ANZ. The Court concluded that money owed by Hamersley to Forge under the contract was for the benefit of Forge and not to the bank; therefore, there was mutuality between Forge and Hamersley.
The appeal is good news for contracting parties when seeking to rely on a set-off clause in an insolvency where registered security interests are involved. Parties need not worry about the invalidity of a set-off clause against any present or future security interests. On the other hand, for those providing finance and registering their interest, it does not necessarily mean their security interest will have priority over an unsecured interest where a set off claim is involved. If you have any queries in relation to set-off rights and the PPSA, please contact us to discuss.