Limitations to the right of set off

Introduction

A recent decision of the Supreme Court of Western Australia has held that where a company is in liquidation:

• The only right of set off available to a debtor is pursuant to section 553C of the Corporations Act 2001 (Cth) (Act) and contractual and other rights of set off are not enforceable; and
• Where there is a security interest over the debtor, the secured creditor will be entitled to recover the debtor free from any rights of set off, including pursuant to section 553C of the Act.

The decision has a number of practical implications not only in the context of proofs of debt and recovery of debtors but also in considering what type of appointment might be appropriate should a secured creditor wish to enforce its security.

The decision

The decision in Hamersley Iron Pty Ltd v Forge Group Power Pty Ltd (in liq) (recs and mgrs apptd)¹ was concerned with a construction contract.²  In 2012, Hamersley engaged Forge to design and construct two power stations.  In 2013, Forge entered into a facility agreement with ANZ and granted in favour of it a General Security Agreement (GSA) over all of Forge’s assets.  In February 2014, administrators were appointed to Forge and, on the same day, ANZ appointed receivers.

Forge, through its receivers, claimed $77m from Hamersley in respect of unpaid progress claims.  Hamersley claimed that it was owed $633m in damages, including for the additional cost to complete the work.

Hamersley’s defence to Forge’s claim included that it was entitled to set off against the debt owing to Forge the $633m owing to it and then prove for the balance in the liquidation.  Forge maintained that the set off was not available.  Justice Tottle found in favour of Forge and ANZ.

The starting proposition was the finding that section 553C is a code that regulates set off in a liquidation.  Hamersley maintained that it was entitled to rely on the set off contained in the contracts and, separately, it had an equitable right of set off.  The Court held that parliament intended that in a liquidation the only circumstances in which a set off will be permitted is as set out in section 553C.  Any contractual, equitable or other rights of set off that would otherwise be available are not available in a liquidation.

Hamersley also maintained that it was entitled to a set off pursuant to section 553C.  In order to satisfy the requirements of section 553C, there must be ‘mutuality’ between the debts owing by and to the company in liquidation.  That requires that the debts are owing by and to the same parties is the same capacity.

Forge maintained there was no mutuality.  It asserted that the effect of the GSA operating in favour of ANZ was that ANZ had a proprietary interest in the debtors that was sufficient to defeat the mutuality requirement.  That was accepted by the Court.

Hamersley argued that ANZ’s interest was in the nature of a “floating charge” and until that charge ‘crystallised’ or ‘attached’ to the debtor ANZ’s interest under the GSA was not a sufficient proprietary interest to destroy mutuality.  The Court rejected that argument and found that the concepts of ‘floating charge’ and ‘crystallisation’ are irrelevant in a PPSA world.  Rather, the GSA gave ANZ a sufficient proprietary interest in the debtor to destroy mutuality on creation of the debtor.

Hamersley also sought to rely on section 80(1) of the Personal Property Securities Act 2009 (PPSA), that preserves rights of set-off upon the transfer of accounts to ANZ (affected by way of the GSA). Although section 80(1) would have otherwise preserved rights of set off,³ once Forge was placed in liquidation section 80 ceased to be operative.  The Court held that parliament did not intend for section 80 to override the position that section 553C is the only source of set-off when a company is liquidation.

Finally, Hamersley argued that, separately to the right of set off contained in the contracts, the effect of the contracts was that there was a ‘netting-off’ before a party had an obligation to pay an amount to the other party. The set off applied where amounts were payable by each party but could be set off whereas Hamersley’s argument on this point was that there was a ‘netting off’ before an amount became payable by a party to the contract.  The Court rejected Hamersley’s argument having regard to the terms of the contract.

Practical Implications

The decision is obviously of significant benefit to secured creditors.  It also has a number of other practical implications including:

• As the unavailability of a set off only applies in a liquidation,⁴ it may have an influence on the type of appointment a secured creditor may make in an enforcement scenario. The issue is unlikely to be the sole determinant in any particular case⁵ but it is an issue to consider in any particular case;
• The assessment of proofs of debt in a liquidation will be limited to section 553C, including whether the knowledge of insolvency exception applies. A liquidator will not need to consider contractual terms and set offs amongst corporate group members will not be permitted; and
• It is still necessary to consider the contract in question as the particular provisions may provide for a ‘netting-off’ before an amount is payable.

The decision is subject to an appeal and may lead to a different result.  However, in the meantime these issues will remain applicable if a company is placed in liquidation.

This article was written by Andrew O’Halloran, Partner, and Gilbert Hallahan, Law Clerk in our Adelaide office.

Publication Editor: Grant Whatley.

¹[2017] WASC 152
²The principles arising from the case apply to debtors generally and are not limited to construction contracts
³At least for some of the debtor claims – not all of the claims were accounts for the purposes of the PPSA
⁴Or DOCA that adopts the relevant provisions
⁵Other issues that may be relevant are (a) whether it is expected a receivership will be followed by a liquidation such that leave entitlements will receive a priority (b) whether the grantor conducted business as a trustee such that employee entitlements will not have a priority.  There will be a balance between all of these issues that should be considered.