Department of Employment and Workplace Relations v Howell, in the Matter of Castel Electronics Pty Ltd [2024] FCA 566 (McElwaine J – Federal Court of Australia)
This decision of McElwaine J of the Federal Court of Australia addresses a topical issue in insolvency administrations of the determination of ‘circulating assets’ under the Personal Property Securities Act 2009 (Cth) (PPSA) for the payment of employee entitlements.
In this case. receivers and managers were found personally liable for paying funds from ‘circulating assets’ to a secured creditor in contravention of ss433, 556(1)(c) and 561 of the Corporations Act 2001 (Cth) (Act). The case serves as a reminder to insolvency practitioners of the dangers in making distributions based upon mis-characterisation of circulating assets in an insolvency administration given that personal liability may attach if the payments cannot be refunded to the insolvent estate.
The proceedings were initiated by the Commonwealth of Australia which had paid employee entitlements under the Fair Entitlements Guarantee Act 2012 (Cth) (FEG Act), and claimed by way of statutory subrogation under s31 of the FEG Act.
Facts in brief
Castel Electronics Pty Ltd (Castel) carried on business in Australia as a distributor of electrical goods, including air-conditioning units. It entered into a general distributorship agreement with a Chinese company, TCL. Subsequent disputes between Castel and TCL were referred to commercial arbitration, resulting in an amount of approximately $3m being ordered in favour of Castel, and also a smaller amount of approximately $200,000 to TCL upon a counterclaim. The arbitration awards were confirmed by Court orders after appeals were initiated.
The award comprised three components which are relevant in the context of ‘circulating assets’. It comprised amounts for the supply of faulty goods by TCL, an amount for a debt claim and a separate amount for breach of an exclusive supply provision in the distributorship agreement formulated as damages for lost profits.
After the judgment, TCL took several years to pay. In the meantime, Castel entered into a security agreement with 1st Cash Pty Ltd (1st Cash) and an invoice finance deed. After Castel defaulted under its facilities with 1st Cash, it appointed the receivers and managers. They accepted a compromise from TCL for $1.75 million as the settlement sum and also received funds from the sale of stock and inventory. The receivers and managers paid away the settlement sum and the inventory proceeds to 1st Cash and utilised it for their remuneration.
The Commonwealth paid out entitlements under the FEG Act of approximately $630,000 and sought damages from the receivers and managers for breach of s433 of the Act.
Separate Questions for Determination
To ascertain the potential liability of the receivers and managers under s433 of the Act, four separate questions were proposed and agreed upon between opposing Counsel and the Judge. These are set out below with the Court’s findings:
- Was the benefit of the judgment or the ‘enforcement right’ a ‘circulating asset’? — Yes ;
- Was the settlement sum a ‘circulating asset’? – Yes;
- Were the stock and inventory ‘circulating assets’? – Yes; and
- Were the inventory proceeds ‘circulating assets’? –Yes.
Before analysing the separate questions in detail, the legislation will be briefly set out.
The legislative provisions
Section 433 of the Act provides for payment of employee entitlements out of assets comprised by a ‘circulating security interest’ before paying a secured creditor. This term is defined in s9 of the Act in the definitions section to essentially mean a PPSA security interest that has attached to a ‘circulating asset’ within the meaning of the PPSA, and the grantor has title to the asset.
The term ‘circulating asset’ is defined in s340 of the PPSA (quoted in part as follows):
‘General definition
(1) For the purposes of this Act, if a grantor grants a security interest in personal property to a secured party, the personal property is a circulating asset if:
(a) the personal property is covered by sub-section (5) (unless sub-section (2) or (3) applies); or
(b) in any other case–the secured party has given the grantor express or implied authority for any transfer of the personal property to be made, in the ordinary course of the grantor’s business, free of the security interest.
….
Current assets
(5) This subsection covers the following personal property:
(a) an account that arises from granting a right, or providing services, in the ordinary course of a business of granting rights or providing services of that kind (whether or not the account debtor is the person to whom the right is granted or the services are provided);
(b) an account that is the proceeds of inventory;
(c) an ADI account (other than a term deposit);
(d) currency;
(e) inventory;
(f) a negotiable instrument.‘
The term ‘account’ is defined in the dictionary in s10 of the PPSA as follows:
‘ a monetary obligation (whether or not earned by performance, and, if payable in Australia, whether or not the person who owes the money is located in Australia) that arises from:
(a) disposing of property (whether by sale, transfer, assignment, lease, licence or in any other way); or
(b) granting a right, or providing services, in the ordinary course of a business of granting rights or providing services of that kind (whether or not the account debtor is the person to whom the right is granted or the services are provided)….’
McElwaine J observed that the term ‘monetary obligation’, used in the definition of an ‘account’ is not defined in the PPSA.
The Successful Argument of the Commonwealth
The Commonwealth only relied on s340(5) of the PPSA, and was resoundingly successful.
In relation to the first question, the Commonwealth submitted that the enforcement right was a circulating asset within the meaning of the PPSA as it arose from providing services (acting as a distributor) in the ordinary course of business of Castel of providing services of that kind within the meaning s of s340(5)(a). It relied upon the decision of the NSW Court of Appeal in Resilient Investment Group v Barnet and Hodgkinson as liquidators of Spitfire Corp Ltd (in liq) [2023] NSWCA 118; (2023) 111 NSWLR 446. In that case, the Court of Appeal considered what is required for an account to ‘arise’ from the provision of services in s340(5)(a). The Court of Appeal noted that there must be a causal connection between the account (monetary obligation) and the provision of services in the ordinary course of business (Gleason JA (White and Brereton JJA agreeing) at [127]- [131]).
Counsel for the receivers and managers argued that the services were not provided to TCL and therefore the causal connection between the account and the services was not satisfied. McElwaine J examined the distributorship agreement and noted that Castel provided some services to TCL under the distributorship agreement (even though TCL in turn provided countervailing services).
Importantly, his Honour followed the Spitfire decision that the account does not need to arise specifically from the provision of services to an account debtor, but only from the provision of services in the ordinary course of a business (at [59]).
His Honour went further, noting that s340(5) of the PPSA does not require a ‘single cause analysis’ for the monetary obligation arising (at [67]). It was sufficient that the supply of services was a cause of the account, but it need not be the sole cause (at [67]). Put another way, the ultimate springboard for the award of damages was the provision of the distribution services by Castel to TCL.
Faulty goods and debt claims
The faulty goods award was easier to establish, as there was a direct relationship between the faulty goods supplied and the obligations of Castel to be responsible for the safety of customers under the distributorship agreement (at [69]). The same could be said for the debt claim by which the distributorship agreement required TCL to pay Castel for amounts outstanding (at [69]).
McElwaine J also observed that the definition of ‘account’ in s10 of the PPSA is broad. It provides that the monetary obligation may arise whether or not the account debtor is the person to whom the right is granted or the services are rendered, thus showing a statutory intention that s340(5) of the PPSA is to apply broadly, rather than narrowly (at [71]).
Stock, Inventory and Proceeds claim
The third and fourth questions could be answered together with ease. ‘Inventory’ is a deemed circulating asset by s340(5)(e) of the PPSA. The term ‘inventory’ has its ordinary meaning for the purpose of s340 by virtue of s341(1B) of the PPSA. The stock and proceeds claims clearly fell within the concept of ‘inventory’ within its ordinary meaning.
