Major decision on set-off and security interests in insolvency may lead to significant contractual change

The limitations of set-off in a liquidation scenario and the nature and effect of a security interest under the Personal Property Securities Act 2009 (Cth) (PPSA) have been clarified, with significant ramifications for principals and financiers, who should now review their rights, following the WA Supreme Court's decision in Hamersley Iron Pty Ltd v Forge Group Power Pty Ltd (In Liquidation) (Receivers and Managers Appointed) [2017] WASC 152 (Clayton Utz acted for the successful receivers).

The liquidation, the competing claims, and the question of set-off

Forge had entered into a number of construction contracts with Hamersley. Forge had, in turn, charged its rights under the contracts in favour of a secured creditor. When Forge subsequently went into voluntary administration and receivers were appointed, Hamersley terminated the contracts, leaving both parties with substantial claims against each other.

Hamersley argued that its claims against Forge far exceeded Forge's claims against it, so it was entitled to set off its claims (under contract, statute and in equity) in Forge's liquidation and prove for the balance owing to it.

Forge disputes that the net position in regard to the competing claims would be in favour of Hamersley, but in any event Forge's receivers (Scott Langdon and Mark Mentha of Korda Mentha) argued that any arguments in set-off by Hamersley were limited in a liquidation scenario solely to statutory set-off under section 553C of the Corporation Act 2001 (not contractual or equitable set-off); and that section 553C did not operate here because when Forge charged its contractual rights in favour of the secured creditor, it destroyed "mutuality" for the purposes of section 553C.

The findings in Forge

Justice Tottle agreed with the receivers. The key findings were that:

• When a company is in liquidation, the only avenue to set off debts as and between the company and its creditors is section 553C of the Corporations Act 2001 (no contractual or equitable set-off is available).
• An attached security interest under the PPSA can upset the operation of section 553 set-off under the Corporations Act, as it creates a proprietary interest in favour of the secured creditor which has the effect of destroying mutuality of interest between the set-off parties.
• The pre-PPSA concept of crystallisation of security is rendered redundant by the PPSA, so too is the floating charge as a device for taking security over personal property. However, parties can enter into security agreements that operate in a manner that achieves a similar commercial outcome as achieved by a floating charge. In this instance, Forge and the secured creditor had not agreed to do so.

As a result, Forge may now pursue Hamersley for all moneys owing to it under the relevant contracts, for the benefit of the secured creditor. In contrast, Hamersley may only prove for any amounts owing to it under the contracts as an ordinary unsecured creditor in Forge's liquidation.

What the Forge decision means for liquidations and security interests

This decision clarifies the law in Australia as to the limitations of set-off in a liquidation scenario and the nature and effect of a security interest under the PPSA.

It may impact the way principals contract in the future, having regard to the risk of financiers obtaining security interests in the contractual rights, which may leave them exposed to paying contractual claims in a contractor insolvency. If nothing else, it ought put principals on notice of the need to have proper regard to security interests registered on the PPSR.

Clayton Utz acted for Forge's receivers in the litigation, led by partners Alistair Fleming and Clive Luck, with Senior Associates Fiona Schmedje, Rebecca Hanrahan and Dougal West.