The Western Australian Supreme Court decision last year which overturned the previously accepted view that set-off remains effective against a receiver has now been successfully appealed.
We welcome the return of the status quo.
The original Hamersley decision
The Court in Hamersley v Forge  WASC 152 ruled that:
- because the company was in liquidation, the only permissible form of set-off was the one allowed under the statutory liquidation set-off rules
- granting security under the Australian version of our Personal Property Securities Act 1999 (PPSA) confers a proprietary interest on the secured party, which destroys the mutuality required for insolvency set-off, and
- the provision of the Australian PPSA which seeks to preserve rights of set-off in these circumstances (section 102, for us) does not do so in a liquidation context.
Chapman Tripp’s commentary is available here.
Impacts and critiques
If Hamersley was correct, it would have a serious impact on netting and set-off, fundamentally changing the risk profile on a broad range of transactions. It would also alter the accepted characterisation of a PPSA security interest in a way contrary to the direction of local jurisprudence.
Yet the Hamersley decision was difficult to reconcile with the statutory provisions under consideration (which are materially the same in New Zealand) or with the overall direction of case law, which has generally upheld set-off as an important protection where contracts create mutual exposures. For these reasons, it came in for some strong criticism.
A welcome return to the status quo
The Court of Appeal of Western Australia overturned the
lower court on all the key grounds.
- Insolvency set-off/mutuality. The contracts were mutual dealings for the purposes of section 553C of the Corporations Act (the Australian equivalent of section 310 of the Companies Act), because Forge retained the right to use amounts under the construction contracts for its own benefit, despite the security interest. This finding is particularly important for protected netting in New Zealand, which has the same mutuality requirement (section 310D Companies Act).
- Set-off preserved under general law. Even if the amounts were held for the benefit of the secured bank, Hamersley could assert contractual or equitable rights of set-off in proceedings brought by the receiver under the general law principle that assignees take “subject to equities" (including rights of set-of and other defences). It is sufficient that the rights exist at the date of liquidation and will mature into pecuniary demands.
- Section 102 PPSA priority rule. Under section 80 of the Australian PPSA (the equivalent of section 102 PPSA (NZ)) Forge's claims against Hamersley are subject to the terms of the contracts and any equity, defence, remedy or claim arising in relation to them. The insolvency set-off provision (section 553C/section 310) does not operate as a “code", eliminating in a liquidation scenario this priority rule, which in any event merely reflects the common law position just described.
The Court also took the opportunity to re-affirm some key
principles in PPSA regimes:
- because the PPSA has its own rules for the enforcement of security agreements, there is no need to characterise an instrument as either a fixed or a floating charge for the purpose of determining priority disputes under the PPSA, and
- whatever the true nature of a PPSA security, the right to use a circulating asset (e.g. money or receivables) means that mutuality is not destroyed by it.
Chapman Tripp comments
The outcome should come as a relief to those letting construction contracts, who potentially faced a scenario where they are compelled to pay a contractor who has fundamentally defaulted, without being able to set off damages resulting from the same default, being left with a claim in liquidation likely only worth cents on the dollar.
It will be equally welcomed by parties to derivatives transactions, whose risk mitigation is underpinned by netting and who would be in a very vulnerable position if that were to be undermined by the uncontrollable and commonplace circumstance of their counterparty granting a security interest to a third party or (it has even been suggested) to themselves.
Perhaps most importantly, the case is a timely reminder that set-off is not an antagonist of other key insolvency principles (such as pari passu and anti-deprivation), but is an equally ancient and integral part of our insolvency regime.