Securing contractual rights destroys mutuality and right to claim set-off

The recent WA Supreme Court decision of Hamersley Iron Pty Ltd v Forge Group Power Pty ltd (in Liquidation) (Receivers and Managers Appointed) [2017] WASC 152 illustrates the risk of relying on contractual and statutory set-offs where the counterparty has granted security to lenders in an insolvency situation.

The Court held that mutuality was destroyed, and that contractual and insolvency set-off were unavailable to a counterparty to a construction contract, where the other party secured its rights under the contract to a financier. This decision will impact the negotiation and drafting of contracts in the future, as well as how and what security is granted over rights under a contract.

Background

In 2012, Forge contracted with Hamersley to construct the West Angelas and Cape Lambert Power Stations (Contracts). Forge granted its lender, ANZ, security over all of its property, including its rights under the Contracts, under a general security agreement (GSA).

On 11 February 2014, both administrators and receivers and managers were appointed to Forge. On 24 February 2014, Hamersley terminated the Contracts. Liquidators were subsequently appointed to Forge.

Both Hamersley and Forge made claims against each other under the Contracts. Hamersley claimed that it was entitled to a sum of more than $235 million for liquidated damages and the extra costs for completing the works under the Contracts. Forge made claims for payments for work performed prior to the termination of the Contracts.

Hamersley alleged that it did not owe any further monies to Forge under the Contracts because it was entitled to a contractual and statutory set-off under section 553C of the Corporations Act 2001 (Cth) (s553C).

Forge argued that Hamersley was not entitled to contractual or equitable set off and that Hamersley was not entitled to rely on statutory set-off under s553C because there was no mutuality of interest once Forge secured its rights under the Contracts in favour of ANZ.

Contractual set-off

Clause 16.12 of the contract gave Hamersley the entitlement to set-off money due to Forge against any debt or claim which Forge owed to it. Justice Tottle considered whether under this clause, the amounts Hamersley owed Forge never became due because they were subject to Hamersley’s rights to set-off. Justice Tottle held that:

1. money certified as due in a payment certificate became a debt at the time a payment certificate was issued;
   
   
2. this amount certified was then subject to any amounts deducted by Hamersley in accordance with the set-off provisions, provided such amounts were deducted prior to the due date for payment of the payment certificate;
   
   
3. although the payment obligation was expressed to be ‘subject to’ the rights of set-off, Hamersley had a discretion as to whether to exercise that right, and therefore the set-off did not apply automatically; and
   
   
4. the right to be paid the ‘money due’ was unaffected unless and until Hamersley exercised its rights.

Failure to exercise its set-off rights meant that the amount certified in the payment certificate was a debt due and Hamersley was required to make payment. As Hamersley did not exercise its set-off rights until the administrators were appointed, Hamersley’s reliance on the contractual set-off was too late, and it could not rely on clause 16.12.

Interaction between contractual and equitable set-off with s553C

Justice Tottle held that s553C cannot be contracted out of. This section creates a ‘code’ that regulates set-off between an insolvent company and a person asserting a claim or debt against the company, to the exclusion of contractual and equitable set-off. Even if section 553C does not apply, no other type of set-off may be relied upon.

Issues arising under the PPSA

Effect of the PPSA on Hamersley’s contractual set-off rights

Section 80 of the Personal Property Securities Act 2009 (Cth) (PPSA), provides that a transferee of an “account” is subject to the terms of the contract (which may include a right of set-off). Therefore, Hamersley argued that the transfer of the rights under the Contracts to ANZ pursuant to the GSA would be subject to the contractual set-off rights under the Contracts.

Justice Tottle held that s80 of the PPSA does not interfere with s553C nor give Hamersley any right of set-off in the liquidation of Forge other than that permitted by s553C.

Although it may seem unfair that Hamersley cannot rely on s80(1) to assert contractual set-off, its rights must be determined in the context of the liquidation of Forge in which it is seeking to prove a claim.

Is mutuality destroyed by the creation of a security interest?

S553C requires mutuality of interest between the parties.

Justice Tottle held that the mutuality of interest between Hamersley and Forge was destroyed when the GSA was entered into because a statutory proprietary interest was created in favour of ANZ.

The GSA provides that the security interest granted to ANZ was by way of charge over all collateral. The charge has attached (see below) and conferred an equitable interest to ANZ and a proprietary interest in Forge’s claims. This proprietary interest in the collateral is a statutory interest which is recognised for all purposes. It is fixed at the time of attachment.

Attachment of the charge will occur where the grantor has rights in the collateral or power to transfer the collateral to a secured party and value is given for the security interest or the grantor does an act by which the security interest arises (s19(2) PPSA).

In relation to circulating security interests, attachment occurs immediately, that is, it is a fixed security interest coupled with a licence to the grantor to deal with the assets in the ordinary course.

Justice Tottle also held that the pre-PPSA concept of crystallisation and a floating charge as a mechanism for taking security over circulating assets, are redundant.

Conclusion

Hamersley was unable to assert any contractual right of set-off or set-off under s553C because of the lack of mutuality of interest. Forge was left with a claim against Hamersley (for the benefit of ANZ). Hamersley can only prove in Forge’s liquidation for amounts owing under the Contracts as an unsecured creditor.

Implication of Decision

This decision may impact the way in which counterparties contract in the future, where financing is required for the contract. The risk for counterparties is that set-off may not be available where the other party to the contract grants security over its accounts in the scenario where this party enters into liquidation. The counterparty will be left with an unsecured claim in the other party’s liquidation and be forced to pay out any claims it owes under the contract, without the reliance on set-off.

Additionally, this decision illustrates the importance of a party understanding and exercising any contractual right to set-off at the appropriate time under the contract. Attempts to claw back outstanding amounts after the expiry of the relevant period are likely to be unsuccessful.