New Zealand: Have set-off rights been restricted by the PPSA without anyone noticing?

BRIEF COUNSEL

A recent Western Australia decision in the receivership and liquidation of a construction company may have overturned the hitherto accepted view that set-off remains effective against a receiver.

The case in question could cost the principal tens of millions of dollars and is under appeal. The finding is potentially relevant in New Zealand because the provisions relied on are materially identical to those in our Companies Act and Personal Property Securities Act (PPSA).

The context

Set-off is usually a good defence to a claim under a contract. In a construction contract, for example, a claim by the contractor seeking payment can usually be set off against counterclaims by the principal for liquidated damages and the like.

But should the principal be denied the right to a set-off where the contractor had granted security over its assets to a bank or other financier? The presumption over many years has been "no". But the Western Australia Supreme Court in Hamersley v Forge decided "yes"

Liquidation set-off rules are the only basis for set-off in liquidation

The Australian Court found that, because the company was in liquidation, the only permissible set-off was one allowed under the statutory liquidation set-off rules.

These rules are identical on both sides of the Tasman.1 They are well-known and have been a feature of insolvency law in many jurisdictions for a long time. On their face they provide that, subject to certain limitations not relevant here, set-off is to operate as between the company and the counterparty only where there have been mutual dealings. The requirement of mutuality is crucial.

Before the PPSA, it was very clear that a secured creditor could not ignore set-off rights in this way. Because the charge under a debenture was floating, not fixed, the mutuality required for set-off was left intact. The charge crystallised only on enforcement and so all claims up to that point could be set off as between the debtor and the counterparty. In short, the bank could only enforce against the net sum due to the bank's borrower.

Both New Zealand and Australia's PPSAs appeared to have continued that approach in express provisions.2 Both statutes expressly provide that, where a security interest attaches to an account receivable, the secured party's rights in the account receivable are subject to any defence that the counterparty could raise, including by way of set-off.

No mutuality because PPSA security interest is fixed, not floating

Having decided that the only relevant rules were the liquidation set-off rules, the Court in Hamersley v Forge looked at whether there was sufficient mutuality.

By a technical analysis of the PPSA, consistent with the views of the New Zealand Supreme Court,3 the Court saw security interests as being fixed in nature from the outset. Because of this feature, there was no mutuality. Hamersley was instead effectively trying to set-off against the Bank, a claim it had against Forge.

The end result was that Hamersley, despite having set-off claims against Forge for several hundred million dollars, would be obliged to pay about $70 million to Forge, for the benefit of its Bank. The Bank got the benefit of the contract between Forge and Hamersley, but was not saddled with the burden of that contract.

Chapman Tripp Comments

The case involves significant sums so it will not be surprising if the matter is appealed as far as possible. Like the only PPSA case to have reached our Supreme Court, it is a decision that considers the fundamental nature of a security interest under the Personal Property Securities legislation so it deserves the attention of the appellate courts.

Should a New Zealand court be required to consider the same issues it would need to look carefully at a number of questions of both a technical and policy nature.

Although the liquidation set-off rules are a code in the context of liquidation, it does not follow that they apply to govern recoveries by a secured creditor, relying on its security. Traditionally, rights of secured creditors are not affected by a liquidation.

It seems surprising that a provision in a sub-part of the Companies Act dealing with the method by which creditors prove their claims to a liquidator should alter the scope of a secured creditor's security interest. There is conflicting authority on the point in Australia and England.4 It seems that the issue has not yet been considered by the New Zealand courts.

A New Zealand court would also have to consider the real purpose of s 102 of the PPSA. The practical reality is that the PPSA is only ever applied in cases of insolvency. Often that will be where the debtor is in liquidation. Is it really the case that the section would not apply where the company was in liquidation? It is difficult to see any sound policy reason for the outcome differing according to whether the company was in receivership only (where the liquidation set-off rules would not apply) or in both receivership and in liquidation (where they would apply).

At a policy level, the court would need to be satisfied that it was appropriate for a secured creditor to take the benefit of, say, a construction contract, without allowing for the obligations that go with it.

The decision is a controversial one that has surprised a number of Australian commentators. The appeal will be interesting to follow. Of perhaps more interest in New Zealand would be a claim by a financier or receivers that, like Hamersley v Forge, tries to side step a set-off defence.

In the meantime, contracting parties, such as principals and contractors under construction contracts, should be cautious about relying on rights of set-off. If the Hamersley v Forge decision comes to represent New Zealand law, such parties may not be able to rely on set-off rights where a bank holds security over the other party to the contract.

Footnotes

1 New Zealand Companies Act s 310, Australian Corporations Act s 553C.

2 New Zealand PPSA s 102, Australian PPSA s 80.

3 Stiassny v Commissioner of Inland Revenue [2013] 1 NZLR 453.

4 Day and Dent Constructions Pty Ltd (In Liq) v North Australian Properties Pty Ltd (Provisional Liquidator Appointed) [1981] FCA 12; (1981) 54 FLR 277. Re Norman Holding Co Ltd [1990] 3 All ER 757.

The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.

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Authors
Michael Arthur
Michael Harper
 
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