Circulating assets come and go, security remains resilient - Insolvency/Bankruptcy

When do amounts owed to a company constitute 'circulating assets' and how should they be distributed? This crucial question has not always been answered predictably in recent cases. The Court of Appeal's decision in Resilient Investment Group Pty Ltd v Barnet and Hodgkinson as liquidators of Spitfire Corporation Limited (in liq) [2023] NSWCA 118 has provided a framework for navigating the relevant principles in the context of a priority dispute over R&D tax refunds.

Key takeaways

The characterisation of amounts owing to a company as 'circulating assets' remains crucial in predicting the outcome of priority disputes. While this case found in favour of the secured lender, lenders taking security should take care to understand whether they are taking security over circulating assets.
In a liquidation the characterisation can depend on whether there is a 'monetary obligation' at the relevant appointment date. In the case of R&D tax refunds, the majority found that this depended on tax returns having been lodged.
Moreover, the Court of Appeal unanimously found that there must be a sufficient causal connection between that obligation and the company's 'services' in the ordinary course of a business.

Introduction

When do amounts owed to a company constitute 'circulating assets' and how should they be distributed? This is often a crucial question for secured creditors, controllers and external administrators, employees and other stakeholders. Recent cases have approached the question in different ways.

The Court of Appeal's decision in Resilient Investment Group Pty Ltd v Barnet and Hodgkinson as liquidators of Spitfire Corporation Limited (in liq) [2023] NSWCA 118 (Resilient) has provided a framework for navigating the relevant statutory rules, in the context of a priority dispute over R&D tax refunds.

Relevant statutes

The case revolved around two main provisions:

section 561 of the Corporations Act 2001 (Cth) (Corporations Act), which gives priority to certain employee entitlements ahead of 'circulating security interests'; and
section 340 of the the Personal Property Securities Act 2009 (Cth) (PPSA), which defines a 'circulating asset'.

These provisions have a long history. The statutory rules giving employees priority in respect of 'floating' charge property have developed alongside floating charges themselves.¹

The old law on floating charges persists, under the PPSA's statutory overlay. 'Circulating security interests' are now relevantly defined as: security interests attaching to 'circulating assets' to which the grantor has title (each within the meaning of the PPSA); and floating charges.²

The 'circulating asset' definition is found in a part of the PPSA with special rules relating to floating charges. This part of the PPSA states that the rules are "expected to have less relevance over time".³

The rules are nevertheless as relevant as ever. So is the Commonwealth's role, through the Fair Entitlements Guarantee and in its previous forms, as subrogated employee creditor under section 560 of the Corporations Act.

What happened in this case?

The Resilient case began as an application by liquidators of Spitfire Corporation Ltd (in liq) (Spitfire) for directions how to distribute about $2 million of R&D tax refunds, which had become Spitfire's most significant asset. Spitfire was a fintech start-up, providing wealth management and share analysis platforms.

A priority dispute arose between Spitfire's secured creditor, Resilient Investment Group Pty Ltd (Resilient) and the Commonwealth as subrogated employee creditor. As was widely-reported, including by TGIF last year, each were given leave to be heard without becoming party.⁴

At first instance, the primary judge directed the liquidators to distribute the funds to the Commonwealth in priority to Resilient. Resilient was ordered to pay costs.

The appeal

Resilient successfully appealed the decision. The Court of Appeal gave Resilient leave to appeal (despite not being party to the underlying proceedings) given the general importance of giving guidance on how to construe section 340 of the PPSA.

The main issues on appeal were:

First, whether the Commonwealth was the subrogated employee creditor of Spitfire under section 560 of the Corporations Act.

The Commonwealth had paid out the entitlements of employees of Spitfire's related company, Aspiro Pty Ltd (in liq) (Aspiro). Accordingly, this question turned on whether Spitfire was the 'true employer' or whether Aspiro was the undisclosed agent for Spitfire for the purpose of the employment contracts.

Ultimately the Court of Appeal found no error in the primary judge's finding that Spitfire was the employer for the purposes of section 556(2) of the Corporations Act.
Secondly, whether the Commonwealth had priority to Resilient under section 561 of the Corporations Act.

This question turned on whether the R&D refunds were 'circulating assets'. This in turn depended on finding that the refunds were an 'account' under section 340(5)(a) of the PPSA and, therefore, 'personal property' of Spitfire under section 340(1)(a) of the PPSA.

This was the ground on which the appeal succeeded. The result in the Court of Appeal was unanimous but with some subtlety as to the ratio of the case, explained below.

Circulating assets

In delivering the leading judgment, Gleeson JA found that there was some artificiality in treating the concept of 'personal property' for the purpose of section 340 as conceptually distinct from the two groups of assets specified in section 340(1)(a) and (b).⁵

Her Honour found that the question had two aspects:

first, whether the refunds were a 'monetary obligation' at the appointment date; and
secondly, if so, whether the entitlement to the refunds was an obligation that "arises from" the provision of services "in the ordinary course of a business of providing services of that kind".⁶

Following an extensive review of the relevant tax laws, her Honour found that the Commonwealth's case failed on the first of these aspects. Spitfire did not have a chose in action in respect of the R&D refunds at the end of the relevant tax years because Spitfire had not yet lodged the relevant tax returns. Accordingly, the R&D refunds were not an 'account' (i.e. monetary obligation) at the appointment date.

White JA preferred not to express a concluded view on this point, instead inclining to the view that Spitfire had a 'contingent asset' which should be characterised as property and that there was a 'monetary obligation' (albeit contingent on Spitfire lodging tax returns) to pay the refund to Spitfire.

Gleeson JA nevertheless also found (in obiter but with White and Brereton JJA agreeing) that the Commonwealth's case also failed on the second aspect because - even if the R&D refunds were an account - there was an insufficient causal connection between it and Spitfire's services. Her Honour found that to fall within section 340(5)(a):

the services must be provided in the ordinary course of business of providing services of that kind; and
the account must arise from the provision of services answering that description.

In this case Spitfire's services were providing financial platforms, not research and development generating tax offsets.

The lack of a causal connection meant that section 561 of the Corporations Act did not apply and Resilient had a priority claim as secured creditor.

Some final thoughts

Whilst Resilient is directly relevant to the treatment of R&D refunds on the facts specific to the case, it has broader relevance in providing a framework for determining whether there is an 'account' and whether it is a 'circulating asset' for the purposes of the priority rules in the Corporations Act.

This characterisation is crucial and can lead to significant miscalculations in predicting outcomes. As we have observed previously, where a lender is relying on receivables, inventory or proceeds of accounts to cover their position, they will need to take care as to where they sit in relation to circulating versus non-circulating assets. The Resilient case provides welcome further guidance on this.

Footnotes

¹ To overcome the 'great scandal' of floating charges in the 1870s: Commonwealth v Byrnes & Ors (Re Amerind) [2018] VSCA at [220]; Carter Holt Harvey Woodproducts Australia Pty Ltd v The Commonwealth [2019] HCA 20 at [2].

² Section 51C(a), Corporations Act.

³ Section 338, PPSA

⁴ Under r 2.13(1), Supreme Court (Corporations) Rules 1999 (NSW).

⁵ Resilient at [46].

⁶ Resilient at [47].

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.