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5-12-2018

What is the relationship between different types of set-off? 

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If insolvency set-off applies can any other set-off apply at the same time?  Can insolvency set-off have a limiting effect on other set-offs? These questions are discussed following the Australian Court of Appeal’s decision in Hamersley v Forge [2018] WASCA 163.

Facts

Hamersley Iron Pty Ltd (“Hamersley”) and Forge Group Power Pty Ltd (“Forge”) contracted to build a power station.  Hamersley was the principal, Forge was the contractor.  Forge entered into a facility agreement with its bank, ANZ, giving ANZ security over its property.  When Forge entered insolvency, Hamersley claimed that it was entitled to set-off the cross-claims and prove for the balance.  At first instance the set-off claim failed.  The Court held that insolvency set-off was an exclusive code regulating set-off in insolvency such that even when the statutory requirements were not met the provision nevertheless ousted any other form of set-off.  As ANZ’s security interest operated to negate the mutuality of interest between the cross-claims, no set-offs were therefore available.  However, The Court of Appeal (Western Australia) reversed that decision and allowed Hamersley’s insolvency set-off claim.

Hamersley’s set-off claims

Hamersley claimed a contractual set-off, an equitable set-off, and an insolvency set-off pursuant to Section 553C of the Corporations Act 2001.  Section 553C is closely analogous to Insolvency Rule 14.25, the English law provision that applies in company liquidations.  The relevant words are the same. 

The contractual set-off claim failed because the provision was not self-executing and had not been invoked by Hamersley before Forge entered insolvency.  In any event, where insolvency set-off applies, contractual rights purporting to exclude it or give a more extensive or less extensive operation of it, would be unenforceable.

The Court noted that a legal set-off can sometimes be available in insolvency, but outside of the insolvency set-off section.  Davies v Gertig ((No 2) [2002] SASC 257).

Does insolvency set-off displace equitable set-off?  The Court noted the ‘potential vitality’ of equitable set-off notwithstanding the insolvency of one of the parties.  The starting point was Ex parte Stephens ((1805) 32 ER 996).  S instructed her bankers to sell some annuities and invest the proceeds.  They carried out the sale but kept the proceeds for themselves, without informing S.  Later, S’s brother, J, borrowed £1000 from the bankers on the security of a joint and several promissory note given by S and J.  When the bankers went bankrupt, the Trustees in Bankruptcy sued J on the note.  J could not rely on an insolvency set-off because J did not have a claim against the bankers.  S had a claim but was not being sued on the note.  At that time insolvency set-off was not thought to be automatic and self-executing because otherwise S could have relied upon insolvency set-off without waiting to be sued by the Trustees.      

S and J brought proceedings claiming inter alia that S be at liberty to set-off what was due to her against what was due on the note and an order was made in those terms.  The Court considered that the concealment of the fact that S was a creditor gave rise to an equity that prevented the bankers from suing S on the promissory note.  S did not lose that equity when the bankers went into insolvency.  It was not a question of set-off in the 'strict and technical sense' in that the 'question upon the whole' was whether equity could be interposed in the action at law brought by the bankers against J. 

However, if this is right this is not an example of equitable set-off arising in place of insolvency set-off.  S had a right of set-off, but it had not operated to discharge S at the time the proceedings started.  The fraud allowed equity to intervene to ensure that S got the benefit of the set-off. 

In Hamersley insolvency set-off was permitted on the narrow ground that at the commencement of the winding up, ANZ’s security interest did not affect the nature of the debt due to Forge which was at that time a circulating asset available to Forge.  This was because an event of insolvency had yet to occur.  (The appointment of the administrators, that would have effectively “crystallised” the bank’s charge.  The Australian Personal Property Securities Act 2009 (the “PPSA”) does not recognise floating charges as such.  However, where there is a single security interest over circulating assets the same jurisprudence seems to have been applied.) 

Therefore the dealings between Hamersley and Forge were said to be mutual dealings notwithstanding ANZ’s security interest.  More particularly, the Court determined that if it was wrong to conclude that insolvency set-off applied, there was nothing in S 553C or its purpose or policy which would relieve the chargee of any equities which would otherwise apply to the charged debt.  In other words, other set-offs might be available.  (Section 80(1) of the PPSA preserves rights of set-off against a transferee in an analogous way to the common law.)       

Assignment

A third party may have an interest in one of the claims comprising the set-off; typically by way of assignment.  The assignee sues the solvent debtor and the assignor is insolvent.  The effect will be that insolvency set-off cannot apply because the claim and the cross-claim are not mutual.  The crucial question for the assignee is whether any other set-off can apply.  Both legal set-off and equitable set-off can apply in these circumstances (see Bibby Factors Northwest Ltd v HFD Ltd and Another [2015] EWCA Civ 1908.)

ANZ took subject to any equities that existed before notice of the assignment, in reliance on Section 80 of the PPSA. ‘Equities’ includes rights of set-off.  It follows that an argument that insolvency set-off was exclusive such that even when the conditions of S 553 are not met it ousts any other set-off was bound to fail by analogy with the law that has developed to protect debtors against assignees.

Conclusion

Forge argued that had Hamersley’s insolvency set-off failed, any other set-off would also be precluded, but insolvency set-off is not an exclusive code.  If it was it would have prejudiced the debtor and the unsecured creditors in cases like Davies v Gertig (above).  It would mean that debtors’ rights on assignment would be severely curtailed.  It would lead to windfall payments to assignees in the position of ANZ.  The principles and rules developed by the Court ensure that equity will protect debtors’ rights and this is to be supported.  Insolvency set-off can be limited in its effect.  However, that limitation does not depend on insolvency set-off being an exclusive code.

The original report was published in Butterworths Journal of International Banking & Financial Law in March 2019.

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