Priority and the circulating security interest: timing is everything

Services: Banking & Finance, Restructuring & Insolvency
Industry Focus: Financial Services
Date: 09 March 2017
Author: Scott Guthrie, Partner
Partner
T +61 7 3100 5019
M +61 421 369 861
Partner
T +61 7 3100 5167
M +61 438 606 782
Partner
T +61 2 8233 9665
M +61 417 482 408
Partner
T +61 3 8640 1004
M +61 412 745 085

What you need to know

  • The Federal Court has clarified that when a receiver receives property after their appointment and that property is not produced in a company’s ordinary course of business, it will not be subject to the obligation to pay the company’s other priority creditors, as provided by section 433 of the Corporations Act 2001 (Cth).

  • The decision issued this week confirms that trading profits generated by a receiver, as well as payments that become payable to a company consequent upon its insolvency, will not be property created in the ordinary course of business.

  • For banks, the decision is a reminder that it is important to check there are appropriate procedures in place to ensure that property over which security is intended to be ‘fixed’ is not, in fact, circulating and potentially subject to section 433.


This week, the Federal Court provided further clarity about what constitutes property which "com[es] into [a receiver’s] hands" for the purposes of section 433 of the Corporations Act 2001 (Cth) (Corporations Act). The Court confirmed that the interpretation of this phrase is determined by reference to property which existed at the date of the receiver’s appointment and not after it.

In the Forge decision,[1] the Court followed an earlier decision of the Supreme Court of Queensland in CMI Industrial Pty Ltd (in liq)[2] (CMI Industrial). It also highlighted the significance of the definition of 'circulating asset' in the Personal Property Securities Act 2009 (Cth) (PPSA) which, in part, focuses on property 'made' in the ordinary course of business.

The Forge decision will be welcomed by both insolvency practitioners and their appointing secured creditors. It confirms that when a receiver receives property post-appointment which is not produced in a company’s ordinary course of business, that property will not be subject to the obligation to pay the company’s other priority creditors.

Section 433 of the Corporations Act

Section 433 provides that where a receiver is appointed prior to a winding up of a company by a secured creditor pursuant to a circulating security interest “the receiver or other person taking possession or assuming control of property of the company must pay, out of the property coming into his, her or its hands” certain debts in priority to the secured creditor.

The broad policy behind section 433 is to ensure that employees whose labour generates the receivables and other property of a company are not disadvantaged in an insolvency scenario (by not receiving their entitlements) in circumstances where a creditor with the benefit of a circulating security interest could later, absent the statutory prohibition, 'scoop the pool' of the company’s assets. A receiver’s obligation is to first account to statutory priority creditors (mainly employees) and continues in circumstances where a liquidator is subsequently or concurrently appointed.

However, as section 433 makes clear, it only applies to upset the natural order of the secured creditor’s priority by requiring payment to statutory priority creditors "out of the property coming into" the receiver’s hands which is comprised in or subject to a circulating security interest.

The question then arises: what is 'property' for the purposes of section 433 and how is that issue determined?

The Forge facts in brief

Forge is a consolidated tax group for the purposes of relevant tax legislation. It was liable for all tax liabilities of the Forge Group and for lodging returns. Forge had been issued with tax assessments for previous financial years on the basis of its estimated annual income. Upon the appointment of the receivers, many of its trading contracts were terminated, thereby rendering the assessments issued (in retrospect) inaccurate. As a result of that inaccuracy, the ATO refunded over $53 million to Forge (the Refund).

The issue for the Court to consider was whether the Refund was 'property' captured by section 433 (meaning that it ought first be distributed to priority creditors) or property that instead was received for the benefit of the receivers (and their secured appointing creditor).

The receivers sought directions that they were entitled to treat the Refund as falling outside the ambit of section 433. The Australian Government Department of Employment (the Department, acting as contradictor) submitted that the Refund was captured by that section (as it was 'property' for the purposes of section 433) and that the statutory priority outlined therein ought to apply.

What is 'property' for the purposes of section 433?

The first thing to say is that section 433 only applies to property subject to a circulating security interest. So what is a circulating security interest? This is determined by reference to:

  • section 51C of the Corporations Act (which defines the term)

  • section 340 of the PPSA (which clarifies the definition in the Corporations Act by in turn defining a 'circulating asset'), and

  • the terms and conditions of the security interest itself.

Broadly a circulating security interest applies to 'free assets' of a company; that is, those assets which the secured creditor permits the borrower to use in the ordinary course of its business.

Against this background, the question becomes: does section 433 apply only to property which 'exists' as at the date of receiver’s appointment, or does "property coming into [the receiver’s] hands" also include future property?

The Court’s answer in CMI Industrial

In CMI Industrial, the Supreme Court of Queensland held that section 433 did not afford certain creditors priority over property that was subject to a circulating security interest which comprised of trading profits made by the receivers after their appointment.

The Court’s answer in Forge

As the Federal Court noted in Forge, “applying CMI Industrial, 'property' the subject of a floating charge, which may have been future property at the time the floating charge was granted, must exist and be identifiable as at the date of the receivers' appointment (emphasis added) to be caught by the operation of s 433”.[3]

In Forge, the Department argued that the CMI Industrial case was distinguishable on the facts. This was because in Forge, the receivers did not trade and make profit, but simply received into their hands the Refund, which was referable to the former operations of the Forge Group.

The Federal Court rejected that argument. Firstly, and as above, section 433 only applies to property that 'existed' at the date of the receiver’s appointment. The Refund clearly did not. Secondly, the Refund arose by virtue of Forge’s insolvency and the subsequent termination of trading contracts. It did not arise in the ordinary course of Forge’s business.

The Department also argued that to the extent that the secured creditor’s circulating security interest permitted Forge to deal with tax receipts, it did not matter when the Refund was received because the Refund, whenever received, was property contemplated by the terms of the circulating security interest. The Court also rejected that argument on the basis that section 340 of the PPSA defines a circulating asset as one which the secured party, amongst other things, gives implied authority for any transfer of property free of the security interest in the ordinary course of business. Clearly the receipt of the Refund consequent upon an insolvency did not meet that requirement.

Key takeaways

There are a number of takeaways for insolvency practitioners and banks.

  1. Section 433 is clearly limited in its operation to property already 'in existence' at the time of the appointment of receivers (eg receivables and other debtors). It will not operate to capture property which 'comes into existence' after that date.
     

  2. As a corollary to the above, in accordance with the broad policy behind section 433, the receiver’s obligation is likely to only be activated and applied to property which the employees of the company have 'generated', such as inventory, receivables and other 'free assets'.
     

  3. In accordance with decision in CMI Industrial, trading profits generated by a receiver will not be subject to the obligation under section 433 as that 'property' cannot be said to have been produced in the ordinary course of business.
     

  4. Payments which become payable to the company consequent upon insolvency (such as tax refunds and other adjustments) will not fall within section 433 as it is property created after the date of receivership and otherwise outside the ordinary course of business.
     

  5. The Forge case is a reminder to banks to check they have appropriate procedures in place to ensure that property over which security is intended to be 'fixed' is not in fact circulating and potentially subject to the application of section 433. For example, a security interest over a bank account which is not a term deposit may be automatically perfected by control. However, in order to avoid the potential future operation of section 433, a specific PPSR registration indicating the bank has control of that account is also required.

For more information, please contact:

Scott Guthrie | Partner

T +61 7 3100 5019 | M +61 421 369 861

E scott.guthrie@dibbsbarker.com

Jeff Baker | Partner

T +61 7 3100 5167 | M +61 438 606 782

E jeff.baker@dibbsbarker.com

Justin Kang | Partner

T +61 2 8233 9665 | M +61 417 482 408

E justin.kang@dibbsbarker.com

John Stragalinos | Partner

T +61 3 8640 1004 | M +61 412 745 085

E john.stragalinos@dibbsbarker.com

Footnotes

1. Langdon, in the matter of Forge Group Limited (Receivers and Managers Appointed) (in Liq) [2017] FCA 170

2. CMI Industrial Pty Ltd (in liq) (2015) 105 ACSR 635.

3. Langdon, in the matter of Forge Group Limited (Receivers and Managers Appointed) (in Liq) [2017] FCA 170 at [63].

The information in this document, broadcast or communication is provided for general guidance only. It is not legal advice, and should not be used as a substitute for consultation with professional legal or other advisors. No warranty is given to the correctness of the information contained in this document, broadcast or communication or its suitability for use by you. To the fullest extent permitted by law, no liability is accepted by DibbsBarker for any statement or opinion, or for an error or omission or for any loss or damage suffered as a result of reliance on or use by any person of any material in the document, broadcast or communication.
 
This publication is copyright. Apart from any use as permitted under the Copyright Act 1968, it may only be reproduced for internal business purposes, and may not otherwise be copied, adapted, amended, published, communicated or otherwise made available to third parties, in whole or in part, in any form or by any means, without the prior written consent of DibbsBarker.
 
 
 
Recent Publications
13 Jul 2017
As part of its four year review of modern awards, the Fair Work Commission has decided to insert a ‘casual conversion’ clause into most modern awards that do not already have conversion clauses in place.
06 Jul 2017
The Maviglia case involved property in New South Wales where the registered proprietor was a trustee company in liquidation. The mortgagee, Perpetual Limited, had taken possession of the property after exercising its right to self-help.
30 Jun 2017
Key changes affecting Australian workplaces are about to take effect, impacting minimum wages, unfair dismissal, penalties for breaches of the Fair Work Act 2009 (Cth) (Fair Work Act) and superannuation contributions.