Timbercorp appeal fails, as the Great Southern trial draws to a close

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As the marathon Great Southern trial finally draws to a close in the Victorian Supreme Court – just before the first anniversary of its commencement (link) – there has been a significant, relevant judgment delivered. Last week the Victorian Court of Appeal handed down its decision in another class action case involving failed agribusiness managed investment schemes with questions raised about their product disclosure statements – Woodcroft-Brown v Timbercorp Securities Ltd & Ors [2013] VSCA 284.

In dismissing the investors’ appeal, the Court of Appeal held that the trial judge Judd J had not erred in any of his challenged findings. One of those was that the Timbercorp directors did not have actual knowledge of a significant risk to viability until bank support wavered. This was well after publication of the last PDS, and after the collapse of Lehman Brothers in late 2008, which was swiftly followed by the sudden termination of negotiations Timbercorp had been engaged in for the sale and leaseback of certain of its properties and forestry assets. Even then the directors were able to manage those set-backs and address them opening new negotiations with other parties, keeping the banks onside, until their support was withdrawn shortly before Timbercorp’s collapse in mid-April 2009 .

Background

Beginning in 1992, the Timbercorp Group operated a number of horticultural and forestry managed investment schemes (MISs), including almonds, olive oil, grapes and eucalypt plantation projects, with Timbercorp Securities PL as the Responsible Entity. Timbercorp Finance PL’s role was to lend money to investors so that they could invest in the MISs. The defendants to the litigation were those two companies plus three persons who were directors of both companies and of the holding company Timbercorp Ltd.

The Timbercorp Group invested in excess of $2 billion on behalf of about 18,500 investors. Using a combination of debt and equity, the Group would acquire and develop land into plantations and orchards to generate a long term revenue stream from management fees and licence fees and would sell interests in the project to investors. The land and its developments would then be sold either into a property trust where the Group would retain some of the equity in the asset, or it would be sold to a third party buyer, usually on a sale and leaseback basis.

The Group also generated profit by Timbercorp Finance lending to investors, usually up to 90 per cent of their investment. In addition the Group raised funds by securitising its loan book and using the loans as security for finance bonds and bank facilities. To fund the infrstructure and working capital of the projects, the Group would sell assets, raise equity, securitise loans, and arrange debt facilities with the Commonwealth Bank, ANZ, HBOS and Westpac.

After the Group began to experience trouble, Timbercorp kept its bankers informed of developments and the Group’s financiers entered into or renegotiated facilities, extended repayment dates, increased facility amounts and, when necessary, modified covenants to avoid a breach.

The Group’s profitability began to be affected by an adverse tax announcement by the ATO impacting upon the Group in 2007/08. Three days before Lehman Brothers collapsed the Group was managing that issue and its impact, and had already commenced negotiations with various third parties for the sale and leaseaback of a number of its properties and forestry assets.

When Lehman Brothers collapsed in the US on 15 September 2008, this lead to the effective closure of global markets. The next day, one of the purchasers terminated negotiations and the others soon followed. In November further steps were taken to seek to sell assets, and the Group’s auditors expressed concerns about the business as a going concern, noting its working capital deficiency of $82.8 million

In December 2008 Timbercorp Ltd presented an “apparently healthy position” in its Annual Report, including a directors’ declaration of solvency, though the opinion in the audit report included was guarded.

The Group managed to maintain bank support  until April 2009, when it collapsed and went into voluntary administration; liquidation followed in June 2009. At the time the company was wound up, Timbercorp Finance had outstanding loans to more than 14,500 investors totalling $477.8 million.

First Instance Judgment

In striking contrast with Great Southern, the Timbercorp trial ran over (only) 24 sitting days. It dealt with common questions and only looked at individual loss, reliance and causation in relation to the appellant Mr Woodcroft-Brown, and a Mr Van Hoff.

Mr Woodcroft-Brown had commenced proceedings on his own behalf and on behalf of persons who, at any time during the period 6 February 2007 and 23 April 2009 acquired or  held an interest in a MIS of which Timbercorp Securities was the Responsible Entity. Earlier investors were represented by Mr Van Hoff, who had invested in MISs before and after 6 February 2007 and financed the majority with money borrowed from Timbercorp Finance, and evidence was led from him as to breach, causation and reliance.

Mr Woodcroft-Brown argued that had certain matters been disclosed, he would neither have invested in the MISs nor borrowed money from Timbercorp Finance. Mr Van Hoff made a similar argument on behalf of early investors. In particular, they argued that Timbercorp Securities failed to disclose in its Product Disclosure Statement (PDS) information about significant risks, or risks that might have had a material influence on the decision to invest, in breach of disclosure obligations under the Corporations Act 2001 (Cth). They also argued that the Directors’ declarations made in two scheme financial reports were false or misleading and in breach of the Corporations Act, the ASIC Act 2001 (Cth) and the Fair Trading Act 1999 (Vic). The relief sought included declaratory relief, damages and/or compensatory orders, including an order that investors were not liable for repayment of the loans from Timbercorp Finance.

The directors denied the allegations against them, claiming to have taken reasonable steps to ensure that the PDSs would not be defective, a defence under s 1022B(7) of the Corporations Act.

His Honour Justice Judd at first instance found comprehensively in favour of the defendants. His Honour found that they were not required to diclose the risk identified by the plaintiffs, that there had been no misleading or deceptive conduct and, in any case, that there had been no relevant reliance by Mr Woodcroft-Brown or Mr Van Hoff on the alleged non-disclosures or representations. His Honour also made several adverse findings about the way the plaintiffs conducted their case. The first instance judgment may be read here.

The Non-Disclosure of Risk Case – see [29]-[57]

It was necessary for the plaintiffs to establish that there was an obligation to disclose certain matters under either s 1013D or s 1013E of the Corporations Act. Broadly, those provisions relevantly require PDSs to include information which a person would reasonably require for the purpose of making a decision as a retail client whether to acquire the financial product, including information about any significant risks associated with holding the product, and information which might reasonably be expected to have a material influence on their decision.

Section 1013C(2) of the Corporations Act qualifies that, by not requiring disclosure to the extent the information concerned is not known to the disclosing party, here Timbercorp Securiites or any director of it. Section 1013F(1) contains a further qualification, providing that information is not required to be included in a PDS if it would not be reasonable for a prospective (my word) retail client considering the product to expect to find the information there.

The plaintiffs had argued that there should have been discosure of the ‘structural risk’ in each PDS issued after April 2000, and of information about ‘adverse matters’ (matters which put the Group at a heightened risk of failure) as and when they occurred.

His Honour held that because of financial information about the Group available on its website, Annual Reports, ASX announcements and the material prpared by analysts, the information the plaintiffs argued ought to have been provided to potential and existing investors was not required because of the operation of s 1013F.

His Honour found ultimately that the appellant failed to satisfy or displace the operative effect of s 1013C(2) given the absence on the evidence of actual knowledge by the corporation or its directors of the risks as alleged, due to the way in which the appellant pleaded its case. For instance the Directors did not have actual knowledge that the adverse matters (such as the tax issue and the GFC) posed a risk that Timbercorp Securities would be unable to fulfil its contractual obligations, until the Directors realised bank support became equivocal. That was the point at which the ‘adverse matters’ stopped being the types of events that management deals with day to day and address, and turned into a crystallised risk to viability (see [38] and [40]-[53]).

In order to succeed on appeal, the appellant needed to demonstrate that the findings of fact of his Honour on these issues, were not open.

The Misrepresentation Case – [58]-[71]

Section 1022A of the Corporations Act defines a disclosure document or statement (including a PDS) as ‘defective’ if, inter alia, it contains a misleading or deceptive statement. Section 1022B(7) provides a defence of having taken reasonable steps to ensure it would not be defective. Section 12DA of the ASIC Act, prohibiting misleading or deceptive conduct in certain documents, and s 9 of the Fair Trading Act, prohibiting misleading or deceptive conduct in trade or commerce, were also relied upon by the plaintiffs.

They alleged the Timbercorp Group had made two types of false or misleading representations. The first was that the Group was financially sufficiently strong that investors would reasonably expect the MISs to be managed for the foreseeable future and that the principal risks associated with the relevant MISs were fully disclosed. His Honour found that the representations as to the Group’s strength were too vague and uncertain to be actionable, and that there were reasonable grounds for that confidence in any case.

The second was that scheme contributions equalled or exceeded the cost of establishing and maintaining a scheme, in that investors’ payments would be ‘quarantined’ and applied only to their relevant MIS, and MIS contributions would be sufficient to fund the relevant MIS. His Honour held that those representations alleged were not in fact made, and were indeed inconsistent with the PDSs and other generally available information.

The appellant also argued that Timbercorp Securities and the Directors made statements in March and September 2008 that were misleading or deceptive, to the effect that there had been no circumstances that had or may have significantly affected the operations of the relevant MISs. Judd J found that their case here failed on both causation and reliance. It was necessary for the appellant to establish that there was reliance placed upon the non-disclosures and the misleading conduct so as to cause entry into the investment product and, therefore, subsequently to cause loss. His Honour did not believe the evidence advanced by the appellant, or by Mr Van Hoff, on these issues (see [68]).

The Court of Appeal added the observation that the provisions relied on in relation to misleading conduct did not operate in relation to the disclsoure obligations in the PDSs per ss 1041H(3) and 1041K(2) of the Corporations Act, and s 12DA(1A)(c) of the ASIC Act (see [67]).

Shift in the appellant’s case – see [71]-[86]

There was a dispute both at trial and on appeal as to whether the appellant’s case had shifted during the course of the trial such that the appellant pursued a case that went beyond his pleading. The shift concerned the identification of the risks the appellant alleged should have been disclosed. The trial judge found that during the course of the trial, the appellant had materially shifted his conception of the relevant risk and in doing so departed from his pleaded case. One of the changes the trial judge found was the change in the way the appellant relied on the ‘adverse matters’ (such as the tax issue, and the GFC) in that, rather than focusing on their importance as stand alone risks, they achieved their materiality from the risk to the Group’s financing facilities increasing the risk of failure.

His Honour took the view that the reformulation of the appellant’s case was an attempt to ‘sidestep’ the opinions in the joint experts’ report, that as long as the Group’s bankers continued to support the Group’s operations, there was no significant risk that the Group would not have the financial capacity to manage any of the schemes through to their contemplated completion.

His Honour held that the appellant should be confined to his case as pleaded, both because the expert reports and the joint expert report were directed to the case as pleaded, and because of the way in which the respondents had fashioned and presented their evidence in response to that case. The Court of Appeal found no error in his Honour’s approach. Their Honours noted that on appeal, the appellant purported to urge the very case that was not pleaded at trial and which the trial judge rejected. Moreover, so the Court of Appeal observed, even if the appellant was permitted to advance the unpleaded case it was not supported by the evidence at trial.

On Appeal

The appeal was heard by their Honours Warren CJ, Buchanan JA and Macaulay AJA, who delivered a joint judgment.

After a discussion of the decision below, they reviewed the detailed evidence led by the Directors about the Group’s business model and the effect of the events of 2008.

The Group’s business model was to create capital intensive assets with a long term income stream and then to sell those assets within the period of three to five years. For each horticultural scheme, after five years the consequences of failing were intended to reduce to virtually nothing. For each forestry scheme, from about five years, the consequences of failure were intended to reduce gradually until harvest. The appellant submitted that the proper test would be that a risk of total loss of the investment must be disclosed unless the chance of the risk materialising was negligible.

In 2007 moving into 2008, the financial position of the operation was seen to be strong and profitable. The Court noted that importantly, as at 30 September 2008, there was no indication of any risk by reason of financial circumstances to the Group’s capacity to discharge its obligations in relation to the management of the projects. It was not until the last quarter of the 2008 calendar year, following the collapse of Lehman Brothers and after the proposed sale of forestry assets to Harvard Management Company failed to proceed, that banker support wavered. Even then, banker support continued into the new year, with the banks providing Timbercorp with an opportunity to dispose of assets.

At the end of 2008, the bankers for the Group were prepared to increase support. As late as November 2008, the CBA agred to vary loan covenants and extend expiry dates into 2009. Judd J had found there was no sign of the Group having difficulty in securing from capital markets the requisite funding for its activities.

Indeed Judd J had noted that the experts’ report provided a complete answer because, whilst the bank support evaporated eventually after the Lehman collapse, before that time, there was no reason to conclude that it would not be continued on an indefinite basis. In light of that, the experts’ opinion was that there was no significant risk that the Group would not have had the financial capacity to manage any of the schemes through to their contemplated completion, for their full term.

Grounds of appeal 
Some of the specific grounds of appeal raised were as follows –
Ground 1 – [125]-[132] –  The complaint was essentially that his Honour had erred in construing the expression “significant risk” in s 1013D(1)(c) of the Corporations Act. The Court of Appeal held that the trial judge was correct when he said the definition was intended to be a flexible requirement tailored to the type of product involved and its particular circumstances. Amongst the constellation of issues in weighting ‘significant risk’, there is the probability of the occurence, the degree of impact upon investors, the nature of the particular product, and the profile of the investors, together with other matters. This group of issues is not closed and will vary depending upon the circumstances. (See [125]-[132])
Ground 2 – [133]-[141] – Again as to the construction of s 1013D(1)(c), the appellant argued his Honour erred in his assessment of when a risk is “significant”. This ground invoked matters associated with management of risk. In essence, the appellant submitted that the trial judge erred in holding that a risk is not significant if it is capable of successful management and is being managed. However the Court of Appeal disagreed that his Honour considered management of risk for the purposes of construction of the section. Rather, his Honour considered it as a matter of evidence and something that may intercept the potential emergence of a risk of significance.
Ground 4 –  [144]-[157] – The appellant argued his Honour erred in his construction of s 1013F, which provides for what information need not be included in a PDS.
Ground 13 – [212]-[225] -The appellants alleged that in his analysis of whether “the financial representations” and “project contributions representations” were misleading or deceptive, his Honour erred by failing to consider the effect of each PDS on an ordinary and reasonable reader. The criticism made was the focus of the analysis should be the effect of the representations upon the persons to whom the representations were addressed, not upon the mental state of the person making the representations.
The Court of Appeal expressed the view that whether the representations were misleading and deceptive did depend at least in part upon the mental state of the maker of the representations, because they would ordinarily be understood as statements of opinion. They were not apt to mislead if the opinion was genuinely and reasonably held by the maker of the statements. Their Honours also noted that the obligation to disclose risks to the schemes depended upon the actual knowledge of the risks. The respondents met the allegations with detailed evidence of their management of the business risks including the taxation announcement and the credit crisis, and the state of mind of the Directors as to the Group’s financial health and future prospects. It was entirely appropriate, so their Honours averred, for the trial judge to have regard to this evidence in determining whehter the alleged representations were misleading or deceptive. In any event, so the Court found, the trial judge did not simply analyse the representations from the standpoint of the respondents, but examined their likely effect upon the class of investors to whom the PDSs were addressed.
Counsel for the appellant submitted that the trial judge erred in that he failed to consider the impression which the PDSs would have had upon a relatively unsophisticated investor. However the Court disagreed that his Honour’s reasons disclosed that he unduly elevated the understanding and experience of the investors. Their Honours noted that the only two investors to give evidence were both knowledgeable and sophisticated. One was a qualified engineer and successful business engaging in property development through several companies. He was familiar with the share market and was computer literate. He understood balance sheets and P&L statements. The other, Mr Van Hoff, was the sole shareholder and director of a company that conducted a transport business. He had been in business for some 22 years, had a portfolio of shares and a self-managed superannuation fund. In any event, the plurality observed that the appellant’s claim failed for reasons which did not turn upon the perceptiveness, sophistication or knowledge of the investors.
Ground 14 – reliance – [226]-[239] – The appellant challenged the trial judge’s finding that there was no relevant reliance by the two plaintiffs on the alleged non-disclosures, by concluding that the sole driver for their decision to invest was the tax-effective nature of the projects and that they were indifferent to the content of the documents, and that there was a necessary inconsistency between reliance on the strength of the group, and the assumption that projects were quarantined one from another.
To succeed, the appellant had to establish that the alleged representaions constitued a decisive consideration in the decision to invest in the Timbercorp scheme. The witness statements of Mr Woodcroft-Brown and Mr Van Hoff recorded that they read the PDSs and stated their reliance on the representations in temrs which were virtually identical and which echoed hte allegations made in the statemnt of claim. The Court of Appeal described it as unsurprising that the trial judge stated he placed little reliance on this formulaic evidence.
In light of evidence given on cross-examination, the trial judge was not persuaded that the appellant Mr Woodcroft-Brown had read the PDSs in any detail. There had been a meeting with a financial adviser where he was presented with a number of PDSs for a three different investments schemes for him to consider, with a view to reducing his tax liability on a profit earnt, and did not have time to do much more than skim through them. The trial judge concluded that the appellant acted on the recommendation of the financial advisor, motivated by his “anxious desire” to obtain a tax deduction. The trial judge found that the actual content of the PDS or the absence of information, was not what induced the appellant to invest in the project. It was a matter of selecting a project to provide him with the required tax-relief. His Honour said he had no doubt that the financing option – 12 months interest free = was an inducement.
The trial judge found similarly with respect to Mr Van Hoff. He was not satisfied that Mr Van Hoff read any of the PDS in any detail. He may have glanced at parts, but was willing to invest without careful consideration of the documents. That was treated as undermining his evidence insofar as he relied on the contents of the documents, or the absence of information contained in them. His Honour found that Mr Van Hoff did not look to the PDSs as a source of information to assist him in his decision to invest in Timbercorp schemes. He chose the schemes on the basis of advice from his accountant and others, in search of tax relief.
Counsel for the appellant submitted that there was no inconsistency between investing with a view to obtaining a tax-deduction, and investing to obtaining income. However the Court of Appeal observed that while it may be acepted that the appellant and Mr Van Hoff were not indifferent to whether their investments would be profitable, it does not follow that their hope of profit was derived from any representations made by the respondents.
Their Honours upheld the trial judges’ conclusions here also.
Overall, the Court of Appeal held that the appellant had failed to demonstrate that the factual conclusions the trial judge made upon the application of correct legal test were not open to his Honour to find. They held that none of the grounds succeeded, and dismissed the appeal.
Conclusion
Not a good result for the investors in the Timbercorp management investment schemes, although the Timbercorp liquidators should be commended for their announcement following the judgment that they would offer some borrowers a chance to settle their loans and receive a 15% or 10% discount on their debt, although even this may do little to assuage the ongoing financial pain of the borrowers.
It could be a long while yet before his Honour Justice Croft hands down his judgment in Great Southern. After the 24 sitting days of the Timbercorp trial from late May to early July 2011, Judd J handed down his judgment an admirable 2 months later. After the almost full calendar year of the Great Southern class action trial, albeit with breaks punctuating that timeframe, Croft J will have a sizeable job ahead, and it is hard to see how his Honour’s judgment could be likely to be delivered much before mid-2014, and possibly later.
Thus it could be a while yet before we learn what evidentiary problems the Great Southern investors might have had and whether they went to issues that were sticking points in Timbercorp, such as reliance or causation. Nor will we know for a while in detail what the evidence disclosed about the knowledge of the representors in the Great Southern PDSs as to the risks of the investments at the relevant times.
We also do not yet know whether there was a smoking gun in the new evidence found on several company servers and computers that were discovered late in the trial. It has been reported that this development lead to the reconvening of the trial after evidence had been thought to have been closed, and the recalling of several witnesses. It was reported that counsel for the Great Southern investors submitted that the new evidence showed Great Southern used cash top-up payments to mask the fact that log yields from plantations were below forecast. It was not until the 11th month since the trial opened that evidence was reportedly heard from the former head of forestry at Great Southern, that the company was aware at a material time that plantations were not meeting forecast yields. It was also submitted by counsel for the investors that to sate investor demand, the firm bought plots not suitable for yielding plantations as forecast in the PDS (link).
In any event what we can probably be confident of, is that much will now be made in final oral submissions of the Court of Appeal’s judgment in Timbercorp by the Great Southern defendants.

Newsflash: The Bell Group litigation has settled

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Late yesterday and today, an announcement by liquidator Tony Woodings  that the Bell Group litigation has finally settled, is being reported in the press. The case is said to be Australia’s longest and most expensive legal action, and has taken nearly two decades to resolve.

Mr Woodings’ statement noted that:  “The sum for which the case has been settled has not been disclosed. It is subject to various approvals being obtained which are necessary for the settlement to be given effect.” 

The High Court appeal had been due to be heard this month. Last week it came out that the case had been adjourned for six months and withdrawn from the High Court list pending the outcome of settlement negotiations. You can read my post discussing that and other details of the case here.

The reports have appeared inter alia in the Australian (here and here) and ABC News (here and here).

Newsflash: Bell Group litigation adjourned amidst settlement negotations

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For those of you who have not yet heard, it is being reported today that the Bell Group litigation has been adjourned for six months and withdrawn from the High Court list pending the outcome of settlement negotiations. The High Court appeal had been due to be heard this month.

There is far more to this very complex and multi-faceted case, but broadly, in 1990 the Banks had agreed to extend the Group’s loans in order to allow it to restructure and remain afloat, in exchange for a range of securities. Perhaps the Banks were in too deep – some of the banks had already committed staggering percentages of their own capital base to the one client (see [1839]-[1848] of the appeal judgment). However at the time, Bell Group was on the brink of insolvency, and it was alleged that the Banks knew enough regarding Bell Group’s financial position and other relevant circumstances. When Bell collapsed in 1991, the Banks seized assets worth $280 million.

At first instance in 2008, the consortium of 20 banks including Westpac, the CBA, the NAB, HSBC Australia and a range of overseas banks including Lloyd’s TSB Bank had been found liable by his Honour Justice Owen – at the conclusion of his 2,600 page judgment – in all the circumtances, to pay approximately $1.58 billion to the liquidators of Bell Group (link).

The Banks’ appeal of that decision to the West Australian Court of Appeal substantially failed in August last year (link), and in broad terms, the Banks had been ordered to pay to the liquidators more than $2 billion.

Now, Australia’s reportedly most expensive and longest-running court case could finally, potentially, be drawing to an end. If the settlement negotiations prove to be successful, the liquidators of the Bell Group might finally be placed in a position to commence the process of making distributions to creditors, who have been waiting an exceedingly long time.

Administrators’ applications for directions s 447D – Strawbridge, re Retail Adventures

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Yesterday the Federal Court handed down its decision on an application by administrators of related parent and subsidiary companies for directions under s 447D of the Corporations Act 2001 (Cth) in Strawbridge, in the matter of Retail Adventures Pty Ltd (Administrators Appointed) [2013] FCA 891. **See the end of this post for further developments.

The parent company Retail Adventures Holdings Pty Ltd (RAHPL) had given a guarantee under certain leases of the subsidiary (RAPL) which did not allow it to “prove in competition with” the landlord in the administration of the subsidiary company. The parent company had, however, and prior to the appointment of its Administrators, submitted two informal proofs of debt for the purposes of voting at the creditors meeting of the subsidiary. The parent company’s Administrators now sought directions as to whether they were justified in withdrawing those proofs of debt – one for nearly $80.5m in respect of loans said to be secured by a charge, and the other for $68m in respect of debts arising from subordinated notes.

Relevant Legal Principles

Section 447D(1) of the Act relevantly provides –

“The administrator of a company under administration, or of a deed of company arrangement, may apply to the Court for directions about a matter arising in connection with the performance or exercise of any of the administrator’s functions and powers.”

Although he did not enumerate them as I now will, his Honour Jacobson J distilled the following principles from the key authorities on such an application (see [36]-[41] and the authorities there cited) –

1. It is well established that the principles and authorities relevant to the rights of liquidators to seek directions from the Court are applicable to the rights of administrators to seek directions.

2. The purpose of s 447D is to provide a procedure for administrators to obtain the benefit of the Court’s guidance on matters of principle and law. Directions given under the section provide protection to the administrator against incurring personal liability in relation to the action the subject of the application.

3. There must be something more than the making of a business or commercial decision before a court will give directions in relation to, or approving of, the decision. It may be a legal issue of substance or procedure, it may be an issue of power, propriety or reasonableness, but some issue of this nature is required to be raised.

4. The Court will not make orders as to the rights of third parties in an application under s 447D.

5. Accordingly, directions under s 447D do not constitute any binding or authoritative determination of substantive rights, but function to protect the administrator’s rights in the event of an allegation of breach of duty in respect of the conduct of the administration.

6. The Court has the power to grant leave to, inter alia, a creditor of the company to be heard on the question in order to assist the court, without being made a party or for any directions to take any binding effect over the creditor.

Application

Clause 23.8 of the guarantee the parent company RAHPL had given to guarantee the performance of its subsidiary RAPL’s obligations to its landlords under the leases was entitled “Suspension of Guarantor’s rights” and provided relevantly as folllows –

“The Guarantor [RAHPL] may not:

(a)…(b)…

(c) make a claim or enforce a right against the Tenant or its property; or

(d) prove in competition with the Landlord if a liquidator, provisional liquidator, receiver, administrator or trustee in bankruptcy is appointed in respect of the Tenant or the Tenant is otherwise unable to pay its debts when they fall due,

until all money payable to the Landlord in connection with this Lease or the Tenant’s occupation of the Premises is paid.”

The companies in question were part of a larger group. RAPL conducted a business involving a number of discount variety store businesses around Australia under various trading names. RAHPL had never traded. It was the immediate holding company of RAPL and its sole role was as a vehicle for the movement of funds between another company in the group and RAPL.

Following their appointment, the Administrators had granted one of the related companies (DSG) a licence to operate the business of RAPL whilst the Administrators conducted a sale process. Subsequently, the Administrators sold the business of RAPL to DSG for $58.9m.

There had been a DOCA proposed in respect of both RAPL and RAHPL, involving the creation of a single DOCA fund against which the creditors of both companies would claim, comprising cash held by the Administrators at the time of execution of the DOCA and a $5.5m contribution from two related companies (DSG and Bicheno) and the current and former directors. The Administrators estimated that under the DOCA, unsecured creditors of RAPL would receive about 6.46 cents in the dollar. By contrast, if RAPL were wound up, they were likely to receive between 20.71 cents and 45.12 cents in the dollar. Based on this, as well as some additional inherent risks and issues associated with the DOCA, the Administrators recommended that creditors not accept the DOCA proposed by the related entities.

A key issue was whether the relevant restrictions in the lease guarantees prevented RAHPL from lodging proofs in the administration of RAPL, giving them a significant proportion of the voting rights at the second creditors meeting.

Jacobson J observed that this was an issue of construction which affected the reasonableness of the proposal of the Administrators to withdraw the informal proofs of debt. It was quintessentially one which fell within the power of the Court to give directions to an administrator to guide him or her on matters of law or principle so as to protect him or her against accusations of acting unreasonably. His Honour proceeded to evaluate the arguments and do so.

The Administrators submitted that the proofs of debt lodged by RAHPL would constitute “proving in competition” with the landlord for the purposes of clause 23.8(d), and that in lodging an informal proof or voting at the second meeting of creditors of RAPL, RAHPL would also be making a claim or enforcing a right against RAPL or its property within the meaning of cl 23.9(c).

Counsel for DSG, a related company, submitted that ordinarily the phrase “prove in competition” would connote the lodgement of a proof of debt for the purpose of obtaining a distribution or dividend in the winding up of a company. However his Honour took the view that the terms of the clause do not merely preclude RAHPL from proving in competition with the landlord if a liquidator is appointed. RAHPL was also so precluded in a wider range of insolvency events, including the appointment of an administrator.

As his Honour observed (at [57]), distributions to creditors are not payable out of an administration. They are payable to creditors in a winding up, or under a DOCA if one is adopted. But it follows from this that proofs of debt are not lodged in an administration for the purposes of payment. They are so lodged for the purposes of voting. And since RAHPL contractually bound itself not to “prove in competition with the Landlord if a[n]…administrator…is appointed in respect of the Tenant…“, it in effect agreed not to lodge a proof for the purpose of voting in an administration. Whilst his Honour observed that there was some force in the DSG’s submission that proving for the purposes of voting is not proving in competition with the Landlord, in the end his Honour concluded otherwise, observing that to read the clause as DSG urged would give no effect to the extension of the prohibition beyond the event of liquidation to other insolvency events including administration. And, his Honour opined, the clause made some sense read that way. The competition with the Landlord arose from the assertion of an entitlement to attend and vote.

His Honour acknowledged that the construction he preferred would have the serious consequence of preventing RAHPL from voting on the question of whether RAPL should enter into the DOCA or be placed into liquidation. The outcome of the meeting would be left to the votes of a minority of creditors. However that was the effect of cl 23.8(c) and (d), and its proper construction as supported by its language, the objective purpose of the clause, and also by regulation 5.6.23 of the Corporations Regulations 2001 (Cth). (See paras [47]-[68].)

In terms of the outcome of the meeting, it is to be noted that a decision to wind up RAPL would mean a liquidator could potentially act on the Administrators’ report to ASIC that in their view there was compelling evidence of insolvent trading (link to reference). A liquidator could also explore the possible claw back of any voidable transactions. In this regard it has been reported that the Administrators had informed creditors in April that whilst investigations were not yet finalised, their investigations to date indicated that some 90% of a $98million debt incurred by RAPL had been formed within 5 months of the Administrators being appointed.

The Court made orders that the Administrators of RAHPL were justified in withdrawing and conversely, as Administrators of RAPL they were justified in rejecting, the proofs of debt lodged by RAHPL in the amounts of $69m and $80.5m respectively. An order was made that notice be provided to the creditors of RAPL by email or, where none was known, in writing to their last known address.

Postcript 

This application by the Administrators was filed on 27 August 2013, heard on 27, 28 and 30 August 2013, and judgment was handed down yesterday, 2 September 2013. This was also the scheduled date for the second creditors meeting.

It has been reported that at the meeting yesterday, interestingly, creditors of RAPL voted in favour of the DOCA. This is despite the fact that unsecured creditors would receive between 5 and 6 cents in the dollar, much less than was projected under a liquidation.

Insolvent trading, public examinations and privilege – Le Roi Homestyle Cookies v Gemmell

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Yesterday her Honour Ferguson J handed down an interesting decision, which serves as a  useful reminder about public examinations of directors for potential insolvent trading claims – including de facto and shadow directors – and the consequences of those individuals failing properly to maintain their privilege against self-incrimination for criminal or penalty proceedings. The case was that of Le Roi Homestyle Cookies Pty Ltd (in liquidation) v Gemmell [2013] VSC 452.

Before issuing any insolvent trading proceedings against two individuals alleged to have been both de facto and shadow directors, the liquidators had conducted public examinations of each of them. In large part, the insolvent trading claims against the defendants were based on information elicited in the course of the public examinations.

Public examinations are seen as something of a Star Chamber procedure, although there are obvious public policy reasons for permitting this. Whilst directors are inevitably reluctant to answer questions under public examination and potentially furnish the liquidators with evidence to use against them in future litigation, under s 597 of the Corporations Act 2001 (Cth) examinees are compelled to attend (s 597(6)) and to answer the liquidators’ questions (s 597(7)).

Whilst examinees must answer even if the answers might expose them to a penalty or criminal prosecution, they are afforded some protection. If they expressly claim the privilege, their answers may not be used against them in criminal or penalty proceedings. Sub-sections 597(12) and (12A) provide –

“(12) A person is not excused from answering a question put to the person at an examination on the ground that the answer might tend to incriminate the person or make the person liable to a penalty.

(12A) Where:

(a) before answering a question put to a person (other than a body corporate) at an examination, the person claims that the answer might tend to incriminate the person or make the person liable to a penalty; and

(b) the answer might in fact tend to incriminate the person or make the person so liable;

the answer is not admissible in evidence against the person in:

(c) a criminal proceeding; or

(d) a proceeding for the imposition of a penalty;

other than a proceeding under this section, or any other proceeding in respect of the falsity of the answer.”

Generally, where advised to do so by their legal practitioner and/or given the usual warning in this regard by the Associate Judge, director examinees will claim the privilege and thereafter simply say the word “privilege” as a preface to every answer they give.

Here, whilst they received the warning, neither defendant claimed either penalty privilege or privilege against self-incrimination. Despite this, in the insolvent trading proceedings subsequently brought they sought orders dispensing with and relieving them from complying with the pleading and discovery requirements of the rules to the extent that compliance may have a tendency to expose them directly or indirectly to a civil penalty in respect of the subject matter of the proceeding, or to a criminal sanction. Contravention of s 588G(2) exposes directors to civil penalty orders (s 1317E(1)) and, if the person’s failure to prevent the company incurring the debt whilst insolvent was dishonest, criminal proceedings (s 588G(3)).

The Associate Judge dismissed their application, and the defendants appealed. Ferguson J held that the defendants had waived their rights to claim privilege, could no longer invoke those privileges to avoid filing fully responsive defences or make discovery, and must now plead defences and make discovery in accordance with the Rules.

Ferguson J reproduced, with approval, the relevant principles as distilled by Robson J in Re Australian Property Custodian Holdings Ltd (in liq)(recs & mgrs apptd) (No 2) [2012] VSC 576; (2012) 93 ACSR 130 (also cited as “Re APCH (No 2)“) – a judgment which I commend to you as providing an excellent and detailed consideration of the key relevant authorities – at [115] –

(a) In the case of self-incrimination privilege, the defendant must establish that the provision of information or the production of documents in the civil case leads to a real and appreciable risk of a criminal prosecution before the privilege can be invoked;

(b) In an action to recover a penalty it is not necessary for a defendant to establish that there is a risk the defendant will be subjected to a penalty by providing information to the plaintiff. the plaintiff is seeking the information for that very purpose.

(c) In civil actions, where no claim for penalty is made, the defendant must show that providing the information requested would tend to subject him to a penalty in separate proceedings before he can rely on the privilege.

(d) The privilege against exposure to a penalty is a common law right of privilege that may be availed of as of right and is enforced and protected by the Court.

(e) The privilege against the exposure to penalty may be relied on by a defendant to a civil procedure in which a penalty is not sought (“the non penalty civil proceeding”).

(f) The privilege against the exposure to penalty extends to the obligation upon a defendant to plead, give discovery and answer interrogatories in the non penalty civil proceeding.

(g) As a general rule, the privilege does not entitle a defendant to a non penalty civil proceeding to obtain an order in limine excusing him or her from giving discovery or answering interrogatories.

(h) In exceptional circumstances, a defendant may be entitled to such orders in limine.

(i) By extension, in exceptional circumstances, a defendant may be entitled to orders in limine that he may deliver a defence that departs from the Rules of Court only insofar as to protect his privilege against exposure to penalty.

(j) Exceptional circumstances may exist where the defendant to the civil proceeding is also the subject of separate civil penalty proceedings alleging the same or similar conduct.

(k) Where a defendant seeks to take the privilege against exposure to penalty in a defence, the proper course is to plead accordingly and – if challenged – the defendant will be required to justify that the privilege is taken in good faith and on reasonable grounds for the privilege to stand.

Her Honour added to this list a principle I will denote as “(l)” –

(l) The privileges can only be overridden by statutory authority, or waived and may not be abrogated by the purported exercise of a judicial discretion (see [10]).

Ferguson J considered the submissions put for the parties at [17], including the submission for the liquidators that the prospect of criminal prosecution of the defendants was remote, and that penalty privilege is of a lower order of importance. Her Honour observed that if the liquidators established their claims against the defendants, it was almost inevitable that the facts necessary for the imposition of a civil penalty would also be established. It would also be likely to establish at least some of the elements that would need to be proved in a criminal prosecution (although her Honour did not comment on the differing standards of proof). Her Honour indicated that in her view, here it could not be said that the risk of penalty or criminal proceedings was not so low as to be of no consequence.

However whether the defendants ought be excused from filing defences and providing discovery turned also upon whether they had waived any right to maintain the privileges in this proceeding. Ferguson J noted that there was no suggestion that by pleading their defences or providing discovery, the defendants would expose themselves to any different penalty or criminal proceeding to which they were not already exposed by virtue of having failed to claim privilege during the course of their public examinations. That information was already in the hands of the liquidators, and potentially ASIC or a prosecutor, and could be used by them without the restrictions that might otherwise have applied had a claim for privilege been invoked. Moreover, the defendants had had their rights explained to them at the beginning of their examinations by the Associate Judge. Having received that warning, they did not claim either privilege (see [30]).

Ferguson J found that the defendants had waived the right to claim the privileges in respect of the answers that they gave during their public examinations, and held that they should not be permitted to avoid properly pleading and providing discovery. If they were to be so excused, the outcome would be irrational. They had already lost the protection they now sought, and they did not submit that in pleading their defences and making discovery they would have to go beyond the information already provided during their examinations. There was no justification for relieving them of their obligations to comply with the pleading and discovery requirements.

Snapshot updates on Willmott Forests, phoenixing and new offers of compromise rules

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Willmott Forests

Earlier this month the High Court heard the appeal against the Victorian Court of Appeal’s decision in Re Willmott Forests Ltd (Receivers and Managers appointed)(in liquidation) v Willmott Growers Group Inc and Willmott Action Group Inc [2012] VSCA 202.

I wrote on the Victorian Court of Appeal’s decision last year here. (My reviews of earlier Willmott Forests decisions are here and here.) In short, the Court of Appeal held that a tenant’s leasehold interest could be extinguished by disclaimer of the lease agreement by the liquidator of the lessor, pursuant to s 568(1) of the Corporations Act 2001 (Cth). The transcript of the High Court hearing of the appeal from that decision may be read here, and the parties’ written summaries of argument are available online here (under the heading for proceeding M99 of 2012).

The Victorian Court of Appeal’s decision has excited some controversy. In their summary of argument for special leave to appeal from that decision, Willmott Growers Group Inc noted that disclaimer of a lease by a liquidator of a corporate tenant is common (at [42]). However, they argued that disclaimer of a lease by a liquidator of a corporate lessor is a novel use of the liquidator’s disclaimer power, and that the implications of the Court of Appeal’s decision are far reaching. Tenants, particularly retail shop tenants, typically invest substantial sums into the goodwill and fit-out of their leased premises. Much of this expenditure is lost of the tenant is forced to relocate. Also, as the Court of Appeal’s decision erodes the security of tenure under a lease, it may impact upon the willingness of banks and financiers to grant finance on the security of a lease. They noted that the consequences for lessees, in particular retail tenants, are significant. The Victorian Court of Appeal had indicated at [51] that the implications of its decision extended to “shopping centre leases”. (See [36]-[41] of the applicant’s summary of argument.)

We await the High Court’s judgment with interest.

Update on draft legislation targeting phoenix companies

Early last year I wrote about a set of two draft bills that had been released by the Gillard government directed at cracking down on phoenix companies. These were the Corporations Amendment (Phoenixing and other measures) Bill 2012 (the Phoenixing Bill), and the Corporations Amendment (Similar Names) Bill 2012 (the Similar Names Bill). You can read my detailed discussion of those two draft Bills here.

Briefly, the Phoenixing Bill comprised two measures. One was to give ASIC administrative powers to order the winding up of abandoned companies. The primary aim of this measure was said to be the protection of workers’ entitlements, and their ability to access GEERS, with the additional benefit of enabling a liquidator to investigate the affairs of an abandoned company, including suspected phoenix activity or other misconduct. The second set of measures in that Bill was to facilitate the online publication of corporate insolvency notices. As many of you will know, this Bill was enacted last year and ASIC’s insolvency notices website went live in July 2012.

The draft Similar Names Bill proved to be more controversial. Broadly, it proposed amendments to the Corporations Act which would impose personal joint and individual liability on a director for debts of a company that has a similar name to a pre-liquidation name of a failed company (or its business) of which that person was also director for at least 12 months prior to winding up.  The debts for which a director could were to become personally liable were debts incurred by the new (phoenix) company within five years of the commencement of the winding up of the failed company. There was to be scope for directors to obtain exemptions from liability.

My comments on that draft Bill may be read here. There were numerous other fairly significant criticisms made of the draft legislation, set out in submissions lodged by a number of bodies concerned with the proposals, including the Australian Institute of Company Directors and the Law Council of Australia. Their criticisms included that the exposure draft drew no distinction between failed companies, and those abandoned or placed into liquidation for the purpose of engaging in phoenix activity; it did not define “fraudulent phoenix activity” or require a dishonest intention on the part of directors to defraud or deceive creditors before it imposed personal liability; and that it effectively reversed the presumption of honesty or “innocence”, unless the contrary were proven.

It appears that those submissions and the draft reforms were under consideration, as that Bill was not then introduced to Parliament. Indeed it had still not been introduced by the time of the dissolution of Parliament and the onset of the caretaker conventions ahead of the upcoming federal election. Thus the future of the draft Bill, or any other legislative measures to be taken to address phoenix activity, will be a matter for a future federal government to consider.

New Victorian Supreme Court Rules on Offers of Compromise

These are to come into effect on 1 September 2013 and can be read here.

The amendments include a new rule 26.02(4) which requires the issue of costs to be expressly addressed in an offer of compromise. Offers of compromise may be expressed to be inclusive of costs, if preferred by the offeror. New rule 26.02(4) requires that:

“An offer of compromise must state either – 

(a) that the offer is inclusive of costs; or

(b) that costs are to be paid or received, as the case may be, in addition to the offer.”

Note that the minimum time for which an offer of compromise must remain open to be accepted remains 14 days (r 26.03(3)), although there has been an adjustment to the timeframe for payment to be made post acceptance, where the offer does not provide otherwise (increases to 28 days – see the amendment to rule 26.03.01.)

New rule 26.08(4) provides for a defendant whose offer of compromise is unreasonably refused to be awarded standard costs up to the time of the offer and indemnity costs thereafter, unless the Court otherwise orders.

New rule 26.08.01 provides for Courts to take into account pre-litigation offers when making a determination as to costs. Thus offers made even when no litigation is yet on foot ought be given careful consideration. Potentially, the unreasonable refusal of a pre-litigation offer could leave a party exposed to an increased costs order.

Effect on guarantees of failure to register a security interest on the PPSR?

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It seems that the seal is well and truly broken through now, in terms of PPSA litigation starting to come through the Courts around Australia. Last month the West Australian Supreme Court considered inter alia the issue of the effect on guarantees of a failure by a creditor to register a security interest on the PPSR in Industrial Progress Corporation Pty Ltd v Wilson [2013] WASC 225. Amongst other things, the first defendants there argued –

  • that the plaintiff’s failure to perfect its security interest involved a breach of “its equitable duty to perfect securities“: O’Donovan J and Phillips JC, The Modern Contract of Guarantee (3rd ed, 1996), pages 397-400,
  • that the first defendants as guarantors were entitled to be credited, in reduction of their liability, to the extent that that breach diminished the value of the security: Williams v Frayne [1937] HCA 16; (1937) 58 CLR 710 at 738, and

At [27] Beech J took the view that there may be no breach as it was at least seriously arguable that the rights of the plaintiff were temporarily perfected under the transitional provisions of the PPSA. However his Honour observed that even if there were breaches by the plaintiff of what he referred to, without discussion or examination, as “the equitable duty to perfect its security”, it was by no means clear that such breach would reduce the amount of the debt owed by the first defendants under the guarantee to nil.

It followed, in that case, that the plaintiff’s claim against the first defendants “had or may have substance”, such that the application there to extend the operation of the plaintiff’s caveats over land of the guarantors was successful. It should be noted that the matter did not have to be finally decided in that case.

Where will guarantors stand where there has been a failure by a secured party to register a security interest on the PPSR?

The question moving forward is what will be the position for guarantors, where the creditor or other secured party has failed to protect their security interest in the primary debtor’s collateral by perfecting it pursuant to the provisions of the PPSA, and being unable to recover there, seeks to recover in full against the guarantor?

The answer will depend at least in part, if not largely, upon the terms of the guarantee in question. I note that in this West Australian Industrial Progress Corporation case, clause 2 of the guarantee provided only that: “This Guarantee shall be a continuing Guarantee to the Company for the whole of the Customer’s indebtedness or liability to the Company from time to time howsoever and whenever arising and it will not be affected by:…(b) the Company taking or failing to take or enforcing or failing to enforce or holding any other security for the Customer’s indebtedness or varying or surrendering any such security…”. (See further below.)

Also, even if there is a “duty to perfect securities” and it is found to have been breached, the guarantor’s position would depend upon whether the evidence established any deficiency caused by the breach: see Buckeridge v Mercantile Credits Ltd [1981] HCA 62; (1981) 147 CLR 654, 676.

Returning to the question of whethere there is such a “duty” in the first place, I note at least that well before the PPSA, it was an accepted principle that where a creditor has sacrificed or impaired a security, or by its neglect or default allowed it to be lost or diminished, the surety is entitled in equity to be credited with the deficiency in reduction of his liability: Williams v Frayne [1937] HCA 16; (1937) 58 CLR 710 at 738 per Dixon J. The principle can perhaps be seen, in a sense, as a derivative of a surety’s rights of subrogation, which would also be lost or diminished by a creditor’s failure to protect its security interest.

In theory I see no reason why this principle should not continue to apply in the new PPSA world we now inhabit. However, I am not so sure that it will truly translate or extend to a “duty to perfect a security”. Rather, I suggest that the terms of the guarantee will often be determinative of the issue, whether they either expressly dispose of the issue, or they leave the door open for a condition to be implied.

Perhaps under the PPSA a similar approach will be taken to that of Pincus J in Re Kwan; Ex parte Hastings Deering (Solomon Islands) Ltd [1987] FCA 275; (1987) 15 FCR 264, turning upon what conditions may be implied into a guarantee. I here gratefully draw upon the excellent summary of that case given by her Honour McMurdo P in the Queensland Court of Appeal decision in ING Bank (Australia) Ltd v Leagrove Pty Ltd [2011] QCA 131 at [24]. In Kwan’s case, Kwan successfully applied to set aside a bankruptcy notice arising from his liability under a guarantee, essentially on the ground that the creditor would not have needed to resort to the guarantee if it had not failed to register a security given by the principal debtor. Pincus J referred to and applied the comments of Brennan J in Buckeridge v Mercantile Credits Ltd (supra) and observed at 266:

“In a case where the act of a creditor does not discharge a surety, but the creditor has nonetheless sacrified or impaired a security, or by his neglect or default allowed it to be lost or diminished, the surety is entitled in equity to be credited with the deficiency in reduction of his liability.”

Pincus J found that the creditor neither registered the security in time nor, when that failure was pointed out, did it do anything to effect registration of the security until it was too late. His Honour continued at 267:

“On the evidence the case is one of a kind familiar in commercial life: the directors of a private company were asked to guarantee a company debt to support a substantial security taken over the company’s property, there being no express statement that the efficacy of the guarantee depended upon the creditors troubling to perfect the security. In such a situation, it is (in general) at least implicit that the creditor will take all reasonable steps to perfect the security. It would be contrary to expectation of business people that the creditor, not having perfected the security given by the principal debtor, would be free to have recourse to the guarantors. In my opinion, here, where the guarantee was given on the basis of an express stipulation that there should be a bill of sale, there was such an implied condition as I have mentioned; the guarantee is therefore discharged for breach of that condition. It should be added, perhaps superfluously, that what is held here has nothing to do with instances in which the guarantee is so drawn as to exclude the use of such a defence by the guarantor, nor with a case in which the failure to perfect the security was not the fault of the creditor.”

For a more recent case, which went the other way in terms of outcome, I note the judgment in Commonwealth Bank of Australia v Bobby Sailesh Anand [2011] NSWSC 613. There the Bank brought proceedings against Mr Anand on the basis of a guarantee he had entered into to secure a loan to his company, and for possession of property the subject of a mortgage given in support of the guarantee. The security for the loan was a charge over the whole of the company’s assets, and the guarantee and mortgages given by Mr Anand. Section 263 of the Corporations Act 2001 (Cth) required the charge to be lodged with ASIC within 45 days of its creation. It was not lodged until 3 months later. When the company was placed into liquidation, the Bank was reduced to proving for recovery of the loan as an unsecured creditor as the charge was void, for not having been registered in time. Hence it pursued its rights under the guarantee and supporting mortgages.

In that case, the Bank succeeded in its argument that the effect of the terms of the guarantee and relevant provisions of the Corporations Act was that Mr Anand was not entitled to any discharge or partial release because of the Bank’s failure to register the charge. Hidden J referred to the NSW Court of Appeal’s decision in Credit Lyonnais Australia Ltd v Darling (1991) 5 ACSR 703, where the creditor had expressly undertaken to register the charge but had failed to do so, however the guarantor still failed because of a clause of the guarantee expressly protecting the creditor’s rights or remedies under the guarantee from any omission on its part to complete a collateral security and from any collateral security being void. In CBA v Anand, also, there was a term of the guarantee, clause 10.1, which relevantly provided:

“Our rights and your liabilities under this guarantee are not affected by any act or failure to act by us or by anything else that might otherwise affect our rights or your liabilities under law relating to guarantees, including:…(d) the fact that we do not register any security which could be registered…”.”

As Hidden J put it at [47], the terms of the exemption in clause 10 were unequivocal, and were a complete answer to the guarantor Mr Anand’s defence.

Conclusion

Clearly, regard should be had to the terms of the guarantee in question in each case, as they may bear upon the outcome in a particular instance. Indeed regard ought be had at an earlier stage – to the intended effect of any failure to register a secured interest in the collateral of the principal debtor on the PPSR in drawing post-PPSA guarantees, or before executing one already drawn up.

For instance, there may be an express term that the guarantee will remain unaffected by any failure to perfect or otherwise protect the secured party’s security interest, such as in CBA v Anand, and Credit Lyonnais. By contrast, there may be a term that the guarantee will be given upon condition that a specified security shall be perfected by the secured party under the PPSA, and that any failure in the performance of this condition operates to discharge the surety. Another possibility is that the terms of the guarantee will be such as to exclude the implication of a condition such as outlined by Pincus J in Kwan’s case.

Extension of time for PPS registration of circulating security interest: s 588FM Corps Act

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In an ex tempore judgment two weeks ago, Hammerschlag J granted an extension of time for registration of a circulating security interest under the Personal Property Securities Act 2009 (Cth) (PPSA) – In the matter of Apex Gold Pty Ltd [2013] NSWSC 881.

The plaintiff (RF Capital Pty Ltd as trustee for the RF Capital Trust) brought the application for extension of time under s 588FM(1) of the Corporations Act 2001 (Cth). Subsection 588FM(2) empowers the Court to make the order sought if it is satisfied inter alia that the failure to register it earlier was accidental, due to inadvertence or due to some other sufficient cause. His Honour, applying the reasoning of Black J earlier this year in In the matter of Cardinia Nominees Pty Ltd [2013] NSWSC 32, was satisfied by the affidavit evidence that the failure to register the security interest earlier was accidental or due to inadvertence on the part of the deponent or those acting under her supervision, and that the orders sought should be made (see [13]-[19]). It is notable that his Honour Black J in Cardinia, had reviewed key authorities dealing with the former s 266 of the Corporations Act, as well as UK judgments as to failures to register a security interest (see [14]-[17]), and their discussion of the concept of “inadvertence”.

Background

In 2012, the plaintiff gave financial accommodation to Apex Gold’s parent company Apex Minerals NL. There was an event of default. In January 2012 the plaintiff agreed to forbear from taking action to enforce its security against Apex Minerals in consideration for, amongst other things, Apex Gold providing security.

Thus on 2 January 2013, Apex Gold entered into the Apex Gold General Security Agreement with the plaintiff, under which it granted a circulating security interest to the plaintiff in its collateral, being all of its present and after-acquired property.

On 26 March 2013 the plaintiff registered its circulating security. As events transpired, this was too late, and this application was filed, heard and decided on 25 June 2013.

Consideration

There was evidence before the Court that Apex Gold (and Apex Minerals) may be or may be about to become insolvent, and that the plaintiff intended to exercise powers under its securities to appoint both a voluntary administrator and receivers to both companies.

Broadly, if an insolvency-related event of this nature occurs in relation to a company, s 588FL(2)(b) fixes a time by which a PPSA security interest granted by the company must have been registered under the PPSA failing which, under s 588FL(4), the security interest may vest in the company.

Here, the circulating security interest granted by Apex Gold to the plaintiff was not entered on the PPS Register until 26 March 2013. The last date for registration under s 588FL(2)(b)(ii) (being 20 business days after the security agreement was entered into) was 31 January 2013. The registration was, thus, out of time for the purposes of that section.

Hence the plaintiff brought this application under s 588M for an order fixing a later time (26 March 2013) for the purposes of subsection 588FL(2)(b)(iv).

His Honour gave consideration to what other security interests had been granted by Apex Gold since 2 January 2013. There had been a number of purchase money security interests granted, but between 2 January 2013 and 26 March 2013 there was just one other (non PMSI) security interest granted to a company named Dyno Nobel Asia Pacific Pty Ltd. The orders his Honour made provided for the priority of the Dyno security to be unaffected by his grant of extension of time (at [15]-[17]).

Interestingly, his Honour noted at [18] that he was informed from the Bar table that the company that was the object of the orders sought, Apex Gold itself, had not been given notice of these proceedings. He proceeded to make the orders sought nonetheless, and included an order reserving liberty for Apex Gold (or any liquidator, administrator, deed administrator or unsecured creditor of Apex Gold) to apply to vary his orders within set periods of time.

Lesson

Quite simply, delay in registering PPS security interests at your peril.

As the Explanatory Memorandum to the 2010 amending Bill explains, section 588FL was intended to vary section 266 of the Corporations Act. Section 266 had required that a security interest be registered within 45 days of being created, or before 6 months of the commencement of an administration, liquidation, or DOCA. Section 588FL(2) instead provides (broadly) that if such an insolvency event occurs, a security interest must have been registered within 20 business days of being created, or before 6 months of such an insolvency event (or such later time as ordered by the Court).

I leave you with the examples set out in the Explanatory Memorandum, illustrating how s 588FL was intended to operate. However in reading these examples, note this caveat:  at the time of the EM, the proposal was “20 days”, not the “20 business days” that appears in the Corporations Act –

Example:
           CompanyA grants FinanceA a security interest in its all present
           and after acquired property.  FinanceA registers its security
           interest 15 days after the creation of the security interest.
           CompanyA becomes insolvent 30 days after the security interest
           is granted.  FinanceA would retain their security interest,
           because FinanceA registered the security interest within the
           required 20 day period.
           Example:
           CompanyA grants FinanceA a security interest in its all present
           and after acquired property.  FinanceA registers its security
           interest 25 days after the creation of the security interest.
           CompanyA becomes insolvent 30 days after the security interest
           is granted.  The security interest would vest in CompanyA
           because FinanceA did not register the security interest within
           the required 20 day period or within the six month period prior
           to the critical time.
           Example:
           CompanyA grants FinanceA a security interest in its all present
           and after acquired property.  FinanceA registers its security
           interest 25 days after the creation of the security interest.
           CompanyA becomes insolvent eight months after the security
           interest is granted.  FinanceA would retain its security
           interest because it registered its security interests prior to
           the six month period before the critical time.
           Example:
           CompanyA grants FinanceA a security interest in its all present
           and after acquired property.  FinanceA registers its security
           interest 15 days after the creation of the security interest.
           CompanyA becomes insolvent 5 months and 25 days after the
           security interest is granted.  The security interest would not
           vest in CompanyA because FinanceA registered the security
           interest within the required 20 day period (despite the fact
           that the registration was also made within 6 months before the
           insolvency).

Newsflash / case review – First major PPSA decision in Australia handed down

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And it is not good news for owners. It may seem counter-intuitive for lawyers and insolvency practitioners who were taught long-standing rules of property law, and have until now advised and operated in that context. However when it comes to personal property it is clear now that in Australia, to put it simply, ownership is no longer king.

Just over a week ago, on 27 June 2013, the first major PPSA decision in Australia was handed down by Brereton J in the New South Wales Supreme Court:  In the matter of Maiden Civil (P&E) Pty Ltd; Richard Albarran and Blair Alexander Pleash as receivers and managers of Maiden Civil (P&E) Pty Ltd v Queensland Excavation Services Pty Ltd [2013] NSWSC 852.

The case involved three civil construction vehicles located in the Northern Territory, identified by their VINs; a caterpillar wheel loader (the 930), a 30 tonne caterpillar excavator (the 330), and a 20 tonne caterpillar excavator (the 320).

A company Maiden Civil (P&E) Pty Ltd (Maiden) had been engaged between 2010 and May 2012 to undertake civil construction work in the Northern Territory. It had acquired possession of the Caterpillars with the assistance of Queensland Excavation Services Pty Ltd (QES), under a hire-purchase type of facility used in many industries. Broadly, QES purchased the Caterpillars chosen by Maiden and then leased them to Maiden at a premium. Pre-PPSA, by gaining title to the Caterpillars pending the paying out of the lease term, this arrangement was considered to give the finance-provider the best security possible. However post-PPSA, as we are learning, ownership is no longer king. Without registering what is deemed under the Act to be a “security interest”, priority in the particular personal property can be lost, even for the owner of the personal property.

To break the financing arrangement employed here down into its elements –

  • The vendor sold the Caterpillars to QES in 2010
  • QES paid the deposits to the vendor, and the balances were financed by Esanda (for the 320) and Westpac (for the 330 and 930), secured against the home of QES’s principal Mr Callum Rutherford and guaranteed by Mr Rutherford and a related  company
  • Concurrently (more or less) with the payment of the deposits to the vendor, QES received from Maiden funds that corresponded with the amounts of the deposits
  • Maiden took possession of the Caterpillars
  • Thereafter, QES invoiced Maiden on a periodical basis for amounts that corresponded to finance charges payable by QES to Esanda and Westpac, plus ten percent, which Maiden paid
  • In March 2011, Maiden provided to QES the funds required to pay out the Esanda finance in respect of the 320, and QES thereupon discharged that finance
  • After 23 March 2011, QES rendered no further invoices to Maiden in respect of the hire of the 320
  • QES continued to render invoices in respect of the 330 and 930, and Maiden continued to pay them, if irregularly.

In about March 2012, Maiden sought short-term finance from a third party, Fast Financial Solutions Pty Ltd (Fast). Fast’s solicitors prepared the documentation, including a Loan Agreement for a three-month loan of $250,000 and a General Security Deed. The Deed attached schedules listing Maiden’s property, including the Caterpillars, and sent these to Maiden’s lawyer on 2 May 2012.The General Security Deed purported to grant to Fast a “security interest” in, inter alia, the Caterpillars. The documents were executed by Maiden and by Fast on 31 May 2012. Fast transferred funds into an account as directed by Maiden.

Already by July 2012 there were a number of events of default under clause 11.1 of the General Security Deed, and on 27 July 2012 Fast appointed receivers and managers.

Following their appointment, the receivers claimed possession of the Caterpillars. Maiden entered into voluntary administration on 27 August 2012 and then liquidation on 24 September 2012.

The contest as to the superior interest in the Caterpillars was between –

1. QES, who claimed to be the owner of the 330 and 930 Caterpillars, and of the 320,

2. The financier and secured creditor, Fast, and

3. The parties claiming a lien over the 320 (it was unclear if this was a company called Central Plant Hire (NT) Pty Ltd or a Mr Cullenane).

His Honour Brereton J addressed the key issues in turn.

1. Who was the “true owner”?

QES claimed to be what his Honour referred to as the “true owner” of the Caterpillars, having purchased them and hired them to Maiden. This was disputed.

His Honour held that the arrangements between QES and Maiden included that upon payout of the relevant financier from whom QES had obtained funding for a particular Caterpillar, title to the Caterpillar would be transferred to Maiden. The arrangement was not a mere lease, but included an agreement to transfer title upon discharge of the finance (see [17]). In the meantime, QES was the legal owner of the Caterpillars, having acquired title from the vendor and being the sole recourse for Esanda and Westpac.

His Honour concluded (at [18]) that Maiden was the “true owner” of the 320, having paid out its finance. However QES was the “true owner” of the 330 and 930, and thus had a claim in competition with Fast as to the 330 and 930. His Honour observed that while the case ultimately fell to be resolved according to the system of priorities established by the PPSA, “the notion of title – or ‘true ownership’ – is not irrelevant”.

Brereton J does not explain this last remark further. I suggest that, as the rest of the judgment demonstrates, its relevance is not to the resolution of the competing claims, but is confined to determining whether an asserted “true owner” retains an interest in the asset in question at all. In this case, his Honour held that this issue resolved the question as to QES’ claim to an interest in the 320 in the negative, such that as to that Caterpillar, there was no competition at all. As to the the other two Caterpillars, the 330 and 930, QES’ claim to ownership held good. For those Caterpillars, then, the analysis proceeded to the next stage – the competition between claimed interests in those Caterpillars.

2. The security interests in the Caterpillars

(a) Meaning of “security interest” 

Section 12(1) of the PPSA defines “security “interest in this way –

“A security interest means an interest in personal property provided for by a transaction that, in substance, secures payment or performance of an obligation (without regard to the form of the transaction or the identity of the person who has title to the property).”

Section 12(2) lists examples of such transactions which may provide a security interests in personal property.

Importantly, section 12(3) then provides –

“A security interest also includes the following interests, whether or not the transaction concerned, in substance, secures payment or performance of an obligation:

(a) the interest of a transferee under a transfer of an account or chattel paper,

(b) the interest of a consignor who delivers goods to a consignee under a commercial consignment, 

(c) the interest of a lessor or bailor of goods under a PPS lease.”

I pause there to note that section 12(3) is the provision which makes it clear that ownership or title to goods is deemed a “security interest” under the PPSA, and is subject to its provisions.

A “PPS lease” is defined in section 13 to mean a lease or bailment of goods –

(a) for a term of more than one year,

(b) for an indefinite term (even if determinable by either party within a year),

(c) for a term of up to a year that is automatically renewable if the total of all the terms might exceed one year,

(d) a term of up to a year, where the lessee or bailee consensually retains substantially  uninterrupted possession of the property for at least a year from the day they took possession, or

(e) for goods that may or must be described by serial number, for a term of more than 90 days in certain circumstances, or less than 90 days in certain circumstances.

There are certain exclusions from the definition of a “PPS lease” in sub-sections 13(2) and (3). Relevantly, sub-section 13(2)(a) excludes a lease by a lessor who is not regularly engaged in the business of leasing goods.

(b) QES’s interest

It was common ground that if QES was the owner of any of the Caterpillars, this was a “security interest” within the meaning of the PPSA. Although the lease of the Caterpillars from QES to Maiden was not in writing, and there was no evidence of any agreed term, his Honour found that the hire was continuous, was for a period of more than a year, and that Maiden retained uninterrupted possession of the Caterpillars for more than a year. On this basis, his Honour held (at [24]) that sub-sections 13(1)(b) and/or 13(1)(d) of the PPSA were satisfied, such that the agreement between QES and Maiden was a PPS lease. His Honour also held that sub-section 13(1)(e)(ii) and/or (iii) was also satisfied, as the Caterpillars were goods that may or must be described by serial numbers and were in Maiden’s possession for more than 90 days.

The exclusions from the definition of “PPS lease” in sub-section 13(2) did not apply. His Honour accepted that the income from hiring the three machines was QES’s only income, and that it was Mr Rutherford’s intention to continue to let the Caterpillars for hire on short-term rentals. His Honour held that on that basis it was not established that QES was not regularly engaged in the business of leasing goods (at [24]).

I pause here to note respectfully that I harbour some doubt as to the correctness of that conclusion. Whether what would appear to have been a one-off transaction coupled with an intention to continue to hire those vehicles is sufficient to denote a regular engagement in the business of leasing goods may be, I suggest, open to question.

In any event, Brereton J held that as the leases of the Caterpillars by QES to Maiden were PPS leases within the meaning of s 13 of the PPSA, it followed that QES’ interest in the Caterpillars, as lessor, was a “security interest” within PPSA s 12(3)(c).

(c) Enforceability of security interests against grantors – “attachment”

(In this case, the relevant “grantor” as that term is used by the PPSA was Maiden, the lessee of the Caterpillars.)

Section 19 is the key provision here. Subsection 19(1) provides that attachment is required before a security interest is enforceable. Subsection 19(2) provides that a security interest attaches to the relevant personal property (“collateral”), relevantly, where the grantor has rights in the collateral, or power to transfer rights in it to the secured party (at (a)).

Subsection 19(5) provides –

“For the purposes of paragraph 2(a), a grantor has rights in goods that are leased or bailed to the grantor under a PPS lease, consigned to the grantor, or sold to the grantor under a conditional sale agreement (inlcuding an agreement to sell subject to retention of title) when the grantor obtains possession of the goods.”

Brereton J observed that here, pursuant to s 19(5), Maiden – as PPS lessee in possession of the Caterpillars – had rights in them to which a security interest could attach. His Honour noted that these rights are not limited to possessory rights, but can also be proprietary rights. He noted there are equivalent provisions in the New Zealand and Canadian PPS legislation, and at [26] quoted the following remark of Iacobucci J of the Supreme Court of Canada in Re Giffen [1998] 1 SCR 91; (1998) 155 DLR (4th) 332:

“Thus, upon delivery of the car to the bankrupt, the lessor had a valid security interest in the car that could be asserted against the lessee and against a third party claiming a right in the car. However, the lessor’s security interest remained vulnerable to the claims of third parties who obtain an interest in the car through the lessee including trustees in bankruptcy. In order to protect its secuirty interest from such claims, the lessor must therefore perfect its interest through registration of its interest…, or repossession of the collateral… The lessor did not have possession of the car, and it did not register its security interest. Thus, prior to the bankruptcy, the lessor held an unperfected security interest in the car.”

At [27]-[29], his Honour considers key provisions of the New Zealand PPSA and certain New Zealand judgments, discussing conceptually how the rights of a lessee in leased goods are not merely possessory but are also proprietary, such as to permit a secured creditor to acquire rights in priority to those of the lessor (or, as Brereton J puts it, the “true owner”).

At [29] of Brereton J’s judgment, there is a quote from a Canadian article by Bridge, Macdonald, Simmonds and Walsh, “Formalism, Functionalism and Understanding the law of Secured Transactions” (1999) 44 McGill LJ 567 at pp 602-603, where the authors suggest that under the US Uniform Commercial Code and the Canadian legislation:

“The internal logic of the Article 9 and PPSA priority regime is premised on a rejection of derivative title theory in favour of registration as the principal mechanism for ranking priority both among secured creditors and as between the secured creditor and the debtor’s general creditors including the trustee in bankruptcy….On this interpretation, ostensible ownership – in the radical sense of bare possession or control of the collateral – has effectively replaced derivative title for the purposes of determining the scope of the secured debtor’s estate at the priority level.” 

At [30]-[31] Brereton J refers to a  2005 decision of the New Zealand Court of Appeal which, as the enactment of the PPSA in Australia subsequently approached, was the case which certainly caught the attention of those of us in Australia coming to grips with the concepts and potential effects of the new regime. The case was that of Waller v New Zealand Bloodstock Ltd [2005] NZCA 254; [2006] 3 NZLR 629.

In brief summary, in 1999 a financier took a debenture over the assets of a farming company which it registered on 1 May 2002, the day the PPSA commenced in New Zealand. In 2001, the farming company had leased a stallion named Generous from the stallion’s owner for a term of more than one year. The owner did not register its interest as owner/lessor. In 2004, the owner/lessor terminated the lease and repossessed Generous. Shortly thereafter, the financier appointed receivers to the farming company, under its debenture. The receivers sued the stallion’s owner for possession, claiming that the financier was entitled to priority under the PPSA. The New Zealand Court of Appeal held that the lease ammounted to a “PPS lease”, that the owner/lessor’s interest amounted to a “security interest” under the PPSA, that the financier had given value for its security interest under the debenture, that the farming company had rights in the stallion under the PPS lease, and that the financier’s security was enforceable against the stallion’s owner/lessor. As the financier’s security interest had been perfected by registration, it took priority over the competing security interest of the stallion’s owner/lessor, as with respect to priority of competing security interest, the principle nemo dat quod non habet was ousted by the PPSA.

Robertson and Baragwanath JJ of the NZ Court of Appeal observed (at [54]) that because the lease was for a term of more than one year, then for the limited purpose of priority of securities, the contracutal language of the agreement to lease (which provided that title to Generous would remain with the owner/lessor) was overridden by statute, and instead of its previously inviolable title to the stallion, the owner/lessor was deemed to have a statutory “security interest”, which was liable to be overridden by a competing security interest. A salient lesson indeed.

(d) Fast’s Interest

Here Fast, the financier, under its General Security Deed with Maiden, was granted a “security interest” in the “personal property” to secure the due payment of the “secured moneys”. Clause 1.1 of the Deed defined “personal property” to mean all of Maiden’s assets, including all personal property in which Maiden had rights, whether then or in the future, including the serial numbered “collaterals” listed in schedules, which included the Caterpillars.

His Honour held that the General Security Deed was a “security agreement”, and the interest created in Fast’s favour was  a “security interest” within the meaning of the PPSA (at [34]). Pursuant to s 19(2), Fast’s security interest had attached to the Caterpillars when it gave value for its security interest by advancing the funds referred to in the Loan Agreement and General Security Deed. Once it had attached, it was enforceable by Fast against Maiden the grantor, pursuant to s 19(1).

(e) Priority between competing security interests – the key provisions

Both QES and Fast held “security interests” in Caterpillars 330 and 930. The competition between the two interests was to be resolved not by title, but by priority under the rules laid down in the PPSA.

Section 55 sets out the default priority rules. Broadly –

  • Where two security interests in the same collateral are both unperfected, the first in time takes priority (in terms of the order of attachment) – s 55(2)
  • Where one security interest is perfected and another in the same collateral is not, the former has priority – s 55(3)
  • Where two security interests in the same collateral are both perfected, the first in time takes priority (in terms of the order of perfection, and so long as perfection has remained continuous) – s 55(4), (5) and (6).

Section 21 sets out the main rule for perfection. In broad terms and all other things being equal, registration will in many cases achieve perfection. However, it is more complicated than that.

Under subsection 21(1), a security interest in a particular collateral is perfected if either –

(a) it is perfected or temporarily perfected by force of the PPSA; or

(b) all of the following three things apply –

(i) the security interest is attached to the collateral,

(ii) it is enforceable against a third party, and

(iii) sub-section (2) applies.

Subsection 21(2) applies if –

(a) the security interest has been registered and its registration remains in effect, or

(b) the secured party has possession of the collateral (not by seizure or repossession), or

(c) the secured party has control of the collateral, for certain specified kinds of collateral (These are not relevant here. They include certain types of credit instruments, but curiously, (vi) is “satellites and other space objects”).

Note that subsection 21(1)(b)(ii) above directs attention to whether a security interest is enforceable against a third party. For the answer to this, regard must be had to section 20.

Section 20 governs the enforceability of security interests against third parties. Subsection 20(1) relevantly provides that a security interest is enforceable against a third party only if it –

(a) is attached to the collateral, and

(b) either –

(i) the secured party has possession,

(ii) the secured party has perfected the security interest by control, or

(iii) a security agreement that provides for the security interest covers the collateral in accordance with subsection (2).

Section 20(2) provides, relevantly, that a “security agreement” must be evidenced in writing with certain details addressed, and either signed or adopted by the grantor.

(f) Competition between the security interests of QES and Fast 

For Fast, in terms of enforceability against third parties, Brereton J concluded that s 20(1)(a) was satisfied, as Fast’s security interest had attached to the Caterpillars. The General Security Deed was a security agreement evidenced in writing signed by Maiden as grantor within s 20(2)(a)(i), contained a description of the particular collateral (s 20(2)(b)(i)), and contained a statement that a security interest was taken in all of the grantor’s present and after-acquired prorperty (s 20(2)(b)(ii)). Accordingly, the security agreement “covered the collateral” for the purposes of s 20(1)(b)(iii), and Fast’s security interest in the Caterpillars was therefore enforceable against a third party, including QES.

In terms of the perfection of Fast’s security interest, his Honour noted that as it had attached to the Caterpillars, this meant that s 21(1)(b)(i) was also satisfied. As it was enforceable against a third party s 21(1)(b)(ii) was satisfied. And as it had been registered and the registration remained effective within the meaning of s 21(2)(a), s 21(1)(b)(iii) was satisfied. It followed that Fast’s security interest in the Caterpillars was perfected under the PPSA. That was all common ground. (See [39]-[40])

However, his Honour observed at [41] that for QES – it had not registered its security interest in respect of any of the Caterpillars, and they were therefore not perfected (subject to what appears below). Section 55(3) therefore applied, so that Fast’s perfected security interest in the Caterpillars had priority over QES’s unperfected security interest in them. His Honour also observed that QES’s security interest was vulnerable on the grounds that it was not enforceable against third parties under s 20, because there was no security agreement that covered the collateral for the purposes of s 20(1)(b)(iii). While the PPS leases were “security agreements”, they were not evidenced in writing as required by s 20(2), thus s 20(1)(b) was not satisfied (see [41]).

(g) Transitional security interests – deemed perfection?

QES contended that its security interest in the Caterpillars had priority as “transitional security interests” which were, it argued, perfected by force of the Act immediately before the registration commencement time (see [42]).

Chapter 9 of the PPSA sets out the transitional rules.

Section 308 defines “transitional security interest” to mean –

“a security interest provided for by a transitional security agreement, if –

(a) in the case of a security interest arising before the registration commencement time – this Act would have applied in relation to the security interest immediately before the registration commencement time, but for section 310 [which provides the Act only starts to apply to security interests at the registration commencement time]; or

(b) in the case of a security interest arising at or after the registration commencement time:

(i) the the transitional security agreement is in force immediately before the registration commencement time provides for the granting of the security interest; and

(ii) this Act applies in relation to the security interest.”

Section 311 provides for the enforceability of transitional security interests against third parties, by applying the law that applied immediately before the registration commencement of the PPSA (which was 1 February 2012):

“Despite section 20, a transitional security interest is enforceable against a third party in respect of particular personal property if it would have been so enforceable under the law that applied to the enforceability of security interests immediately before the registration commencement time, and as if this Act had not been enacted (whether the secuity interest arises before, at or after the registration commencement time).”

Section 320 provides a guide to priority rules for transitional security interests, relevantly –

  • A perfected transitional secuirty interest has priority over an unperfected security interest (whether transitional or not), because of s 55(3)
  • A perfected transitional security interest has priority over a perfected non-transitional security interest, because of ss 55(5), 322 and 322A
  • An unperfected transitional security interest has priority over an unperfected non-transitional security interest, because of sections 55(2) and 321
  • A perfected security interest (whether transitional or not) has priority over an unperfected transitional security interest, because of section 55(3).

Section 322 provides for the deemed perfection of transitional security interests. I note that this provision is likely to be crucial for many transitional security interest holders, although not for the unfortunate QES.

The main rule as to the perfection of transitional security interests, set out at s 322(1) is this –

“A transitional secuity interest in collateral is perfected from immediately before the registration commencement time, whether the security interest arises before, at or after the registration time (including a transitional security interest that arises after the end of the month that is 24 months after the registration commencement time).

Note 1: As a result of this subsection, the priority time for a transitional security interest under subsection 55(4) will be immediately before the registration commencement time, as long as the security interest remains continuously perfected.”

Subsection 322(2) then provides for when a transitional security interest stops being perfected under s 322(1), which is at the earliest of the following times –

(a) when the security interest is perfected by registration under Division 6 (by migration),

(b) when the security interest is perfected by preparatory registration under Divison 7,

(c) when a registration under Division 6 or 7 is amended so that the registration perfects the security interest,

(d) when the security interest is otherwise perfected by registration, or is perfected by possession or control,

(e) when the security interest is otherwise perfected (but not temporarily perfected) by this Act, other than under this section,

(f) the end of the month that is 24 months after the registration commencement time [so after 31 January 2014].

Subsection 322(3) then provides for an exception – that subsections 322(1) and (2) do not apply to a transitional security interest in collateral if the interest is of a class prescribed by regulations made for the purposes of this subsection.

Brereton J explains at [47] that s 322 interacts with s 55 through s 21(1)(a), which provides that a security interest in particular collateral is perfected if the security interest is temporarily perfected, or otherwise perfected, by force of the Act.

Here, Fast and the receivers of Maiden accepted that any security interest of QES in the Caterpillars was a “transitional security interest” within s 308 and that, but for s 322(3), the effect of ss 322(1) and (2) would be to give QES’s security interest priority over Fast’s security interest, even though it was not registered on the PPS register. However, Fast and the receivers contended that s 322(3) applied so as to exclude QES’s interest from protection under s 322.

Regulation 9.2 of the Personal Property Securities Regulations 2010 provides that a transitional security interest is prescribed for the purposes of s 322(3) where it is registrable on a transitional register and where it was not registered on the relevant register prior to the registration commencement time.

Under section 10, “transitional register” has the meaning given it by s 330, which is contained in Division 6 (Migration of personal property interests).

Section 330 provides as follows –

“This Division applies if, at or after the migration time, and before the registration commencement time:

(a) an officer or agency of the Commonwealth, a State or a Territory gives the Registrar data, in relation to personal property, that is held by the officer or agency in a register (a transitional register) maintained under a law of the Commonwealth, a State or Territory; and

(b) the data is given in the approved form; and

(c) the Registrar accepts the data.”

The Northern Territory Register of Interests in Motor Vehicles and Other Goods was a register existing prior to the PPSA, data from which was migrated to the PPS Register within the meaning of s 330. Accordingly, it was a “transitional register” within the meaning of the PPSA.

The Caterpillars, being wholly propelled by a volatile spirit and not used on a railway or tramway, had qualified as “motor vehicles” and thus also of “prescribed goods”, for the purposes of the relevant NT Register Act. A “registrable interest” under the NT Act included a lessor of the prescribed goods, and QES’s interest in the Caterpillars was a registrable interest.

Accordingly, QES’s interest in the Caterpillars as lessor was registrable on a transitional register within the meaning of the PPSA (being the NT Register), but they had not been so registered prior to the registration commencement time. His Honour held at [55] that in those circumstances, the exception in s 322(3) of the PPSA applied, and the protection otherwise afforded to transitional security interests by subsections 322(1) and (2) did not avail QES.

(h) Further arguments by QES

QES ran another argument, to the effect that perfection of its security interest pre-PPSA fell to be determined according to the law of Queensland, not the Northern Territory, and that if the Caterpillars were not registrable on a transitional register in Queensland, then the exception in s 322(3) was not attracted. His Honour at [57]-[68] discussed this argument and the provisions of the PPSA dealing with governing laws for goods, noteably ss 233-238, in particular s 238, and rejected it.

QES ran a further, quite interesting argument that Fast and the receivers had no enforceable right to possession, as Maiden no longer had a right to possession of the Caterpillars (QES having terminated the leases), the receivers’ rights to deal with the Caterpillars deriving from, and being no greater than, those of Maiden. As His Honour observed at [69], the first limb of this submission was, in substance, that the grantor Maiden had a mere right to possession under the leases, that Maiden (and its receivers) have repudiated the lease by denying QES’s title and failing to pay rent, that QES has accepted the repudiation, terminated the lease and re-assumed possession; and accordingly, that neither Maiden nor its receivers nor Fast could have any further right to possession under the lease. The second limb invoked s 112(1) of the PPSA, which provides that in exercising rights and remedies provided by PPSA Chapter 4, a secured party may deal with collateral only to the same extent as the grantor would be entitled to so deal with the collateral.

In rejecting the first limb of this argument, his Honour noted the following –

  • s 267(2) of the PPSA provides that any security interest granted by a corporation that is unperfected at the commencement of its administration or winding up vests in the corporation (at [70]),
  • Thus upon commencement of the administration and/or the winding up of Maiden, QES’s unperfected security interests in the Caterpillars vested in Maiden. There is an exception in s 268(1)(ii) in respect of PPS leases of serial numbered goods, but it did not apply because one or more of s 13(1)(a) to (d) applied, as Maiden as lessee retained possession under the lease for more than a year (at [72]),
  • The practical effect was that QES’s security interest was extinguished; QES had no further interest in the Caterpillars, and Maiden held them subject only to the perfected security interest of Fast (at [72]).

Moreover, his Honour noted that Maiden did not have a mere right to possession under the QES leases, but also proprietary rights to the extent that it could grant security interests to third parties. The PPSA sees such a transaction as, in substance, a security transaction, even though in form it is a lease. Thus it treats the lessee under a PPS lease as the grantor of a security interest with rights in the collateral (the personal property), and the lessor as a security party. His Honour noted that as the Canadian and New Zealand cases show, the PPSA recognises that a lessee may validly and effectively grant security interests in the collateral to third parties, that can take priority over the lessor’s unperfected interest, because the lessee is regarded for that purpose as having rights in the collateral (see [73]). Maiden acquired possessory and proprietary rights in the Caterpillars upon taking possession of them, and granted a security interest in them to Fast under the General Security Deed.

As to the second limb of QES’ argument, invoking s 112 of the PPSA and effectively arguing the nemo dat rule, his Honour dismissed this also and concluded that Fast’s priority entitled it to possession of the Caterpillars, either under the General Security Deed or pusuant to Chapter 4 of the PPSA. He also noted that s 116 of the PPSA provides that Chapter 4 does not apply in relation to property while a person is a controller of the property as a receiver or receiver and manager. His Honour also expressed the view that this was not affected by s 51F of the Corporations Act 2001 (Cth). (See [75]-[82].)

(i) The lien claim of Central or Mr Cullenane

It seemed that one of either Central or Mr Cullenane was in possession of the 320 Caterpillar and claimed a lien, arising from an oral agreement with a Maiden director that Central/Mr Cullenane would have security over unspecified equipment of Maiden for work done by him “said to be” to the value of $60,000. His Honour mildly observed that Mr Cullenane had exercised this purported right to take the 320 as it was the only machine left on the job site that was not locked.

His Honour noted there was no admissible evidence of these matters, and there was nothing to suggest any such interest could prevail against Fast. In particular, s 21(2) did not apply as there was nothing to suggest the interest had been registered, and his seizure of the 320 had not amounted to perfection. Moreover any such security interest being unperfected, it too would have vested in Maiden upon the commencement of its administration and/or winding up, pursuant to s 267 of the PPSA. (See [83]-[85].)

Conclusions

His Honour concluded at [86]-[95] that –

1. Maiden was the true owner of the 320, although QES was the true owner of the 330 and 930.

2. Fast had a security interst in all three Caterpillars pursuant to the General Security Deed, which attached to the Caterpillars, was enforceable against third parties, and perfected by registration.

3. QES had a security interest in the 330 and the 930 as a lessor under a PPS lease. QES had not registered is security interest on the PPS Register. While it was a transitional security interest, it had been registrable on a transitional security register (the NT motor vehicle Register). QES had failed to so register at the relevant time, thus the exception in s 322(3) applied and the protection (of “deemed perfection”) otherwise afforded to transitional security interests in ss 322(1) and (2) did not avail QES.

4. Accordingly, QES’s security intertest was unperfected. In those circumstances s 55(3) applied, such that Fast’s perfected security interest in the Caterpillars had priority over QES’s unperfected security interest in the 330 and 930.

5. Moreover, upon Maiden going into administration and/or liquidaiton, Maiden became entitled to the Caterpillars – subject to the perfected security interest of Fast – because QES’s (and Central’s or Mr Cullenane’s, if any) unperfected secuity interest thereupon vested in Maiden.

6. The Receivers and Fast had enforceable rights of possession of the Caterpillars against those defendants who presently possessed them, flowing from events of default under the General Security Deed having occurred, s 112 not affecting Fast’s entitlements and Chapter 4 not applying.

It will be interesting to see if this decision is appealed. In the meantime, aside from my query mentioned above as to his Honour’s finding that the QES-Maiden lease was a “PPS lease”, as it did not fall within the exclusion in s 13(2)(a), I would anticipate that this judgment by his Honour Brereton J will be relied upon and applied as authoritative. It ought be closely considered by any practitioner advising upon the operation of the PPSA in such circumstances.

This case serves as a stark illustration for any who were not already aware, that the PPSA has changed the playing field significantly when it comes to personal property; particurly as to long-held notions of the primacy of the rights of the owner of personal property leased or bailed to a third party. Where that third party subsequently fails, the rules have been changed fundamentally, when it comes to a competition between a prior, unregistered owner/lessor, and a subsequent registered secured creditor. As I observed at the outset: to put it simply, ownership is no longer king.

Developments – Mistaken payments due to fraud – change of position defence

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1. Citibank v NAB 

In October 2011 I reported on the decision of Hammerschlag J of the NSW Supreme Court in William Co-Buchong v Citigroup Pty Ltd & National Australia Bank Ltd [2011] NSWSC 1199 (link). This was an interesting contest between two banks, neither of which had acted negligently or outside of standard banking practices, and both of which had been the victim of fraud.

In that case, the customers involved were joint account holders with both Citibank and the NAB. Citibank had transferred money via the SWIFT system from its customers’ account on the basis of a fraudulent faxed instruction, to those customers’ account at the NAB. The NAB then also received fraudulent instructions, by way of three International Transfer Application Forms, and paid out the money in three tranches to accounts held in various names at HSBC Hong Kong Ltd.

Citibank’s claim was put as one for restitution. It had paid the money to NAB on the fundamentally mistaken belief that it had been so instructed by its customers. Absent restitution, claimed Citibank, NAB would be unjustly enriched. NAB’s defence was that it changed its position to its detriment by paying away the funds on the faith of the receipt.

Briefly, NAB won; its defence of change of position succeeded. His Honour considered the earlier decisions of the NSW Court of Appeal in State Bank of New South Wales Ltd v Swiss Bank Corporation (1995) 39 NSWLR 350 and in Perpetual Trustees Australia Ltd v Heperu Pty Ltd [2000] NSWCA 84; (2009) 76 NSWLR 195 and held in favour of NAB. Both banks were duped. However Citibank paid first without the customers’ authority as a result of which NAB credited the customers’ account rendering it vulnerable to the fraud to which it succumbed. His Honour remarked that:

“In these circumstances and where neither party criticises the other for falling for the fraud, it would lead to an inequitable result were Citibank to be made whole at the expense of NAB.”

For a more detailed discussion of the analysis, see my earlier post here.

I did not report on this at the time, but on 4 December last year the NSW Court of Appeal (a five judge bench) unanimously dismissed Citibank’s appeal, upholding his Honour’s decision that NAB had established its change of position defence. NAB, as the recipient of the funds from Citibank, had acted in “detrimental reliance” on the receipt “in good faith”, and had thereby displaced Citibank’s prima facie right of recovery for mistaken payment – Citigroup Pty Ltd v National Australia Bank Limited [2012] NSWCA 381.

It is to be noted that in his judgment Barrett JA discusses Hammerschlag J’s view as to three interconnected requirements emerging from State Bank of NSW Ltd v Swiss Bank Corporation (outlined in my earlier post). At [101] his Honour observes that if Hammerschlag J’s formulation limits the information upon which the relevant recipient (here the NAB) can rely to information received from the payer, it is too narrow. It is true that a payer who instructs that the transferred funds be placed to the credit of a particular customer’s account does not expressly sanction subsequent payment out to that customer. But as Barrett JA observes, such payment out is a natural corollary; and sanctioning of it comes from the context in which the transfer is made and the instruction is given, which must recognise that the customer will have resort to the funds in the customer’s own account. As his Honour then says at [102] –

“This emphasises the point that matters of context already known to the recipient may properly be taken into account. As recognised in Port of Brisbane Corporation v ANZ Securities Ltd, action by the recipient that is inconsistent with the payer’s instruction will not be action taken in reliance on or on the faith of the receipt. But as explained in Perpetual Trustees Australia Ltd v Heperu Pty Ltd, the causal link between the receipt and the subsequent action will exist if that action has a foundation of information obtained in connection with the receipt considered in the attendant circumstances.”

Bathurst CJ, Allsop P and Meagher JA agreed (at [5]).

Citibank was left solely liable to bear the whole loss of repaying the funds to its customers. It is not yet clear whether or not Citibank has lodged an application for special leave to appeal to the High Court of Australia.

Interestingly, of the five judge bench of the NSW Court of Appeal who delivered judgments in that case, Macfarlan JA and Barrett JA (who wrote the initial draft judgment to which the others referred) delivered individual judgments, and there was a joint judgment of the remaining three judges – Bathurst CJ, Allsop P and Meagher JA. Those three judges also delivered judgment on the same day, in the next case I discuss below, and refer to it in their joint judgment in Citigroup v NAB.

2. Hills Industries v Australian Financial Services and Leasing 

On the same day, 4 December last year, the NSW Court of Appeal also handed down its judgment in Hills Industries Ltd v Australian Financial Services and Leasing Pty Ltd [2012] NSWCA 380. This was another case where the Court had to choose between two innocent parties, as to who would bear the loss resulting from mistaken payments due to fraud on the part of a third party.

In order to avoid the collapse of the Total Concept Projects group of companies (TCP) a director sought finance from the Australian Financial Services and Leasing Pty Ltd (ASFL). The TCP director in question approached ASFL and fraudulently claimed to be seeking finance for the acquisition of goods from two suppliers. In fact, TCP already owed those suppliers (Hills Industries Ltd and Bosch Security Systems Pty Ltd) considerable sums of money, and the finance was really sought to pay the debts, in order to stave off liquidation. The director Mr Skarzynski created false invoices and AFSL was convinced to pay the money directly to the suppliers for the non-existent goods. The suppliers had been told by TCP that their old debts were being paid by funds obtained from a third party, and processed the payments accordingly.

On the evidence, it was clear that AFSL had made the payments to the suppliers under a mistake (ie that the money was paid to acquire goods TCP sought to purchase) and that the threshold requirements for restitution for mistaken payment existed. For a useful and learned discussion of the relevant principles of restitution for mistaken payment in Australia, I commend you to read the judgment of Allsop P at [66]-[75], and the passages which follow at [76]-[166], discussing the potential defences to such claims and reviewing the authorities in some depth.

The question on appeal was whether relief should be denied, on the basis that the suppliers had established the change of position defence such that they were entitled to retain the money paid to them by ASFL.

The Court of Appeal held that both suppliers had. Although only Bosch had succeeded on this defence at first instance, their Honours held that the payments were received by the suppliers Hills and Bosch in good faith and in the ordinary course of business as moneys owed to them by the TCP companies. They both gave up, to their detriment and on the faith of the receipt, both the debts owing by the TCP companies, and a real and potentially valuable opportunity to enforce or secure payment from them. Having received the moneys, Hills refrained from taking proceedings it would otherwise have taken against Mr Skarzynski and his companies. It also continued to trade with those companies, albeit at a lower credit limit. Bosch, when it received the funds, consented to the setting aside of default judgements that it had already obtained against the TCP companies and abandoned other proceedings then on foot. It refunded certain overpayments to the TCP companies and continued to trade with them, on a COD basis. Those circumstances were such as to make it unjust to order restitution.

It is rumoured that AFSL may be seeking special leave to appeal to the High Court from this judgment, however that is not yet confirmed on the High Court’s website. I will endeavour to keep an eye on the lists.