In Focus - Preferences and Secured Debts SEPTEMBER 2017

f In Focus - Preferences and Secured Debts SEPTEMBER 2017

Preferences and Secured Debts This edition of In Focus continues our series with respect to preferential payments. This article addresses the relationship between voidable preferences and PPSR / retention of title claims as discussed in a recent Federal Court case. A decision of the Federal Court in 2016 Hussain v CSR Building Products Ltd in the matter of FPJ Group Pty Ltd (in Liquidation) [2016] FCA 392 ( the Reasons ) amongst other things considered the relationship between the PPSR Act and Part 5.7B Corporations Act 2001 which prescribes that certain transactions entered into between a company and third parties in the period before liquidation of that company may be voidable as against the Liquidator of that company. Specifically, in his Reasons, Edelman J addressed transactions which were voidable as unfair preferences (section 588FA Corporations Act 2001). Facts FPJ Group Pty Ltd ( the Company ) commenced trading in late 2010. The Company conducted a business of providing building supplies to builders. CSR Building Products Ltd ( CSR ) was one of the suppliers with whom the Company traded to purchase goods for on sale to its customers. On 26 September 2010, the Company entered into a credit agreement with CSR ( the Agreement ). The Agreement included the following salient terms: You agree that any goods you receive remain the property of CSR until CSR receives payment for them. In addition, the terms of sale that accompanied the Agreement included the following clauses: 3. We own the goods until they are paid for. Goods supplied to you remain our property until we receive payment for all amounts you to us. If your account is in default we have the right to enter your premises (or the premises of any associated company or agent) to retake possession of the goods, without liability for trespass or damage. If you resell the goods, or if you sell products manufactured using the goods, then you must keep the proceeds of sale in a separate, identifiable account until we have been paid in full In addition, the Agreement included a clause that the Company charged all real property in which it had an interest (now or in the future) to secure payment of all money owing from time to time. When goods were delivered by CSR to the Company, included with the goods, was amongst other things, the terms of sale which were identical to those attached to the Agreement. Between January 2014 and June 2014, the Company made eighteen (18) payments totalling $153,554.35 to CSR ( the Payments ). It was the Payments which the liquidators of the Company sought to impugn as voidable preference payments. The Company was wound up in insolvency on 18 July 2014. 2

The Reasons The legislative focal point of the proceeding was sections 588FA, 588FC, 588FC and 588FF Corporations Act 2001 and in particular section 588FA Corporations Act 2001 which relevantly prescribes that: A transaction is an unfair preference given by the company to a creditor of the company if, and only if: (a) (b) the transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor more than the creditor would receive from the company in respect of the debt, if the transaction were set aside and the company were to prove for the debt in a winding up of the company (2) For the purposes of subsection (1), a secured debt is taken to be unsecured to the extent of so much of it (if any) as is not reflected in the value of the security In determining the proceeding before him, Justice Edelman determined that there were four (4) issues which he was required to determine, including (a) whether it had been established that the Company was insolvent and (b) whether the debt owing by the Company to CSR was an unsecured debt. In the ultimate result, his Honour found that it had not been established that the Company was insolvent and that in any event, the debts owing by the Company to CSR were secured. It is the second issue addressed by Justice Edelman, specifically whether the debts owed by the Company to CSR were secured to which this presentation is directed. Secured Debt? At paragraphs [6] and [7] of his Reasons, his Honour observed that: Another obstacle to the liquidators case was that a payment will only be an unfair preference under section 588FA(1) (b) of the Corporations Act if there is a transaction which results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor, more than the creditor would receive from the company in respect of the debt if the transaction were set aside (emphasis added). But the credit agreement between FPJ Group and CSR secured the debts. One of the forms of security required by the credit agreement between FPJ Group and CSR was a retention of title clause over all goods supplied until payment was received for them. Each payment of a debt to CSR had the effect of increasing the assets available to creditors by the same amount because the payment caused title to the goods to pass to FPJ Group. In Airservices Australia v Ferrier [1996] HCA 54; (1996) 185 CLR 483, 502, Dawson, Gaudron and McHugh JJ said that to have the effect of giving the creditor a preference, priority or advantage over other creditors the payment must ultimately result in a decrease in the net value of the assets that are available to meet the competing demands of the other creditors. In the Reasons, Justice Edelman directed his attention to two (2) specific issues. The first issue was whether the Payments in respect of an unsecured debt, such that section 588FA(1)(b) Corporations Act 2001 applied. The second issue was, when determining the value of any security in accordance with section 588FA(2) Corporations Act 2001, at what date is the security to be valued? Were the Payments for a Secured Debt? CSR accepted that the Company did not own at any time real property. In the premise, the only assets over which CSR could claim they held security were the goods they supplied to the Company. 3

The Reasoning Process The phrase unsecured debt is not defined in the Corporations Act 2001. In the face of the lacuna of the phrase unsecured debt in the Corporations Act 2001, Justice Edelman proceeded to consider the meaning and concept of secured debt at common law. To that end, his Honour made the following observations in respect of retention of title, the word secures and the phrase security interest : 1. In different instances the word secures can be construed in a wide and a narrow sense (General Motors Acceptance Corp Australia v Southbank Traders Pty Ltd [2007] HCA 19; (2007) 227 CLR 305, 312 [20]); 2. By way of example construing the word secures broadly has resulted in a guarantee from a third party being treated as security (see Singer v Williams [1921] 1 AC 41, 49); 3. Security has also been defined as anything that makes the money more assured in its payment or more readily recoverable (Stroud s Judicial Dictionary); 4. Retention of title has been recognised since the decision of Aluminium Industrie Vaassen BV v Romalpa Aluminium Ltd [1976] 2 All ER 552 (from which decision the common parlance Romalpa Clause has been derived); 5. The genesis of Romalpa or retention of title clauses has been described as being to protect the unpaid seller of goods from the consequences of the buyer s insolvency by the simple expedient of providing that the seller would retain title in the goods until they were paid for (Associated Alloys Pty Ltd v Metropolitan Engineering & Fabrication Pty Ltd (Voluntary Administrators Appointed) (Receivers and Managers Appointed) (1998) 16 ACLC 1633 at 1637); 6. Whilst the Corporations Act 2001 does not define the phrase unsecured debt, in 2010 the definition of security interest (which was in actual fact a definition of PPSA Security Interest) was included in the Corporations Act 2001 which reads as follows: PPSA Security Interest means a security interest within the meaning of the Personal Property Securities Act 2009 to which that Act applies, other than transitional security interest within the meaning of that Act. 7. I interpolate to observe that the notes to section 51 Corporations Act 2001 direct attention to the definition of security interest in section 12 Personal Property Securities Act 2009; 8. The definition of security interest in the Corporations Act 2001 provides an aid to determining the proper construction of the phrase unsecured debt in section 588FA Corporations Act 2001; and 9. In the Second Reading Speech introducing the bill which amended the Corporations Act 2001 to introduce the meaning of security interest, Dr Craig Emerson expressly said that: The third objective is to ensure the Corporations Act treats property provided by a supplier on a retention of title basis as secured property Treating such supplies as secured property is consistent with the PPS scheme s approach of treating transactions that in substance secure payment or performance of an obligation the same way, regardless of the form of transaction. 4

By reason of the time when the Agreement was executed the security interest of CSR in the goods it supplied to the Company was not a PPSA Security Interest, but a transitional security (see section 51 Corporations Act 2001 and paragraphs [151] [153] of the Reasons); Nevertheless, Justice Edelman opined that The timing does not prevent the retention of title clause in that agreement from negating the unsecured nature of the [Company s] debts. Or in other words, the fact that retention of title clause in that agreement not being a security interest pursuant to the Corporations Act 2001 did not mean that the Payments were not secured when made by the Company to CSR. At paragraphs [151] [159] of the Reasons, Justice Edelman undertook an excursion through the relevant provisions of the Corporations Act 2001 and the Personal Property Securities Act 2009 to make good his conclusion that section 51A Corporations Act 2001 did not apply to the Agreement which was a transitional security interest. That excursion need not be repeated in this instance. What is important is that the reasoning of his Honour appears sound and only applies to transitional security interests not security interests to which section 51A Corporations Act 2001 applies. The retention of title clause in the Agreement not being a security interest as defined by section 51A Corporations Act 2001, his Honour turned his attention to the definition of retention of title clause in section 9 Corporations Act 2001 which is defined as: Property is subject to a retention of title clause under a contract for the sale of property: (a) (b) (c) if the contract contains a provision to the effect of which is that the seller retains title in the property until the purchase price, or another amount, has been paid in full; if the purchase price, or the other amount, as the case may be, has not been paid in full; and to the extent that the contract does not give rise to a PPSA security interest in the property. Significantly, a contract which gives rise to a PPSA security interest is outside the definition of property which is subject to a retention of title clause for the purposes of the Corporations Act 2001. By reason of the Agreement in this instance being a transitional security, it did fall within the definition of property subject to a retention of title clause under a contract for sale of property within the meaning prescribed by the Corporations Act 2001. Having articulated that the Agreement was not a security interest, but met the criteria for a retention of title clause in the Corporations Act 2001, his Honour thereafter proceeded to identify instances in the Corporations Act 2001 where the security interests and retention of title clauses had been treated the same (see for example sections 442CB and 442CC Corporations Act 2001). Premised on the similar treatment of both security interests and retention of title clauses, his Honour concluded that the statutory intention was to treat retention of title clauses as securing debts to which those clauses relate for the purpose of section 588FA Corporations Act 2001. 5

The Conclusion Relying upon: (a) the treatment of retention of title clauses as common law as being a form of security; (b) the fact that the Agreement was a transitional security interest and therefore section 51A Corporations Act 2001 did not apply; and (c) the treatment of retention of title clauses and the rights arising from them in the Corporations Act 2001 as equal to or the same as security interests under the Personal Property Securities Act 2009. his Honour concluded that a retention of title clause ought to be treated as security for the purpose of section 588FA(1) (b) Corporations Act 2001. Therefore, the Payments could not be voidable preferences as they were in payment of secured debts. Implications The commentary I have cited addressing this case appears to suggest that the Reasons represent a change in the law and that a creditor of a company with a valid retention of title clause since the introduction of the PPSR has a defence to a claim by a liquidator for a voidable preference payment. I make two (2) observations about those commentaries. First, as disclosed above, the reasoning is only applicable to transitional security interests not security interests which are or ought to be registered pursuant to the Personal Property Securities Act 2009. Secondly, it seems to me that the abovementioned commentaries do not grapple with the issue of determining the extent of the security provided by a retention of title clause and whether that security is equal to, greater or lesser than the amount paid by a company in discharge of a debt. If the security provided by a retention of title clause is equal to the amount paid for the debt, then there could be no preference payment as the creditor is wholly secured. This conclusion ought not to be surprising since it is similar to where a creditor provides goods or services on a cash on delivery basis. If the creditor provides goods to a value of $500.00 to a company and after sale of the goods in question, the company remits $500.00 to the creditor, the payment to the creditor is wholly secured. The same outcome would apply to an instance where the goods subject of a valid retention of title clause were provided by a company to a creditor and in the same period of time, the company received less than the value of the goods. However, where the creditor provides goods the subject of a valid retention of title clause to a company which are of lesser value than the amount of payments they receive, those payments will not be wholly secured and to the extent of any difference between the value of the security and the payments, the creditor will have potentially received a voidable preference payment. All of the above, ought to draw attention to the anterior question of at what date are the goods the subject of a valid retention of title clause to be valued. By reason of the manner in which the proceeding was conducted, on grounds of procedural fairness, the liquidators were not permitted to press their contention that the date to value the goods the subject of a valid retention of title clause ought to be the date of winding up. Nevertheless, Justice Edelman, after identifying that there is very little authority about at what date property the subject of a security interest ought to be valued for the purpose of section 588FA(2) Corporations Act 2001, proceeded to make a number of observations without deciding the issue. 6

His Honour observed that in favour of the argument is the fact that the law of insolvency, and the rationale of section 588FA Corporations Act 2001 is focused upon ensuring equality as between creditors (regularly referred to as the pari passu principle). Therefore, so the argument goes, as the distribution of assets to unsecured creditors in a liquidation (subject to statutory priorities afforded to some creditors pursuant to section 556 Corporations Act 2001) is by reference to the debts that are owed to them at that date, the value of any security ought to be determined as at the date of winding up, not at some other notional winding up on an earlier date (Reasons at [178]). Arguments to this effect found favour in the decisions Walsh v Natra Pty Ltd [2000] VSCA 60; Williams (as liquidator of Scholz Motor Group P/L (In liq) v Peters [2009] QCA 180; (2009) 232 FLR 98. The argument to the contrary is that 588FE Corporations Act 2001 requires a person to pay to the company in liquidation from whom they received a voidable preference an amount that, in the court s opinion, fairly represents some or all of the benefits that the person has received because of the transaction (emphasis added). Justice Edelman opined that since section 588FE Corporations Act 2001 is not concerned with the benefit received and retained then symmetry should require that the security that the person held should also be assessed at the time of the transaction. To that, I humbly add that since the focus of each of the provisions addressing voidable preference payments is upon the transaction between the company and a creditor, there is substantial force in the argument that the assessment of the value of security ought be undertaken at the time of the payment which constitutes the transaction as a reflection of the purpose of the provisions and in application of the ultimate effect doctrine described above in the decision of the High Court of Australia in Airservices Australia v Ferrier [1996] HCA 54; (1996) 185 CLR 483, 502, Dawson, Gaudron and McHugh JJ. Admittedly, an argument of a similar sentiment was raised by Justice Edelman, albeit from a different perspective, in paragraphs [181] [188] of the Reasons. However, his Honour did not fully explore the matter or express a final view where the matter was not fully argued before him. Conclusion In conclusion, it is the case that Justice Edelman concluded that a creditor who has a contract with a company which contains a valid retention of title clause which contract is not caught by the definition of security interest within the meaning of section 51A Corporations Act 2001 receives payments from a company they are not unsecured debts for the purpose of section 588FA Corporations Act 2001. It seems to me that the abovementioned conclusion is uncontroversial and a restatement of settled law. However, what remains is the open and vexed question as to the time at which the assets secured by a valid retention of title clause are to be valued for the purpose of section 588FA(2) Corporations Act 2001. Until that question is resolved, holders of security interests in the form of retention of title clauses remain at risk of having payments received by them from a company entering liquidation who enters into liquidation within six (6) months of that payment being clawed back as voidable preference payments. The same observation applies equally to creditors who have a registered PMSI purchase money security interest. 7

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