A scrappy defence sees administrators personally liable

Articles, Restructuring + Insolvency

The decision of the Supreme Court of New South Wales in THC Holding Pty Ltd v CMA Recycling Pty Ltd [2014] NSWSC 1136 (THC Holding) acts as a reminder that the Personal Property Securities Act 2009 (Cth.) (PPSA) is not always the final word on ownership, and administrators should obtain legal advice before selling property when its ownership is in dispute.

In the THC Holding decision, voluntary administrators were ordered to pay damages for selling someone else’s property in the mistaken belief that title had vested under the PPSA.

The facts

THC was a scrap metal reseller. CMA and SIMS were scrap metal recyclers.

In early 2013, THC ordered and paid for 5,800 metric tonnes (MT) of scrap metal from CMA. However, CMA was unable to fill the order and there was a shortfall of 1,376 MT, which CMA was obliged to deliver later.

In order to make up the shortfall, THC did a deal with CMA and SIMS (another supplier): SIMS would supply the missing 1,376 MT to THC straight away, and CMA would then build up an equivalent amount of scrap on behalf of THC and eventually use it to “pay back” SIMS.

SIMS duly supplied the shortfall, and CMA slowly began to accumulate the scrap metal earmarked for THC in a separate pile in its yard. When enough scrap had accumulated, CMA advised THC and SIMS that it was ready for collection. SIMS inspected the scrap and, on 2 August 2013, confirmed it was acceptable.

On the same day, administrators were appointed over CMA. This is where complications arose. One of CMA’s regional managers warned the administrators that the 1,376MT of scrap in the SIMS pile belonged to THC. THC’s solicitors also wrote to the administrators and put them on notice. The administrators responded to THC asserting that CMA owned the scrap. Without any further notice, they then proceeded to sell it to a third party.

THC commenced proceedings against both CMA and its administrators.

Ownership of the 1,376 MT of Scrap

One of the preliminary issues to be decided concerned the ownership of the 1,376 MT of scrap (irrespective of any PPSA issues). CMA and its administrators said that title to the pile of scrap had always remained with CMA and never passed to THC in the first instance. THC’s position was that it owned the scrap the moment CMA advised that it was ready for collection.

After reviewing the authorities the court decided that ownership of the pile of scrap passed to THC the instant SIMS inspected the scrap and accepted that it was of the quality and quantity specified. From the perspective of the PPSA, the starting point was therefore that THC owned the scrap, but it was in CMA’s possession at the time of the administrators’ appointment.

Application of the PPSA

The Judge decided that THC’s interest in the scrap was not a “security interest” within the meaning of section 12 of the PPSA and that as such the Act did not apply in this case.

The breach of section 442C

Section 442C of the Corporations Act 2001 (Cth) says an administrator ‘must not dispose of … property of the company that is subject to a security interest’ unless the disposal is:

  • In the ordinary course of business; or
  • With written consent of the secured party; or
  • With court approval.

Given that THC owned the scrap metal, the administrators clearly breached section 442C when they sold it as part of CMA’s plant equipment and stock.

The Breach of Fiduciary Duty and Knowing Assistance

Once ownership of the 1,376 MT of scrap passed to THC, CMA became a ‘bailee for reward’. Ordinarily, such a bailee does not owe a fiduciary duty to act in good faith.

The agreement between THC and CMA, however, specifically stated that CMA would hold the scrap ‘in good faith in the yard’. In other words, CMA had contracted into owing a fiduciary duty. Selling THC’s scrap to a third-party clearly breached that duty.

The real question was whether the administrators had knowingly assisted that breach. That would usually require proof of a ‘dishonest or fraudulent design’.

However in Grimaldi v Chameleon Mining NL (No 2) [2012] FCAFC 6, it was held that:

[245] …where the third party knowingly induces or procures a breach of trust or breach of fiduciary duty whether for his or her own, or for another person’s, benefit. As with corporate alter ego cases, it is not necessary to show any dishonest or fraudulent design…

The court relied on this and found the administrators had no hope of escape; they knowingly assisted the breach of fiduciary duty by causing CMA to sell the scrap.

The remedies

The court held that compensation should be awarded and that the administrators should be personally liable because:

[198] …[they] chose to sell the 1,367 MT knowing that there was a dispute about CMA’s title to those goods, and without notification to THC. That was robust conduct… That conduct is, in my opinion, sufficient to attract accessorial liability and to impose on the administrators an obligation in equity to account for their conduct.

Take away points

We are now all well accustomed to the (once astonishing) notion that the legal ownership of property in third party possession can pass to the third party under the “PPS lease” provisions of the PPSA.

This case reminds us that the PPSA is not always the last word on the passing of ownership and that, if the PPS lease provisions are not enlivened, the old rules relating to ownership still apply.

For more information please contact ERA Legal.

 

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