My article commenting on the case Re O’Keeffe Heneghan Pty Ltd (in liq) (No 2) [2018] NSWSC 1958 has been published in the Journal of Banking and Finance Law and Practice.
Constructive trusts, proceeds and the priority rules in the Personal Property Securities Act 2009 (Cth)
Case comment on In the matter of O’Keeffe Heneghan Pty Ltd (in liquidation); Aus Life Pty Ltd (in liquidation); Rocky Neill Construction Pty Ltd (in liquidation) trading as KNF Group (a firm) (No 2) [2018] NSWSC 1958.
Linda Widdup
Barrister & Solicitor/Consultant
This comment concerns the case In the matter of O’Keeffe Heneghan Pty Ltd (in liquidation); Aus Life Pty Ltd (in liquidation); Rocky Neill Construction Pty Ltd (in liquidation) trading as KNF Group (a firm) (No 2)[1] (O’Keeffe). At issue was a priority dispute between two secured parties each with a security interest in certain funds of an insolvent partnership, both of which security interests were subject to the Personal Property Securities Act 2009 (Cth) (PPSA). Therefore, the PPSA’s priority rules apply to govern the dispute. However, the Court in O’Keeffe imposed a constructive trust over the funds on the basis of a breach of fiduciary duty. The imposition of the constructive trust gave priority to one secured party, whereas the strict application of the rules in the PPSA may have produced a different result to give priority to the other secured party. The question that this decision raises is whether it was appropriate for the Court to impose a constructive trust rather than apply the rules under the PPSA. Is the imposition of a constructive trust an alternative to applying the rules under the PPSA?
The O’Keeffe case
In O’Keeffe, the three companies in liquidation operated as a partnership (Partnership). In 2013, each of the companies and the Partnership granted security to Commonwealth Bank of Australia (CBA) over all present and after-acquired property. While CBA perfected its security interest in the assets of each of the companies by registering a financing statement on the Personal Property Securities Register (PPSR), it did not register a financing statement with respect to the assets of the Partnership. In 2016, the Partnership granted to IFG Network Australia Pty Ltd (IFG) a security interest in all of the Partnership’s present and after-acquired property including specifically its receivables to secure debts owing to IFG. IFG perfected this security interest by registering a financing statement on the PPSR.
In 2017 with its insolvency impending, the Partnership transferred from its account with CBA $240,000 dollars to an account, also held with CBA, of Rocky Neill Construction Pty Ltd (RNC) one of the partner companies. As the Partnership’s assets, these funds were subject to the security interests of both CBA and IFG. The funds were then transferred to an offshore bank account through OzForex Ltd (OzForex). This transfer failed and OzForex repaid the funds to the liquidators of RNC. IFG appointed receivers over the assets of the Partnership and claimed the OzForex funds as property belonging to the Partnership and subject to IFG’s security interest.
The Court accepted that the payments by the Partnership to RNC were made in breach of the fiduciary duty owed by the companies to the Partnership. IFG requested that the Court impose a constructive trust as a remedy for the breach, the effect of which would return the funds to the Partnership as Partnership assets. CBA contested the imposition of the constructive trust alleging that IFG was relying on the constructive trust to improve its security position over CBA’s security position, even though, the Court’s ultimate imposition of the constructive trust handed priority to CBA.
In the alternative, IFG claimed its security interest in the transferred moneys could be traced into the funds in RNC’s account as proceeds under ss 31 and 32 of the PPSA. IFG wanted a declaration to that effect. Although the Court addressed the operation of these sections, Black J stated:
I do not consider it necessary to determine this claim or make the declaration sought by the Plaintiffs in respect of it, where I would order the return of the OzForex Monies to the Partnership consequential on my finding that a constructive trust should be imposed, and the declaration sought by the Plaintiffs would not resolve the priority dispute that exists as between CBA’s and IFG’s claims to the OzForex Monies.[2]
It is true that a declaration that IFG’s security interest could be traced into funds as proceeds under ss 31 and 32 would not resolve the priority dispute. However, the application of the comprehensive priority rules in the PPSA would have resolved the priority dispute without resorting to the imposition of a construction trust. The only PPSA priority rules that the Court did apply were those that gave priority to CBA on the basis that it had control over the funds in the Partnership account.[3] These rules were applied only after the imposition of the constructive trust essentially “returned” the funds to the Partnership account. However, the remaining PPSA priority rules were overlooked once the Court seized on the remedy of constructive trust.
The PPSA’s priority rules
If the application of the priority rules under the PPSA provides an answer to a priority dispute, it is unlikely that the imposition of a constructive trust is appropriate.[4] It is true that the PPSA is not a code and requires the general law to support it. Section 254(1) states:
This Act is not intended to exclude or limit the operation of any of the following laws (a concurrent law), to the extent that the law is capable of operating concurrently with this Act:
- a law of the Commonwealth (other than this Act);
(b) a law of a State or Territory;
(c) the general law.
“General law” is defined in s 10 to mean the principles and rules of the common law and equity.
The query raised by this case, then, is whether the constructive trust is capable of operating concurrently with the PPSA when an answer to a priority dispute can be found within the four corners of the statute obviating any need to impose a constructive trust. This is a particularly vexing question in this case because if we accept the Court’s finding that the funds are proceeds for the purposes of the PPSA, an argument can be made that the application of the PPSA’s rules would have given priority to IFG, not to CBA.
The Court accepted that if the funds remained in the Partnership account, then CBA would have priority over IFG despite the fact that it failed to register on the PPSR against the Partnership’s assets. As alluded to above, CBA had perfected its security interest in the Partnership’s accounts by control[5] which gave it priority over any other security interest in the account regardless of the fact that it was not registered on the PPSR.[6] The imposition of the constructive trust in effect landed the moneys back into the Partnership account over which CBA had control. CBA thus had priority over the funds. The Court reasoned that CBA would have had priority over IFG in the funds in the Partnership account if they had not been transferred to RNC and then to OzForex so the imposition of the constructive trust did not affect CBA’s priority position as CBA had alleged.
However, the fact of the matter is that CBA lost control over the funds once they were transferred out of the Partnership account. The PPSA contains answers to resolve this contingency. How would the priority dispute be resolved under the PPSA if the Court had not imposed the constructive trust to plant the moneys back into the Partnership’s bank account with CBA?
If the transferred funds are “proceeds” under the PPSA…
The Court accepted that the transfer of the funds by the Partnership to RNC’s account and then to OzForex and the liquidators gave rise to proceeds, and that both CBA’s security interest and IFG’s security interest attached to the funds in the hands of the liquidators as proceeds. However, as discussed above, the Court found it was unnecessary to continue this point due to the imposition of the constructive trust. If we set aside the constructive trust and apply the PPSA, does the result change?
Assuming for the moment that the funds in the hands of RNC or OzForex or the liquidators are, indeed, proceeds for the purposes of the PPSA as the Court accepted, then s 32(5) provides that the time of perfection of the original collateral (that is, the CBA bank account) is the time of perfection in relation to the proceeds of the collateral. If this is the rule, then CBA’s security interest will have priority as it was perfected by control in 2013 while IFG’s security interest was perfected by registration in 2016.
However, the transfer of the funds out of CBA’s bank account means that CBA no longer had control over those proceeds, and CBA’s security interest was no longer perfected by control. Section 33(1) states that a security interest in proceeds is perfected only if a registration describes the proceeds or a registration covers the original collateral. CBA did not have a registration with respect to the Partnership. Therefore, it is arguable that CBA’s security interest in the proceeds is not perfected, in which case, IFG has priority because it has a registration perfecting the original collateral and the proceeds.
Section 33(2) also relates to CBA’s security interest in proceeds. It states that if a security interest in original collateral is perfected (that is, CBA’s security interest in the Partnership’s bank account perfected by control), but a security interest in proceeds is not perfected (CBA’s security interest in the funds transferred out of the Partnership’s bank account due to the lack of registration), then the security interest is temporarily perfected for a 5 business day period after the transfer. If the security interest in the proceeds is not perfected within those 5 business days, then it becomes unperfected. Once the funds were transferred to OzForex, CBA did not have a perfected security interest in the transferred funds unless it registered within 5 business days. Therefore, under this rule, as CBA did not register, its security interest in the funds became unperfected. IFG’s security interest in the proceeds was perfected by a registration so it would have priority.
If the transferred funds were not “proceeds” under the PPSA…
The above analysis applies if the transferred funds were, indeed, proceeds for purposes of the PPSA. But as summarily raised by the liquidators, the transferred funds were not proceeds. The Court declined to deal with this submission because it was unnecessary due to its finding of the constructive trust. However, if the Court applied the rules in the PPSA instead of imposing a constructive trust, then it may have found that the transferred funds were not proceeds.
Section 31(1) defines proceeds as identifiable or traceable personal property “that is derived directly or indirectly from a dealing with the collateral”. Thus, proceeds do not arise without a dealing with the original collateral that gives rise to a replacement asset for the grantor. For example, if the grantor sells an asset subject to a security interest, the sale gives rise to an account owing from the purchaser of the asset. This account is property of the grantor to which the security interest in the original asset will attach. In this case, the Partnership as the grantor of the security interest transferred the funds gratuitously to RNC. No replacement asset was derived directly or indirectly from this dealing. Therefore, the gratuitous transfer of the funds to RNC now in possession of the liquidator cannot be proceeds for the purposes of the PPSA.
To further substantiate this point, the PPSA’s meaning of proceeds provides that personal property is proceeds only if either the grantor has an interest in the proceeds or the grantor has the power to transfer rights in the proceeds to the secured party.[7] By transferring the funds to RNC, the Partnership divested itself of any interest in the funds or any power to transfer rights in the funds.
Although the Partnership divested itself of any interest in the funds, it did so with both CBA’s and IFG’s security interests attached. As a result, the security interests remained attached to the funds when acquired by RNC and when acquired by the liquidator. Section 32 states that if collateral is dealt with giving rise to proceeds, the security interest will continue in the collateral unless the secured party expressly or impliedly authorised a disposal giving rise to the proceeds. Although the facts suggest that neither CBA nor IFG provided any such authorisation, s 32 does not apply because the disposal of the funds by the Partnership to RNC did not give rise to proceeds. However, the security interests continue in the funds once transferred to RNC on a simple application of nemo dat quod non habet. As confirmed by s 254 set out above, the principle of nemo dat survives the enactment of the PPSA if it is capable of operating concurrently with the provisions of the PPSA. None of the “taking-free” rules in Part 2.5 of the PPSA apply to cut off the security interest when it was transferred by the Partnership to RNC.[8] Therefore, RNC received the funds subject to both security interests.
The funds once transferred out of the Partnership account are not proceeds for the purposes of the PPSA, but the funds remain subject to the security interests of CBA and IFT in the hands of the liquidator. We now must look further into the PPSA’s comprehensive priority rules to find a resolution to the priority dispute between CBA and IFG. Section 34 addresses this dispute. It states that if collateral is transferred, and at the time of the transfer a secured party held a perfected security interest in the collateral, the security interest remains perfected for a temporary period. Both CBA and IFG had a perfected security interest in the funds in the Partnership’s bank account, CBA by control and IFG by registration. Section 34 provides that CBA’s security interest will be temporarily perfected for a period of 24 months from the date of the transfer while IFG’s security interest will remain perfected until the date shown as the end time on the registration. Therefore, based on the facts presented in the decision, it seems that both security interests remained perfected at the time the funds were paid to the liquidator. As CBA perfected its security interest in the bank account by control in 2013 and IFG perfected its security interest in the bank account in 2016, CBA has priority.
Conclusion
If it is appropriate to impose a constructive trust rather than apply the rules of the PPSA (arguable), then CBA has priority over the funds as found by the Court. If, however, as suggested, the rules of the PPSA should be applied and, as found by the Court, the funds are proceeds, then the rules seem to apply to give IFG priority over the funds. If, however, as further suggested, the funds are not proceeds for the purposes of the PPSA, then the rules in the PPSA apply to give CBA priority. Although this latter application of the PPSA’s priority rules provides the same result as the Court’s imposition of the constructive trust, imposing a constructive trust is not necessary or, arguably, appropriate, when the rules in the legislation provide a resolution to the priority dispute.
[1] [2018] NSWSC 1958.
[2] O’Keeffe, [23].
[3] Sections 25, 57 and 75 deal with perfection by control and priority of security interests in an ADI account such as that held by CBA. ADI is short for authorised deposit-taking institution and defined in s 10 to have the same meaning as in the Banking Act 1959. ADI account is defined as an account with an ADI that is payable on demand or at some time in the future as agreed between the ADI and the keeper of the account.
[4] In the Canadian PPSA context see Jacob S Ziegel, “The Unwelcome Intrusion of the Remedial Constructive Trust in Personal Property Security Law: Ellingsen (Trustee of) v. Hallmark Ford Sales Ltd” (2001) 34 Canadian Business Law Journal 460; Roderick J Wood, ‘Supplementing PPSA Priorities: The Use and Abuse of Common Law and Equitable Principles’ (2014-2015) 56 Canadian Business Law Journal 31; John J Chapman, ‘Mistake, Sharp Practice, Equity and the PPSA’ (1999) 78 Canadian Bar Review 71.
[5] PPSA, s 25.
[6] PPSA, ss 57 and 75.
[7] PPSA, s 31(3).
[8] Part 2.5 comprises ss 41 – 53. In certain circumstances a “buyer or lessee” for value will acquire property free of a security interest. However, these rules have no application to the transfer from the Partnership to RNC as RNC is not a buyer or lessee for value.