Set Off Clauses In Franchise Agreements: Not As Effective Under The PPSR

By Alicia Hill, Principal, Dispute Resolution and Insolvency, MST Lawyers

Most franchise agreements contain a ‘set off’ clause allowing the Franchisor to set off any payments its needs to make to the Franchisee against any amounts the Franchisee owes the Franchisor during the course of the franchise relationship and in some instances post termination.

In addition section 533 of Corporations Act 2001 (Cth) and section 86 of the Bankruptcy Act 1966 (Cth) provide for set off of mutual debts, mutual credits or mutual dealings in situations where a liquidator or bankruptcy trustee is appointed to one of the parties

However the recent case of Hamersley Iron Pty Ltd and Forge Group Power Pty Ltd (In Liquidation) (Receivers and Managers Appointed) [2017] WASC 152, shows that it is not always possible to rely on any contractual set off clause or the s553 Corporations Act or s86 Bankruptcy Act statutory offset regimes against a Liquidator appointed to the other contracting party.

The Facts

In 2012 Hamersley and Forge entered into two contracts. Forge agreed to perform the engineering, procurement and construction of two power stations on behalf of Hamersley. Each contract incorporated a set of general conditions.

In the General Conditions of the contracts there was a clause stating:

[Hamersley] may deduct from monies otherwise due to [Forge]:

1. Any debt or other monies due; and
2. Any claim to money which [Hamersley] may have against [Forge] whether for damages (including liquidation damages) or otherwise, under or in connection with the contract.

 Hamersley also relied upon Clause 17.9 of the contracts which provided:

If the … works have been taken out of [Forge’s] hands … [Hamersley] is, without limiting any other rights it has under the contract or at law, entitled to:

1. cease to make any further payments due and owing …;
2. treat all sums of money otherwise due [Forge] which may be in the hands of [Hamersley] as security for all money which accrued to [Hamersley… and for all claims which [Hamersley] may sustain or incur in the consequence of [Forge’s] default or the termination of the contract;
3. recover from [Forge] any money paid in excess of [Forge’s] entitlement for the works satisfactorily executed …; and
4. recovery from [Forge] any claims which [Hamersley] may have sustained or incurred on termination of the contract.

 Forge commenced work under the contracts in 2012.

On 2 July 2013 Forge entered into a Facility Agreement with the Australia and New Zealand Banking Group Limited (ANZ) and a General Security Agreement (GSA) with ANZ Fiduciary Services Pty Ltd. The GSA was registered on the Personal Properties Securities Register on 2 July 2013.

On 11 February 2014, the directors of Forge appointed Administrators. On that same day, ANZ appointed Receivers and Managers pursuant to the GSA to Forge.

Each contract came to an end on 24 February 2014.

On 18 March 2014 Forge’s creditors resolved that Forge be wound up and that the Administrators be appointed joint and several liquidators of Forge.

Forge’s liquidators sought payment from Hamersley of approximately $77,273,090.01 for progress payments for work undertaken by Forge and wrongful amounts called upon from Forge’s performance securities.

Hamersley sought to have claims totalling approximately $633,575,000 arising from breach of the contracts between it and Forge admitted in the winding up of Forge.  Hamersley’s case was that its claims far exceed Forge’s claims and so it is entitled to set off its claims against Forge’s claims and prove for the balance owing in the liquidation.

The Court’s ruling

The Court was asked to consider if the contractual right to ‘set-off’, an equitable right to set-off, or the statutory scheme under s533 of the Corporations Act could be applied to permit Hamersley to set-off its claims against Forge’s liquidator’s claims.

The Court found that:

1. the contractual clause was a ‘set-off’ clause. The right to be paid was money due to Forge unless Hamersley had exercised its rights. Set-off did not occur automatically. As Hamersley had not exercised those rights as at the date of appointment of the administrators the contractual clause was not operative and could not later be relied upon to set-off amounts between the two companies;
2. the s533 statutory regime for set-off where a liquidator was appointed was a self-contained Code. This meant that it in situations where there was a mutual credits, mutual debits or mutual dealings set- off can occur if the party claiming set-off against the company’s liquidator can prove the ‘mutual’ nature of the interaction with each other. If mutuality could not be proved then no right to set-off under section 533, in contract or equity is available and the liquidator could recover the full amount claimed.
3. Hamersley’s claims for set-off against Forge were found not to be a mutual claim between the same parties. Forge’s entrance into the facilities agreement with ANZ, followed by the grant and registration on the personal property securities register (PPSR) to ANZ of a GSA over Forge’s business assets caused a proprietary right in those assets to be granted to ANZ pursuant to the terms of the Personal Property Securities Act 1999 (Cth).
4. In effect this meant that the party Hamersley’s claims were sought to be set-off against was not Forge, it was ANZ. Thus there was no mutual credit, debit or dealings between the parties.  As such, no right to set off existed under s533 of the Corporations Act.
5. Hamersley could not set-off under contract, equity or s533 Corporations Act the $633 million it was claiming as breach of contract by Forge and could only lodge a proof of debt in the winding up of Forge to try and recover some of that amount. Hamersley was required to pay the $77 million claimed by Forge’s liquidators.

 What does this mean for franchise systems?

 Contractual rights of set-off will only operate effectively if exercised before the appointment of a liquidator. Once a liquidator or bankruptcy trustee is appointed s533 Corporations Act or s86 Bankruptcy Act will apply to rights of set-off.

 An alternate to a ‘set-off’ clause, known as a ‘net benefit payable’ clause might be considered to be a more appropriate clause to use in franchise agreements dependent upon the type of business, the frequency of the credits or debits that occur between the contracting parties, trade practice and public policy considerations.

 In instances after entering into a franchise agreement where a party registers a GSA or other security interest on the PPSR, that registration will remove the ability to rely on s533 of the Corporations Act or s 86 of the Bankruptcy Act set-off provisions where liquidation/ bankruptcy occurs.

 An option to address this may be as simple as registering first a PPSR interest in the rights arising under the franchise agreement (where possible) to ensure the ability to effectively assert rights against a liquidator or bankruptcy trustee should the need arise.

 If you would like to discuss any aspect of this article further, please do not hesitate to email Alicia Hill or call +61 3 8540 0200.