You have a dispute and monies are paid by the other side into a Trust Account or held in Escrow, pending an outcome. You win and then they go broke – NOW WHAT?

You have a dispute with another party and by agreement between the parties or via order of the Court the other side is required to pay money into your lawyer’s trust account as security pending a result, BUT after payment they go broke. Successful litigant keeps the money in trust, yes?

Read on, the answer may not be what you suspect…

The Personal Property Securities Act 2009 (Cth) (“PPSA”) has had a wide-ranging and profound impact since its introduction. It touches many different areas, however a less obvious area it affects are trust and escrow arrangements concerning monies paid by one party as security for a claim, costs or their obligations under an agreement (e.g. rental deposit under a lease).

A Supreme Court decision of Dalian Huarui Heavy Industry International Company Ltd v Clyde & Co Australia [2020] WASC 132 sheds some light on this area.

Summary of Facts

There was a dispute between the plaintiff (Dalian) against the second defendant (Duro) and it was being determined by an international arbitration seated in Singapore (‘Tribunal’).

A Procedural Order 15 (‘PO 15’) was issued by the Tribunal, on 30 September 2019.  By PO 15 the Tribunal granted Dalian’s application seeking security for its claim.  The Tribunal duly ordered that Duro pay $AUD27 million (“Trust Amount”).

The Tribunal by PO 15 largely left it to the parties to agree to a process to give effect to its orders.  Hence, the execution of the Trust Agreement that followed. The Trust Agreement provided “The Trustee [ie, Clyde & Co] may only release or pay the Trust Amount, or any part of the Trust Amount, in accordance with a written direction addressed to the Trustee signed by a below named partner of both Squire Patton Boggs and Clyde & Co or a direction of the Tribunal in the Arbitration …”

The Trust Funds were paid into the trust account of Clyde & Co (“Trustee”) on 28th October, 2019. On the 19th December, 2019 the Tribunal held in favour of Dalian for approx. $AUD53 million.

On 24th January, 2020 the Tribunal issued its PO 17 under which it determined, amongst other things, “[t]hat the Trustee, in accordance with clause 4 of the Trust Agreement, upon receipt of this written direction, must immediately release the Trust Amount, being AUD 27 million, to [bank account nominated by the Plaintiff]”.

Clyde & Co in its capacity as trustee, was concerned that a transfer of the Trust Monies may expose Clyde & Co (and Dalian) to claims by creditors of Duro that would otherwise have benefited from the funds held in trust’ and does not release the funds from trust.

An application was filed in the Supreme Court of Western Australia on 25 February, 2020 to seek direction for the Trustee under the Trustees Act in relation to the Trust Funds.

On February 28, 2020 Duro appointed KordaMentha as voluntary administrators. The Administrators for Duro argued that the Trust Amount is part of the property of Duro and therefore should not be paid to Dalian, for it contended that pursuant to Part 5.3A of the Corporations Act 2001 (Cth) (“Act”) it should now be part of the property subject to the administration.

Before we get to Justice Martin’s decision we need to look at the reasons why trust and escrow agreements are used in such matters.

Trust and Escrow

Parties traditionally have entered into trust and escrow arrangements to effectively place monies/assets in a holding pattern until certain and specified pre-conditions come to fruition. In a way, no one has legal title to the asset until the pre-conditions are satisfied.

The assets are held on trust for either party. This is an equitable right to the asset. However, upon the circumstances of the trust or escrow being satisfied, the trustee or escrow holder would then transfer the assets to the rightful recipient. The equitable interest in the assets by the other party disappears and the successful party’s equitable interest then evolves into a legal right to the asset. Legal title will usually trump an equitable interest in assets. Parties have concerns that the other side does not have the means to satisfy the claim and if the other side goes into administration or liquidation that any funds that were available or set-aside to cover the damages or costs of the dispute would be lost to an administrator or liquidator of the other side. This is why trust and escrow arrangements are popular for the monies are intended to held on trust for both parties and should only be distributed upon the pre-conditions being satisfied. This effectively was used and intended to prevent an administrator or liquidator of a party from automatically taking  the funds and leaving the other side with the miserly position of lodging an unsecured creditor’s proof of claim.

Applying this line of logic, the Administrator had an equitable interest in the Trust Amount, and conversely Dalian could argue it had an equitable interest in the Trust Funds and that same would be determined once the preconditions of the trust had been satisfied. In this case, “in accordance with a written direction addressed to the Trustee signed by a below named partner of both Squire Patton Boggs and Clyde & Co or a direction of the Tribunal in the Arbitration …”

Based on the above, it seems obvious that the Administrator would have no interest in the Trust Amount upon the Tribunal finding in favour of Dalian, but the Administrators raised the impact of Section 267 of the PPSA.

Section 267 PPSA

Under Section 267 of the PPSA, a secured party’s security interest that is unperfected prior to appointment of an Administrator over the property of the Grantor will vest in favour of the Grantor immediately prior to the Administration.

In this matter, it was argued that:

(a)        The Trust Amount was “personal property” of Duro as it was provided as security by Duro as the Grantor in favour of Dalian as the Secured Party;

(b)        The secured party failed to perfect its security over the Trust Amount by failing to register its security interest on the Personal Property Security Register (“PPSR”);

(c)        The unperfected security vested in favour of the grantor; in essence, the Trust Amount belonged to the Administrator and was not to be released to the successful party, Dalian.

The PPSA does not define an interest in a trust as a security interest, and a beneficial interest under a trust does not automatically require all beneficiaries to register a security interest over the trust or trustee.

However, the PPSA does include an interest in a trust as “personal property”. In this case Justice Martin held that Duro had an equitable interest in Trust Amount and this was “personal property”.

Justice Martin then had to consider whether there was a “security interest” over the Trust Amount. His Honour referred to Section 51A of the Act where “security interest” is defined as a PPS security interest, or a charge, lien or pledge. Section 12(1) PPSA defines ‘security interest’ to a ‘transaction’ that in substance secures payment or performance of an obligation.  His Honour was satisfied that the Australian arrangements by the Trust Agreement that led to the payment by Duro of the Trust Amount under the Trust Agreement met that definition.

A method under the PPSA to perfect a security interest is to register it on the PPS Register. In this matter Dalian failed to register its security interest over Duro. On the face of it, Dalian’s unperfected security interest would have vested in favour of the Administrator and the Trust Amount would have been paid to the Administrator. Dalian would have been left making a claim for the full amount as an unsecured creditor.

His Honour then focused on whether the “security interest” was perfected by possession or control upon the Tribunal issuing on the 24th January, 2020 Procedural Order 17 which determined for the trustee (Clyde & Co) to immediately release the Trust Amount to Dalian. His Honour correctly held that perfection by control over the Australian Deposit taking Institution account that held the Trust Amount was not applicable as such “control” is reserved for an Australian Deposit taking Institution (e.g. Bank).

His Honour did hold that Dalian did perfect its security interest over the Trust Account by “possession” for the trustee, Clyde & Co, post 24 January 2020, was for the purposes of s 24(2) PPSA ‘another person’ who then on behalf of Dalian (as the PPSA ‘secured party’), held (and actually then possessed) the Trust Amount (the PPSA ‘property’), then solely on behalf of Dalian – as a fully vested beneficiary of those funds.

His Honour referred to applying the “PPSA’s extended definition of ‘possession’, by reference to s 24(2) of the PPSA.” The author respectfully disagrees with this interpretation and application of “possession” to extend to intangible assets, be that a chose in action, debt or interest in monies held in a trust account. The Australian PPSA is largely based on the Canadian and NZ PPS legislation and their cases provide guidance on the application and interpretation of the PPSA in Australia. The Ontario Supreme Court of Justice case in Fairbanx Corp v Royal Bank (2009) 15 PPSAC (3d) 265 held that intangibles could not be perfected by possession which gives rise to the concept of possession by control under the PPSA.

Fortunately for Dalian, Martin J held that Dalian’s security had ‘perfected’ upon the issuance of the monetary award which occurred before Duro went into voluntary administration. This was because the monetary award, supported by an order from the tribunal directing Clyde & Co to ‘immediately’ release the trust amount, transformed Dalian’s contingent equitable interest into a fully vested equitable entitlement to the trust amount. Duro’s residual equitable interest had been extinguished. On that basis, the Court rejected other arguments by Duro that the funds were captured by s 440B of the Corporations Act which would prohibit a transfer of any property in which Duro had an interest following the commencement of the voluntary administration without the consent of the administrator or the leave of the Court. Had the award been granted after Duro went into VA, then this may have invalidated Dailin’s ability to recover the funds.

Conclusion

This case highlights the risk one takes when trying to solely rely on trusts or escrow as a form of security. Drafting may enable you to clearly define and show that the relationship between the parties and the asset is one of trust, without a security interest being in play. However, ask yourself or your client this simple question: “Why did this money get paid into the trust account?” If their answer in any way uses the words “as security for” then you are going to have a very difficult time arguing that the PPSA will not apply.

It is advisable to play it safe under such circumstances and register a security interest over such monies over the other party and do so within the timeframes required under the PPSA (e.g. within 20 business days of the agreement coming into effect if the other side is a company, etc…).

If you have such an escrow or trust arrangement in place concerning a dispute (e.g. security of costs, damages, rental bond, etc…) then you should revisit perfection of same straight away. If the other side is a company and you are outside of the 20 business days period to register, you can and should still register your security interest on the PPS Register. The consequence of late registration is that some other secured party may have registered their interest before you or if a liquidator has been appointed within 6 months of when you did finally register, the liquidator can set aside your registration. In essence, it is still better to register out of time, then not at all.

Summary

As you can see the PPSA has numerous complexities, requirements and timeframes to comply with, so it is strongly suggested to get the appropriate advice and documentation.

When in doubt, insert a security interest in the documentation and perfect same by PPS registration over the parties concerned to avoid the pitfalls detailed above.

For further information or if your clients wish to meet with one of our lawyers, please contact the author or a member of our Banking & Finance team.

Disclaimer

This information and the contents of this publication, current as at the date of publication, is general in nature to offer assistance to Cornwalls’ clients, prospective clients and stakeholders, and is for reference purposes only. It does not constitute legal or financial advice. If you are concerned about any topic covered, we recommend that you seek your own specific legal and financial advice before taking any action.

The Author

Paul Agnew

PARTNER, BRISBANE

The Author

Paul Agnew

PARTNER, BRISBANE

Nick Amore

PARTNER, MELBOURNE

Mayank Gupta

PARTNER, SYDNEY