Priority of floating charge over a third party guarantee

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17 February 2012

In the recent decision of Bank of Western Australia v National Australia Bank Ltd [2011] QSC 379, the Supreme Court of Queensland considered whether a fixed and floating charge over assets took priority when those assets had been used to guarantee a third party loan from a different lender.

The Facts

The plaintiff bank entered into a loan facility (Loan) with the second defendant (Company), the security for which included a fixed and floating charge over the Company’s assets (Charge).  After using the majority of the funds to pay off an existing debt, the Company deposited the remaining funds in four term deposits with the first defendant.  The Company then agreed to guarantee a loan facility (Second Loan) between the first defendant and an associated company of the Company via a letter of set off against the term deposits the Company held with the first defendant.

The associated company defaulted on its repayments and the Company entered into administration following which the first defendant gave a notice of demand to the Company as guarantor of the Second Loan.  The first defendant then caused the proceeds in the term deposits to be credited to the loan account of the associated company.

The plaintiff bank claimed these proceeds on the basis that:

  • The Company was in breach of the Loan by guaranteeing the Second Loan;
  • The plaintiff’s Charge had crystallised as a result of this breach; and
  • The plaintiff’s Charge took priority over the first defendant’s right of set-off as it had occurred first in time.

The Decision

In dismissing the plaintiff’s claim, McMurdo J considered whether the execution of the letter of set off and guarantee breached the terms of the Loan.  Under the traditional floating charge, the charge floats over assets such as cash that the Company many continue to use in the ordinary course of business.  His Honour concluded that the Company was in the business of land development and accordingly the transaction with the first defendant was in the ordinary course of its business, even if the transaction was to protect the first defendant against the insolvency of the Company and its associated company.  The signing of the letter of set off was therefore not a breach of the Charge.

McMurdo J did find that the execution of the guarantee was a breach of cl. 9.1 of the Loan and subsequently the Charge crystallised when the guarantee was signed.  However, this raised a further problem for the plaintiff as the crystallisation of the Charge had occurred simultaneously and as a result of the execution of the guarantee.  This meant that the plaintiff was unable to claim priority on the basis that it possessed an earlier charge.

Comment

This case highlights some of the difficulties that lenders currently face in securing their interests in floating charge assets.  To some degree, this difficulty is addressed (or made more complicated!) by the new Personal Properties Securities Act (PPSA).  The PPSA does away with the distinction between fixed and floating interests.  A “circulating security interest” (the old floating charge) attaches to “future acquired property” at the same time that it would have to non-circulating (fixed) assets.  In the PPSA world, there is no concept of “crystallisation”.  Priority is determined according to the PPSA rules regardless of whether the security interest is fixed or floating. 

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