The Complications of Taking Charge
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NOVEMBER 2003 INSOLVENCY The complications of Inside: taking charge The Starlec case Can the act of granting a charge breach contractual prohibitions on assignment? Lawyer Nick Bilinsky looks at some recent Macintosh v Turner considerations. Conclusion Introduction When lenders take security over a company’s entire assets, those assets usually include contracts. Many contracts contain covenants against assignment. Getting consents to the charge from all counterparties to all contracts may be diffi cult or impracticable. If the lender does not have a valid security interest over those contracts, then a receiver may not be able to take control of them as part of a company’s business, thereby losing control of those contracts and priority over them. Worse, if the contracts are material, then the lender may not be able to claim a charge over all, or substantially all, of the company’s assets, nor may the lender be able to appoint a receiver if an administrator has been appointed or exercise its right to appoint an administrator. This is on top of the possible concern that, if the charge does breach a contractual prohibition, the counterparty has remedies which may include terminating the contract. Your publication: Project and construction fi nance also involves taking security over contracts, but lenders may wish not to have to worry about getting consents from counterparties to minor If you would prefer to receive contracts. our publications in electronic format, please email: A charge of the normal type arguably should not breach a clause that merely prohibits [email protected] assignment. However, at best, it depends on the drafting of the prohibition on assignment and the charge. Two Australian cases have unfortunately left the position confused, so www.aar.com.au that, in evaluating their security, lenders should assume that a prohibition on assignment in the normal form does prevent a valid charge. VISIT OUR WEB SITE TO READ ALL FOCUS EDITIONS NOVEMBER 2003 Starelec Life Nominees Ltd v National Capital Development Commission, suggesting that there is a completed The latest Australian consideration of the subject equitable ‘assignment’ upon crystallisation. has come from the Queensland Supreme Court in Starelec (Qld) Pty Limited & Vangale Pty Limited (in Kumagai, on the other hand, argued that charges, liquidation) v Kumagai Gumi Co Limited [2002] QSC as hypothecations, do not involve an assignment or 137. While this case did not ultimately decide the transfer of charged property, even on crystallisation. question of whether an equitable charge constitutes an assignment, it did discuss the rights conferred on Regrettably, the confl ict apparent in the authorities a chargee under a charge and left open the possibility was not explored in argument. The diffi culty is that the that a charge is an assignment. word ‘assignment’ is used loosely and the commercial situations in which an equitable interest in a charge will The facts amount to an assignment have not been authoritatively Kumagai engaged a contractor for the development determined. of a resort. A written subcontract was subsequently In Sheahan v Carrier Air Conditioning Pty Ltd, Chief entered into by the head contractor and Starlec, in Justice Brennan comments that the statement that respect of electrical services. assets are ‘assigned’ is too imprecise, and that ‘the Starelec gave a fi xed and fl oating charge to Natwest extent of the equitable interest of a creditor in a fund to Bank (Natwest) over all of its undertaking and assets, be applied in payment of his debts depends upon the both present and future. terms governing the disbursement of the fund that are enforceable by specifi c performance’ (at 422-423). A receiver was subsequently appointed to the head contractor. In Starlec, Justice Mullins remarks: Kumagai and Starelec entered into agreement in In any case, the true effect of the charge given relation to the completion of the services that were the by Starlec…must be determined by reference subject of the subcontract. to the provisions of the charge which may assist in determining whether on crystallisation Natwest crystallised the fl oating charge over Starelec’s the charge takes effect as a charge only or assets, and assigned the contract to Vangale. as an equitable assignment of the charged property. Vangale pleaded that, as a result of it being the assignee from Natwest of all Natwest’s rights under This confusion can create diffi culties in two ways: the the charge, all debts and obligations to pay money clauses prohibiting assignment could be interpreted or damages owed by Kumagai to Starelec became widely, so that ‘assignment’ is given its loosest possible payable by Kumagai to Vangale. As Vangale’s claim meaning so as to include assignments; or picking up against Kumagai was as the assignee of Natwest, its on the dicta quoted by Justice Mullins, a court might rights could not be greater than those which accrued to construe a charge as being an assignment in the Natwest. Accordingly, the application raised the issue stricter sense. of whether the charge upon crystallisation conferred rights on Natwest, especially as a prohibition existed Macintosh v Turner – upon assignment by Starelec of the benefi t of the charges are assignments subcontract. In Macintosh v Turner Corporation Ltd (in liq) & Ors What was said (1995) 13 ACLC 1314, Justice Sackville held that a clause of a contract prohibiting assignment without Vangale submitted that, on crystallisation, there was an consent precludes an assignment of a party’s right to assignment in equity of the charged contractual rights. performance of the contract and also its right to receive It relied on the description given by Senior Puisne benefi ts accrued under the contract, but does not Judge McPherson in Relwood Pty Ltd v Manning prevent a dealing with the proceeds. His Honour relied Homes Pty Ltd that, on crystallisation of a fl oating upon the decision of the House of Lords in Linden charge, the chargor becomes trustee of the asset Gardens Trust Ltd v Lenesta Sludge Disposals Ltd and for the benefi t of the chargee. Vangale also relied the principle that an assignment of contractual rights in on statements in other authorities, such as National breach of a contractual prohibition is ineffective. Unfortunately, both parties regarded the charge as independent of the contract, and were therefore breaching the prohibition on assignment, so the point capable of being charged. In the end, the bank was was not argued. This was understandable in that fortunate to win by virtue of the fact that the money had case because the operative words in the charge were been paid and the asset was not just a benefi t that had that the chargor ‘charges, assigns and transfers’ the accrued under the contract. mortgaged property. The signifi cance of the The facts decision Turner Turner Corporation Limited ( ) entered into a If Macintosh v Turner is followed, in cases where a Austotel building contract with Austotel Pty Limited ( ). bank takes security over assets or benefi ts fl owing The contract contained a provision in which the parties under an agreement, the existence of a non- agreed not to assign the contract without the other assignment provision may invalidate the enforceability party’s consent. of that security (at least where it uses words of assignment) but not over the proceeds. Turner gave a charge to the State Bank of New South Wales, in return for funding. The charge secured While Macintosh v Turner has not been overruled, Turner’s undertaking and assets ‘whatsoever and there is considerable authority, both judicial and wheresoever both present and future’. No consent was academic, to suggest that an equitable charge is not obtained from Austotel. an assignment but, rather, a potential right or power exercisable upon default by the chargor. It differs from The confl ict in the authorities a mortgage (a form of assignment), where there is a has created inherent conveyance of an existing proprietary interest (see uncertainty in the law. Tancred v Delagoa Bay & East Africa Railway Co (1889) 23 QBD 239 and Re Earl of Lucan, Hardinge v Turner defaulted under the charge and the bank Cobden at 475: appointed a receiver. Turner went into provisional ‘What is given is not the thing but a charge liquidation. A dispute arose between Turner and upon the thing. That is the true effect of Austotel under the contract. The liquidator settled the deed.’) the dispute, which resulted in Austotel paying Turner A$1.525 million. When Turner came to be wound up, The position is slightly different where the contract the liquidator applied for directions to see whether it in question is a lease. There is authority that an was justifi ed to pay the money to the bank. A creditor assignment of a lease which breaches a prohibition on of Turner opposed the directions, on the ground that a assignment is still valid. However, the breach will often clause in the contract prohibiting assignment precluded allow the lessor to terminate. the bank’s charge from attaching to the money. Conclusions The Federal Court decision The confl ict in the authorities has created inherent As stated above, Justice Sackville found in favour of uncertainty in the law. For fi nanciers taking charges the bank. His Honour considered that once Austotel over debts, the position is particularly problematic. paid Turner an amount under the contract, the money lost its character as an accrued benefi t under the While the law remains unsettled, and before the contract and simply constituted one of its assets. As a question is resolved by an Australian appellate court, matter of construction, the provision that Turner should fi nanciers must be aware that the law may currently not ‘assign this agreement’ could not prevent Turner read down the applicability of charges in the face of effectively charging an asset constituted by moneys non-assignment provisions.