In an appeal against the High Court decision, the Singapore Court of Appeal (“CA”) upheld that the vesting of an equitable interest in a debt in favour of secured creditors by way of a crystallised floating charge, was sufficient to destroy mutuality of debts required for insolvency set-off to occur. It also discussed the impact of receivership on charged receivables, and how non-assignment clauses and third-party set-off rights could encroach on recovery of charged receivables.

Key Facts

Financing by Senior Lenders: The joint venture Jurong Aromatics Corp Pte Ltd (“JAC”) was tasked with the development of the Jurong Aromatics Plant on Jurong Island (“Plant”). JAC was financed by a syndicate of financiers (“Senior Lenders”), whose loans to JAC were secured by among other things, a debenture (“Debenture”) between JAC and the Senior Lenders’ security agent, BNP Paribas Singapore Branch (“BNP Paribas”) which granted: (a) under clause 3.1(c), a first fixed charge covering among other things, JAC’s present and future book debts; and (b) under clause 4.1, a first floating charge over all of JAC’s assets, both present and future.

2014–Set-off Agreement: Glencore Singapore Pte Ltd (“Glencore”) and BP Singapore Pte Ltd (“BP”) (collectively, “Glencore/BP”) were trade suppliers to and customers of JAC under various feedstock supply/product offtake agreements (“Trade Agreements”). The Glencore-JAC feedstock supply/product offtake agreements provided that parties were not entitled to set-off for any sums due under those agreements. Glencore subsequently contracted with JAC to vary such terms by a set-off agreement, setting-off their mutual claims (“Set-Off Agreement”) under these Glencore-JAC feedstock supply/product offtake agreements, the net effect of which created a debt (“Set-Off Agreement Debt”) payable by Glencore to JAC. No such debt was owed by BP.

2014-2015–Receivers and managers appointed: JAC became substantially indebted to Glencore/BP as a result of the Trade Agreements (“JAC Indebtedness”). The Plant’s operations were shut down. Receivers and managers (“Receivers”) were subsequently appointed by BNP Paribas pursuant to the Debenture. Glencore/BP were notified of the Receivers’ appointment in September 2015. Glencore/BP then issued enforcement notices stating their intention to wind up JAC later in 2015.

2016-2017–Tolling Agreement and Sale of Plant: The plan to wind-up JAC was postponed as the Receivers proposed for continued functioning of the Plant while a buyer was sought. JAC entered into a tolling agreement (“Tolling Agreement”) with Glencore/BP in April 2016, to enable the Plant’s operations to resume, under which Glencore/BP had to pay JAC a monthly fee for use of the Plant. While Glencore/BP initially paid such tolling fees without asserting set-off, they did not pay the fee for August 2017 (“Tolling Fee Debt”). Instead, Glencore, with support from BP, commenced winding-up proceedings in August 2017 against JAC (but was only wound up in 2019). Glencore/BP also followed up with a letter to JAC asserting for the first time, on 20 September 2017, that the Tolling Fee Debt was subject to insolvency set-off against the JAC Indebtedness.

Meanwhile, a buyer, ExxonMobil Asia Pacific Pte Ltd (“Exxon Mobil”), was found in May 2017. Exxon Mobil contracted with JAC and Glencore/BP (by way of a “Transitional Agreement”, as amended by the “Transitional Supplemental Agreement”) to enable the Plant to be sold without shutting it down (ie a “Hot Transition”). The Tolling Agreement, Transitional Agreement and Set-Off Agreement each contained non-assignment clauses. To facilitate such a Hot Transition, Glencore/BP undertook to pay JAC a final payment amount under the Transitional Supplemental Agreement (“Final Payment Amount”), for the value of feedstock transferred by JAC to Glencore/BP at the start of tolling. Such Final Payment Amount was not paid by Glencore/BP to JAC when due. As with the Tolling Fee Debt, Glencore/BP asserted on 20 September 2017 that such Final Payment Amount was subject to insolvency set-off against the JAC Indebtedness.

High Court Decision

JAC and the Receivers sought to claim the charged receivables from Glencore/BP, namely, the Tolling Fee Debt, the Final Payment Amount and the Set-Off Agreement Debt (in Glencore’s case) (collectively, the “Charged Receivables”). Glencore/BP responded they were entitled to set these off against the JAC Indebtedness.

The High Court held that Glencore/BP were not entitled to set-off the Charged Receivables against the JAC Indebtedness. In particular:

(a) as soon as they arose, all receivables payable to JAC became subject to the fixed charge or crystallised floating charge in favour of the Senior Lenders. Thus, the Senior Lenders were entitled to payment of the Charged Receivables rather than JAC. However, JAC owed Glencore/BP the JAC Indebtedness, not the Senior Lenders. The requirement of mutuality of debts for insolvency set-off to operate was therefore not met; and

(b) the Senior Lenders neither ceded control over the Charged Receivables nor released their security in the charges to permit any estoppel, waiver or decrystallisation to arise. Although the Tolling Agreement, the Transitional Agreement and the Set-Off Agreement each contained non-assignment clauses, these clauses could not prevent the equitable interest in the Charged Receivables from being vested in the Senior Lenders, pursuant to the fixed charge under clause 3.1 and crystallised floating charge under clause 4.1.

The Appeal

Apart from its findings on equitable set-off (which was found not applicable), the CA had to decide if insolvency set-off was applicable, either because the crystallised floating charge (ie crystallised on the Receivers’ appointment) had decrystallised or because the assets were released from the charge.

The CA’s findings/observations on the following are also noteworthy:

(a) When will decrystallisation of a crystallised floating charge or release of security from a charge occur?;
(b) Does a non-assignment clause prevent the crystallisation of a floating charge over receivables?; and
(c) Can a third party with knowledge of the receivership of a security provider exercise set-off rights against debts due to such security provider?
CA Decision

Insolvency set-off – not possible if debts are subject to a crystallised floating charge

Broadly, insolvency set-off did not apply as there was no mutuality of debts between the Charged Receivables and the JAC Indebtedness. The JAC Indebtedness were due to Glencore/BP but the Charged Receivables were due to the Senior Lenders by virtue of their equitable interest which was vested by the crystallised floating charge under the terms of the Debenture.

Decrystallisation of crystallised floating charge – possible to set-off after clear evidence of decrystallisation

There needs to be clear evidence before a court can conclude there has been any decrystallisation of a crystallised floating charge. The CA rejected, tentatively, that decrystallisation could only be effected by contracting directly with the charge holder (eg an express agreement between parties on decrystallisation). In deciding if decrystallisation had occurred and if the Charged Receivables were released from the Senior Lenders’ security, the CA focused on evidence of the loss of control over the Charged Receivables.

Non-assignment clauses – may prevent crystallisation of a floating charge

A non-assignment clause may prevent crystallisation of security over an asset not yet affixed with a charge – as tentatively observed by the CA. Tentatively, a non-assignment clause may also continue to be relevant to a crystallised floating charge, which had subsequently decrystallised, by preventing any further crystallisation of the floating charge. As the non-assignment clause in the Tolling Agreement came into existence after crystallisation of the floating charge, and Glencore/BP failed to prove it had subsequently decrystallised, the CA declined to make a pronouncement.
Shook Lin & Bok LLP Client Update | Corporate Banking 3

Unknowing deprivation of set-off rights – knowledge/notice of security and receivership relevant

The CA appears to take a view that a crystallised floating charge should generally be given its full effect in favour of the charge holder. Nonetheless, the CA explored the concern that a customer trading with the security provider in receivership ought not to be unknowingly deprived of his right to set-off. However, on the facts, there was no concern that Glencore/BP, while trading with JAC (in receivership) might be unknowingly deprived of their right to set-off – they were notified of the receivership in 2015 but continued working with JAC on various arrangements including the Tolling Agreement, without asserting their rights of set-off until September 2017.

Conclusion

In essence, the CA upheld that vesting of an equitable interest in a debt in favour of secured creditors by way of a crystallised floating charge was sufficient to destroy mutuality of debts required for insolvency set-off to occur. This is a welcome development to charge holders, as a crystallised floating charge potentially shields debts from insolvent set-off almost like an assignment. However, the outcome of this case may be different if: (a) the security was by way of an assignment (and not a charge) in contravention of the non-assignment clause; (b) the right of set-off accrued before the creation of the security or crystallisation of the floating charge; (c) Glencore/BP had no knowledge or were not notified of the security or receivership; and (d) the Senior Lenders had not exercised sufficient control over the Charged Receivables. Accordingly, it is important for secured creditors to consider the following in receivables financing:

(a) Impact of non-assignment clause – secured creditors should pay close attention to the existence and coverage of non-assignment clauses. In addition, a crystallised floating charge, which is shown to have subsequently decrystallised, may be prevented from further crystallisation by a non-assignment clause. Secured creditors should therefore retain control over charged receivables even after the crystallisation of a floating charge;

(b) Due diligence on trading relationship and underlying contracts – the security interest of secured creditors is often subject to adverse contractual arrangements such as payment conditions and set-off. Due diligence should therefore be done on the trading relationship and underlying contracts between the parties to mitigate such risk;

(c) Knowledge of third parties – it is important for secured creditors to notify relevant third parties of their security interest. This is commonly done by way of notices of security interest to such third parties. It is also prudent to obtain the agreement or acknowledgement of such third parties in relation to certain rights of the secured creditors. In addition, third parties should also be promptly notified of any enforcement actions over the security such as the crystallisation of the floating charge by way of the appointment of a receiver; and

(d) Control and decrystallisation of crystallised floating charge – third parties may, by providing clear evidence, show that a crystallised floating charge has subsequently decrystallised, or that security has been released by the secured creditor. While this is a question of fact, courts are likely to pay close attention to evidence of control or relinquishment of control by a secured creditor.
This update was authored by Liew Kai Zee (Partner) and Siaw Hui (Associate).

For more information, please contact: Liew Kai Zee Partner Head of Banking & Finance T: +65 6439 0768 E: kaizee.liew@shooklin.com Shook Lin & Bok LLP 1 Robinson Road #18-00 AIA Tower Singapore 048542 T +65 6535 1944 F +65 6535 8577 E slb@shooklin.com W www.shooklin.com Shook Lin & Bok LLP (Unique Entity No. T07LL0924K) is registered in Singapore under the Limited Liability Partnerships Act (Chapter 163A) with limited liability.