The recent Western Australian Supreme Court decision of Dalian Huarui Heavy Industry International Company Ltd v Clyde & Co Australia has determined that an interest in funds held on escrow in a trust account may be a "security interest" as defined in the Personal Property Securities Act 2009 (Cth) (PPSA) which is registerable on the Personal Properties Securities Register (PPSR).
Whilst the case arose in the context of arbitration proceedings, there are potentially broader ramifications for situations where sums are held in escrow in commercial transactions generally. This note focusses on the PPSA implications.
The salient facts were:
- Dalian claimed monies from Duro and the companies entered arbitration to resolve the dispute.
- Duro was required to provide security pending the outcome of the arbitration. As a consequence, Duro, Dalian and Duro's solicitors (Clyde & Co) entered into a trust agreement pursuant to which Duro would deposit cash with Duro’s solicitors on terms that the solicitors (as trustee) would release the funds only as directed by the tribunal.
- The arbitration found in Dalian's favour. The tribunal ordered the solicitors to release the trust funds to Dalian. Clyde & Co did not do so immediately.
- Duro subsequently entered voluntary administration and the administrators sought to prevent the solicitors from releasing the trust funds to Dalian pending finalisation of the administration.
- At no time did Dalian register its interest in the trust funds on the PPSR.
Key findings of the Supreme Court of Western Australia were as follows:
- From the time the cash was placed with the solicitors, Dalian and Duro each had an interest in the trust funds:
- Duro had a "residual equitable interest" in the funds, as it would have been entitled to the return of the funds if it had been successful in the arbitration. This residual equitable interest was "property" for the purposes of the PPSA.
- Duro as grantor had granted an equitable interest (by way of charge or lien) in favour of Dalian pursuant to the terms of the trust agreement. Dalian had a security interest that fell within the definition of an in substance "security interest" in the PPSA (being a transaction that in substance secured payment or performance of an obligation), albeit Dalian's initial interest was a contingent equitable interest as it was contingent on the outcome of the arbitration.
- Dalian’s security interest in the trust funds was not perfected by registration. Therefore Dalian’s security interest was at risk of vesting in Duro under section 267 of the PPSA upon the administration or insolvency of Duro.
- However, Dalian had a fully perfected security interest in the funds from the time the tribunal ordered the solicitors to release the funds to Dalian. Dalian's interest was at that point perfected by "possession", even though the solicitors still held the trust funds. The solicitors were considered to have possession of the funds on behalf of Dalian absolutely. Section 24(2) of the PPSA provides that "another person on behalf of the secured party" may have actual or apparent possession.
There has been legal debate about certain elements of this decision, including whether perfection of an intangible by possession is correct. It is also notable that the issue of the priorities of competing security interests was not raised.
Nevertheless, a key observation is that funds held under an escrow arrangement may give rise to an “in substance” security interest requiring perfection under the PPSR. Parties to these types of transactions should be mindful to perfect their interests where possible (and as early as possible) and be aware of potential competing security interests.
  WASC 132