Personal Property Securities Act

After many years of gestation, the Personal Property Securities Act is almost upon us. Here's what to look forward to in this significant piece of legislation.
A detailed preview of the Personal Property Securities Act 2009 (Cth) (PPSA) was published in Proctor in February 2010 (see below - I have included this article). This article highlights some of the key changes introduced by the PPSA and next month we will feature frequently asked questions.
The PPSA, the regulations (PPS Regulations) and the register to be established under them (PPSR) are intended to replace the myriad of existing Commonwealth, state and territory laws and registers for company charges, bills of sale, ship mortgages, motor vehicle securities, crop liens, stock mortgages and most other securities affecting tangible and intangible personal property rights.
The PPSA will not only rationalise the number of laws and registers governing personal property securities, it will also introduce major substantive changes to the current law which will be particularly important for creditors, equipment lessors, consignors and other retention of title suppliers, purchasers of accounts receivable and insolvency practitioners, and have a significant effect on documentation, business processes and risk management.
The PPSA and PPSR are expected to apply from 31 October 2011.

What the PPSA will cover

With limited exclusions, the PPSA will apply to all security interests in tangible and intangible personal property. Personal property is any kind of property other than land, fixtures, water rights or a right, entitlement or authority granted by a Commonwealth, state or territory law and declared by that law not to be personal property for the purposes of the PPSA.
The PPSA adopts a functional approach to ‘security interests'. This means any interest in personal property provided for by a transaction that in substance secures payment or performance of an obligation will be a security interest for the purposes of the legislation regardless of its form or who has title to the collateral (that is, the secured property).
In addition to the broad functional definition, the PPSA will also deem certain interests or rights in relation to personal property to be security interests, whether or not they secure payment or performance of an obligation.
Deemed security interests will include:

  • The interest of a transferee under a transfer of accounts receivable or chattel paper (a new concept in Australia)
  • The interest of a consignor who delivers goods to a consignee under a commercial consignment
  • The interest of a lessor or bailor of goods under a PPS lease.

While in most cases it will be obvious whether a transaction constitutes a security interest under the PPSA, there will be occasions when this is not clear.
Documents may include clauses that constitute security interests even though those clauses are only incidental to the primary purpose of the document. For example, a guarantee that includes a charging clause covering personal property becomes a security agreement and a subordination agreement or guarantee that includes turnover trust provisions becomes a security agreement if it secures payment or performance of an obligation. It is the charging or turnover trust provisions that change the characterisation of the transaction from unsecured to secured for PPSA purposes.
Some other examples of transactions outside the traditional charge or mortgage type of security that could give rise to a security interest under the PPSA include:

  • A sale of goods on a retention of title basis
  • A payment retention clause under a construction contract
  • An escrow agreement
  • An agent's right under an agency agreement to retain the principal's property until the agent has been paid its fees and expenses
  • A security deposit under a supply agreement
  • A real property mortgage, if it mortgages property other than the land, water rights and any fixtures.

New priority rules

The PPSA introduces an entirely new priority regime under which:

  1. Perfection will usually be achieved by registration of the security interest but in some limited circumstances it will be possible to perfect by taking possession or control of the collateral. Perfection by control will ensure priority over perfection by other means. This will be particularly relevant for security interests in shares, managed funds and ADI accounts.
  2. Priority as between security interests perfected by registration or possession will generally be determined on a first-in-time basis so prompt perfection is paramount.
  3. Knowledge of competing security interests is generally not relevant for priority purposes.
  4. A perfected security interest has priority over an unperfected security interest.

Significantly, a security interest can be perfected in relation to collateral in which the grantor does not have title (provided it has sufficient rights in the collateral to grant a security interest for PPSA purposes) and such an interest will prevail against a party with an unperfected titlebased security interest in the relevant collateral.
The consequence of this is that a lessor or retention of title supplier that fails to perfect its security interest can be defeated by a secured party holding an all-assets security granted by the lessee or purchaser.
There are a number of exceptions to these general priority rules, the most important of which relates to purchase money security interests (such as PPS leases and retention of title supplies) which have a super priority provided they are perfected by a registration that records that a purchase money security interest is being claimed and within the timeframes stipulated in the PPSA. Other special priority rules apply for security interests in crops and livestock, accessions and commingled property, intellectual property and intellectual property licences, accounts receivable, accounts with ADIs, negotiable instruments, chattel paper, negotiable documents of title and non-consensual liens.

Insolvency

Subject to certain exceptions, an unperfected security interest held by a secured party will generally vest in the grantor on insolvency, effectively voiding the interest. While this more or less replicates the pre-PPSA position with respect to charge and mortgage type securities, it is a fundamental shift for security interests where title remains with or is obtained by the secured party. A secured party who has title to collateral (for example, a lessor or retention of title supplier) risks losing priority, and its interest in the collateral, if it does not register its security interest.
In addition, the new s588FL in the Corporations Act effectively replaces the 45-day registration rule for company charges under pre-PPSA law with a 20 business-day registration rule for security interests given by a company (including security interests where another party has title to the collateral, if that security interest secures payment or
performance of an obligation (s588FN)). The 20 business-day period runs from when the relevant security agreement is entered into.
To the extent a security interest is a ‘circulating security interest' (as defined in s51C, Corporations Act) it will rank behind employee entitlements (s561, Corporations Act). This is only relevant for the types of collateral that can be ‘circulating assets' under s340, PPSA. Secured parties may wish to retain or acquire title to these types of collateral so that the interest in the collateral will not be a ‘circulating security interest'. Alternatively, if the grantor has title to the collateral, the secured party can take steps to ensure it has ‘control' of that collateral so that it is not a circulating asset under s340, PPSA.

Personal Property Securities Reform... The Countdown is on

The Personal Property Securities Act 2009 (Cth) (PPSA) and the Personal Property Securities (Consequential Amendments) Act 2009 (Cth) were both passed by the Senate on November 26. Finalisation of the legislation follows a consultation process that commenced early in 2006.
Queensland, New South Wales, Victoria and South Australia have already referred power to the Commonwealth to enable the PPS reforms to proceed. Western Australia and Tasmania are expected to follow shortly.
In coming months we will see:

  • Commonwealth consequential amendments legislation dealing with changes to the Corporations Act;
  • State and territory consequential amendments legislation; and
  • Draft regulations under the PPSA (PPS Regulations).

These developments highlight the importance and reach of the PPS reforms; the reform package is one of the most significant commercial law reforms in many years.
The PPSA and the national Personal Property Securities Register (PPSR) are scheduled to go live in May 2011. While this may seem a long way off, a great deal of preparation will be required.

Key features of the PPSA

The PPSA and the PPSR are intended to replace the myriad of existing Commonwealth, state and territory laws and registers for company charges, bills of sale, ship mortgages, motor vehicle securities, crop liens, stock mortgages and most other securities affecting tangible and intangible personal property rights.
The PPSA will not only rationalise the number of laws and registers governing personal property securities, it will also introduce major substantive changes to the current law which will be particularly important for creditors, equipment lessors, consignors and other retention of title suppliers, purchasers of accounts receivable and insolvency practitioners.

What the PPSA will cover

With limited exclusions, the PPSA will apply to all security interests in tangible and intangible personal property. Personal property is any kind of property other than land, fixtures, water rights or a right, entitlement or authority granted by a Commonwealth, state or territory law and declared by that law not to be personal property for the purposes of the PPSA.
The treatment of mining, petroleum and gas tenements will be of particular interest given their economic importance.

What is a ‘security interest'?

The PPSA adopts a functional approach to "security interests". This means any interest or right in relation to personal property provided for by a transaction that in substance secures payment or performance of an obligation will be a security interest for the purposes of the legislation regardless of its form or who has title to the collateral (that is, the secured property).
The definition of security interest expressly includes a fixed charge, floating charge, chattel mortgage, conditional sale agreement (including an agreement to sell subject to retention of title), hire purchase agreement, pledge, trust receipt, consignment, lease of goods, assignment, transfer of title or flawed asset arrangement, that in substance secures payment or performance of an obligation.

Deemed security interests

In addition to the broad functional definition the PPSA will also deem certain interests or rights in relation to personal property to be security interests whether or not they secure payment or performance of an obligation (deemed security interests).
Deemed security interests will include:

  • The interest of a transferee under a transfer of accounts receivable or chattel paper (a new concept in Australia).
  • The interest of a consignor who delivers goods to a consignee under a commercial consignment, and
  • The interest of a lessor or bailor of goods under a PPS lease.

Interests not be covered by the PPSA

The PPSA will not apply to certain transactions and interests. Excluded interests include:

  • A lien, charge, or any other interest in personal property, that is created, arises or is provided for by statute or operation of the general law (that is, non-consensual security interests).
  • Any right of set-off or right of combination of accounts.
  • A transfer of an interest or claim in, or under, a contract of annuity or policy of insurance.
  • An assignment of an account made solely to facilitate the collection of the account on behalf of the person making the assignment.
  • An assignment of an account, if the assignee's sole purpose in acquiring the account is to collect it.
  • An assignment of an account or negotiable instrument to satisfy (either wholly or partly) a pre-existing indebtedness, and
  • A sale of an account or chattel paper as part of a sale of business, unless the seller remains in apparent control of the business after the sale.

Form of security agreements

Parties are generally free to negotiate the terms of their security agreement without the need to satisfy prescriptive form requirements.
However, other Commonwealth, state or territory laws may still need to be satisfied in respect of matters which go beyond mere form and registration requirements (for example, governmental or regulatory authority consents) and to the extent those laws can operate concurrently with the PPSA.

The demise of the fixed and floating charge

The PPSA will not distinguish between "fixed" and "floating" security interests and there will be no ongoing relevance for related concepts such as "crystallisation". However, it is open to the secured party and the grantor to agree the circumstances in which collateral can be disposed of by the grantor. In addition, the extinguishment rules (referred to below) will protect third-party transferees where applicable.
These rules apply even in the absence of provisions in a security agreement allowing certain property to be disposed of by the grantor in the ordinary course of business.
Under the PPSA all security interests are effectively "fixed", to use the current parlance, but the terms of the relevant security agreement or the application of the extinguishment rules may enable a third-party transferee to take free of the security interest. The extinguishment rules do not generally affect priority contests as between secured parties.
Because other legislation and security agreements may continue to refer to "charges", "fixed charges" or "floating charges", the PPSA includes provisions which explain how these terms are to be interpreted in the new PPSAenvironment. While documents that are drafted as charges and which include crystallisation provisions may still provide effective security, they will be interpreted subject to the PPSA and it is expected these forms of documentation will quickly fade anyway.

Entities covered by the legislation

The PPSA will apply to security interests given by corporations, partnerships, registered managed investment schemes, other registrable and non-registrable legal entities and individuals.

Categorisation of collateral

Collateral is categorised into accounts, ADI accounts, chattel paper, commercial property, consumer property, crops, currency, documents of title, financial products, financial property, goods, intangible property, intellectual property, intellectual property licences, inventory, investment entitlements (including rights in an account to which interests in financial products may be credited or debited and which is controlled by an intermediary on behalf of
the account holder), investment instruments (for example, shares and interests in managed investment schemes), motor vehicles and negotiable instruments. These categories are not all mutually exclusive.
Many of the provisions in the PPSA apply equally to any collateral in any circumstances.
However, the different categories of collateral become relevant for the purposes of some specific perfection, priority, extinguishment and enforcement rules.

The PPSR

The PPSR will be wholly electronic and accessible 24/7. It will also operate on the basis of notice rather than document registration.
The notice will be known as a "financing statement" and it can be registered before any secured transaction takes place. One registration can also cover multiple security interests provided it is completed appropriately.
The PPSR can be searched by reference to either the grantor's details, which will disclose security interests registered against the grantor, or, in the case of serial numbered property the unique serial number referable to that property (for example, the VIN for motor vehicles), which will disclose security interests registered against that property. However, the grantor's details will not be registered if the security interest relates to collateral that is serial
numbered consumer property.
The "details" required to be registered in respect of a grantor will be prescribed by the PPS Regulations.
Registrations for consumer property or property described by serial number may be made for up to seven years and may be renewed for further periods of up to seven years. Registrations for commercial property may be made for an indefinite term or for a term up to 25 years and may also be renewed.
It will not be mandatory to register security interests and there will be no time limit for registering an interest. However, failure to perfect will have certain consequences for the secured party.
Interested persons (including the grantor or a person with another security interest in collateral) will be entitled to obtain from a secured party a copy of their security agreement and other relevant information within 10 business days after a request is received.
Collateral subject to a financing statement:

  • Must be described as either consumer property or commercial property.
  • May or must be described by serial number, if allowed or required by the PPS Regulations.
  • Must belong to a single class prescribed by the PPS Regulations (but multiple registrations can be made through one application process).

It has been proposed that the PPS Regulations will prescribe the following classes of property: agriculture, aircraft, all present and after-acquired property, all present and afteracquired property except, financial, intangible, motor vehicle, other goods and watercraft.
Except for “all present and after acquired property” and “all present and after acquired property except”, these classes will be defined so that no item of collateral can fall within more than one class. Sub-classifications have also been proposed. The classification of collateral will, to some extent, be relevant to determining priority between competing security interests.
The PPS Regulations are likely to require that security interests in motor vehicles, watercraft and aircraft that are also consumer property must be described by using its unique serial number. Serial number descriptions would be optional for motor vehicles, watercraft or aircraft that are commercial property. The PPS Regulations will also permit certain intellectual property to be described by serial number.
The PPS Regulations are likely to provide that a description of the collateral may include free text in certain circumstances.

Attachment and perfection of security interests

Attachment

A security interest attaches to collateral when the grantor has rights in the collateral or the power to transfer rights in the collateral to the secured party and either value is given for the security interest or the grantor does an act by which the security interest arises.

Enforceability against third parties

A security interest will generally be enforceable against a third party in respect of particular collateral only if the security interest is attached to the collateral and:

  • The secured party possesses the collateral
  • The secured party has perfected the security interest by control, or
  • A security agreement is evidenced by writing that is:
    • Signed by the grantor; or
    • Adopted or accepted by the grantor by an act specified in the writing that is done with the intention of adopting or accepting the writing, and contains:
      • A description of the particular collateral, or
      • A statement that a security interest is taken in all of the grantor’s present and after acquired property (or, if applicable, specifying certain excluded personal property).

The PPSA contemplates that security agreements can be entered into electronically.

Perfection

A security interest will generally be perfected in relation to collateral if it has attached and:

  • For any collateral, it is effectively registered or the secured party has possession of the collateral (other than possession as a result of seizure or repossession); or
  • For certain kinds of collateral, the secured party has control of the collateral.

Perfection by control will be particularly relevant for security interests in ADI accounts, investment instruments and investment entitlements.

Priority and extinguishment rules

The general priority rules

The following general priority rules will apply:

  • A perfected security interest has priority over an unperfected security interest. This will be the case even where the party with the unperfected security interest has title to the relevant collateral (for example, a lessor or ROT supplier).
  • Perfection by control will ensure priority over perfection by other means. If two interests are perfected by control, priority is determined by the order of perfection if the perfection by control has been continuous.
  • If two interests are perfected other than by control, the first party to perfect will have priority.
  • If there are two unperfected interests, then priority is determined by the order of attachment.

The party who has priority will usually have priority to the collateral and any proceeds. Priority will normally extend to future advances.

Purchase money security interests

The major exception to this is for purchase money security interests (PMSIs) which have a super priority. A PMSI is:

  • A security interest taken in collateral, to the extent that it secures all or part of its purchase price
  • A security interest taken in collateral by a person who gives value for the purpose of enabling the grantor to acquire rights in the collateral to the extent the value is applied to acquire those rights
  • The interest of a lessor or bailor of goods under a PPS lease
  • The interest of a consignor who delivers goods to a consignee under a commercial consignment.

A registration in respect of a security interest which is, or is to be, to any extent a PMSI, must indicate this to obtain the super priority benefit.
Also, the registration must be made within a prescribed timeframe to obtain the PMSI super priority.

Other special priority rules

Other special priority rules apply for:

  • Certain agricultural security interests
  • Security interests in goods that become an accession to other goods
  • Determining proportional priority entitlements where goods subject to different security interests are manufactured, processed, assembled or commingled and as a result the original property loses its identity in the product or mass but the security interests continue in that product or mass
  • Intellectual property and intellectual property licences
  • Accounts receivable, accounts with ADIs, negotiable instruments, chattel paper, negotiable documents of title and non-consensual liens arising by operation of law or equity.

The priority rules can be displaced by priority or subordination agreements between secured parties.

Extinguishment rules

There are a number of extinguishment rules in the PPSA benefiting third-party transferees.
In addition, different extinguishment rules apply for security interests over serial numbered property. Three of the more important are:

  • Unperfected security interests – a buyer or lessee of personal property, for value, takes free of an unperfected security interest, if the buyer or lessee is not a party to the transaction that provides for the security interest.
  • Serial numbered property – a buyer or lessee of personal property that may, or must, be described by serial number will take free of a security interest if the buyer or lessee provides value, does not hold the property as inventory or on behalf of a person who would hold the property as inventory, a search of the PPSR using only the correct serial number would not disclose the security interest, and the buyer or lessee does not have
    actual knowledge that the sale or lease constitutes a breach of the security agreement that provides for the security interest.
  • Ordinary course of business – a buyer or lessee of personal property who buys or leases that property in the ordinary course of the seller’s or lessor’s business of dealing with the property of that kind takes the property free of a security interest that is given by the seller or lessor if the buyer or lessee has no actual knowledge that the sale or lease constitutes a breach of the security agreement under which the security interest was created and, if the property may, or must, be described by serial number, the buyer or lessee does not hold the property as inventory or on behalf of a person who would hold the property as inventory.

Registration does not constitute notice or impute actual or constructive knowledge of a security interest registration or its contents to other persons. However, where a transferor and transferee are associated entities certain presumptions about actual or constructive knowledge and value will apply.
The PPSA also contains rules regarding the actual or constructive knowledge of bodies corporate and other entities.

Transfer of collateral

In addition to the extinguishment rules there are specific priority rules dealing with what happens when collateral that is the subject of a security interest is transferred in circumstances where none of the extinguishment rules apply and the transferee grants or has previously granted a competing security interest.
Although many of the priority and extinguishment rules in the PPSA are complex, they inject considerable certainty into an area of law which is currently confusing and uncertain.

Enforcement

Chapter 4 of the PPSA includes enforcement provisions dealing with seizure, disposal and retention of collateral. These provisions apply to most security interests other than deemed security interests.
Many of these provisions can be excluded by agreement between the parties when the collateral is not used predominantly for personal, domestic or household purposes.

Insolvency

Subject to certain exceptions, an unperfected security interest held by a secured party will generally vest in the grantor on insolvency, effectively voiding the interest. While this mirrors the current position with respect to charge and mortgage type securities it is a fundamental shift for deemed security interests where title remains with or is obtained by the secured party. A secured party who has title to collateral (for example, a lessor or retention of title supplier) risks losing priority and their interest in the collateral if they do not register their security interest.
A secured party whose security interest is void on insolvency will be able to claim as an unsecured creditor.

Changes to and relationship with other legislation

Corporations Act

Chapter 2K (Charges) of the Corporations Act is to be repealed with the exception of sections 266 and 267 which will be retained and relocated in a modified form taking account of the PPSA.
Currently, certain employee entitlements rank in priority to the claims of chargees to the extent the charged property is the subject of a floating charge. Floating charges become redundant in the PPSA environment but the PPSA deems certain security interests over "circulating assets” to be floating charges where there are references to floating charges in Commonwealth laws, including the Corporations Act but excluding the PPSA itself, or in a
security agreement with the aim of achieving a substantially similar priority outcome for employee entitlements. There will be other consequential amendments to a number of other insolvency-related provisions in the Corporations Act.

National Credit Code

Where collateral is used for consumer purposes and the National Credit Code applies to the relevant security interest, the PPSA and the National Credit Code will operate concurrently and a secured party will have to comply with both the requirements in the PPSA and in the code. Where both the code and the PPSA contain similar obligations relating to enforcement, the PPS Regulations, provided there is no significant impact on either party,
will deem that a secured party who has complied with the relevant provision of the code has complied with the corresponding obligations in the PPSA.

Other state, territory and Commonwealth legislation

Some existing state and territory securities laws may not be repealed from the commencement of the PPSA due to transitional and other issues. If a law of a state or territory requires or enables a person to register a security interest, a failure to register under that law will not affect the validity, priority or enforceability of the security interest. Similarly, if a prescribed state or territory law has the effect of requiring a security agreement to be in a particular form or to be witnessed or executed in a particular way, a failure to satisfy those requirements will not affect the validity, priority or enforceability of the security interest. To the extent a state or territory law would otherwise restrict or affect attachment or perfection under the PPSA it will be inoperative.
Subject to the provisions mentioned in the previous paragraph, the PPSA is not intended to exclude the operation of Commonwealth, state or territory laws or the general law, to the extent they are capable of operating concurrently with the PPSA. A referring state may also exclude the application of the PPSA (or parts of it) to specified  matters.
Amendments to sale of goods legislation may be necessary to ensure that the “buyer and seller in possession” rules work seamlessly with the PPSA extinguishment and priority rules relating to the transfer of collateral.

Transitional arrangements

Security interests taken after the commencement date for the PPSA will need be registered on the PPSR in order to be perfected by registration.
It is anticipated that existing security registrations (for example, company charges and REVS securities) will be electronically migrated to the PPSR where possible.
In addition, secured parties with existing registrations will have two years in which to reregister on the PPSR security interests that cannot be electronically migrated and to register interests that have not previously required any registration (for example, leases or hire purchase agreements over goods other than motor vehicles and retention of title supply or consignment agreements).
Secured parties will need to carefully consider the priority issues surrounding the proposed transitional arrangements.

Conclusion

The PPSA will rationalise and modernise an area of commercial law that has been crying out for reform for a long time.
The new regime should result in greater transparency, improved risk management, more certain priority outcomes, business process efficiencies and cost savings, but in the short term it will require a careful review of documents, credit policies and procedures and IT systems by financial institutions, other lenders, equipment lessors and  retention of title suppliers.


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