Australia's new personal property securities law - no more false starts

The Commonwealth Personal Property Securities Act 2009 (PPSA) has had several false starts. Most recently, the Government encountered problems in ensuring its new register would work as intended. But it now appears certain that the new PPSA regime will commence operation on 30 January 2012.

On that day, Australia's commercial law will change more radically than ever before. The changes brought by PPSA will be profound. Not only will the law of "traditional" securities over personal property (mortgages, charges, bills of sale and the like) be completely rewritten, but the new system will change fundamental rules and assumptions about ownership of personal property in many other contexts. Practitioners need to be well aware of the new regime and how it might affect their clients.

PPSA is a comprehensive new law about security interests in "personal property". "Personal property" is basically everything except land and certain statutory licences. So PPSA will cover equipment and other goods, financial and contractual assets such as book debts, shares, bank accounts, and other investments, intellectual property and licences and so on.

Despite the fact that PPSA has been on the statute books for more than two years (and has been amended three times already), there are many businesses that may still be unaware of its implications. There has been little publicity for the new law beyond stakeholder, legal and finance industry groups and this has been noted as a matter of concern by several commentators.

This article looks at some key implications of PPSA for hiring, leasing and retention of title and consignment sales. In my view, these are the areas where the change wrought by PPSA will be most profound ... and unexpected.

"Perfection" - the policy key to PPSA

One policy objective of PPSA is to encourage those who claim an interest in personal property left in the hands of someone else to make their interest public.

Protection under PPSA can be obtained by "perfecting" the security interest - normally by registering it on the PPS Register, although in certain cases perfection may be by possession or control.

If "secured parties" (as PPSA calls them) choose not to perfect, then they face the possible loss of their property or rights. This is a potentially dramatic effect of the new regime.

It is not an offence not to perfect under PPSA, but PPSA contains a number of priority, extinguishment and vesting rules that will commercially punish security interest holders for failure to perfect and which are likely to negate ownership or other rights when they are most needed.

PPSA - a new paradigm

PPSA reaches far beyond "securities" as that term is typically understood in a finance context. It applies a wide and "functional" definition of a security interest. As well as applying to mortgages and charges, PPSA will apply to receivables financing (factoring and invoice discounting) and, in terms of the focus in this article, it will also apply to:

• retention of title (ROT) sales;

• certain long-term or indefinite leases and bailments for value. These are called "PPS leases" and are deemed to be "security interests";

• commercial consignments - also deemed to be "security interests".

Businesses that rely on their ownership in these arrangements will need to adjust to a new legal reality - ownership of the personal property is by itself no guarantee that it can be reclaimed in an insolvency of the hirer or buyer.

Equally, it may not enable recovery if the hirer or buyer has wrongfully dealt with the equipment in favour of a third party.

PPSA will modify or abolish a number of legal rules, not least of which is the nemo dat quod non habet rule [broadly, you cannot give what you do not own], which is substantially undermined.

Unperfected security interests lose priority

Under PPSA, a perfected security interest has priority over an unperfected security interest in the same personal property. The operation of this kind of rule is well illustrated by a New Zealand decision. (The PPSA is closely modelled on the New Zealand legislation.)

In Waller v New Zealand Bloodstock Limited [2006] 3 NZLR 629, Glenmorgan Farm had given security over "all its present and future assets" to Lock, a financier. Glenmorgan entered into a lease to purchase agreement for a thoroughbred racehorse, "Generous" with New Zealand Bloodstock. Lock perfected its security interest by registering a financing statement on the PPS register. But New Zealand Bloodstock failed to perfect.

Glenmorgan defaulted under the lease agreement with NZ Bloodstock and the lease was terminated. NZ Bloodstock repossessed Generous, however, Lock claimed that it was entitled to Generous.

The NZ High Court found that:

• relying on the particular statutory wording and a broad reading of the expression "assets", Lock's security interest encompassed Glenmorgan's interest in Generous.

• NZ Bloodstock had a security interest in the lease under the general provisions of the NZ legislation, but because this was not perfected, Lock's security interest had priority.

Allan J referred to the Canadian Supreme Court (Canada also has a PPSA-style regime) decision in Re Griffin [1998]:

"A person with an interest rooted in title to property in the possession of another, once perfected, can, in the event of default by the debtor, look to the property ahead of all others to satisfy his claim. However, if that interest is not perfected, it is vulnerable, even though it is rooted in title to the goods."

The New Zealand Bloodstock case was not determined on traditional concepts of title and ownership but by applying the PPSA-type legislative priority rules. Lock's security over Glenmorgan gave it a priority claim to the horse even though the horse was at no point owned by Glenmorgan.

Unperfected interests "vest in the grantor" on insolvency

Under PPSA, if a security interest has not been perfected it "vests in the grantor" upon the grantor's insolvency.

If a security interest is a "traditional" one like a mortgage or charge, the effect is comparable to the security being "void" (as is currently the case for example for unregistered company charges).

However under PPSA, the security interest might be a deemed security interest such as the interest of a lessor under a PPS lease. The new (and radical) effect is that upon an individual or company entering into bankruptcy, administration, winding-up or a deed of company arrangement, there is effected a kind of statutory expropriation with the property in the asset transferring from the lessor (secured party) to the lessee (grantor of the security interest).

The income tax and GST implications of 'vesting in the grantor' will doubtless require exploration in due course.

Extinguishment rules

The extinguishment or "taking free" rules provide a further incentive to perfect. A buyer or lessee of personal property can "take free" of an unperfected security interest.

In the case of some kinds of goods, it will not be enough simply to perfect the security interest to protect against this extinguishment. It will also be necessary to perfect in a way that includes the serial number of the goods in a PPS registration. This is discussed below in the hire industry context.

PPSA and the hire industry

PPSA applies to leases (which include hires) and bailments of equipment for more than certain defined periods. It also covers these arrangements where they are for indefinite periods.

The trigger period for a "PPS lease" is one year but a shorter period of 90 days applies in the case of "serial number registrable" property - see below.

If a lessor under a PPS lease fails to perfect, there are a number of significant risks.

Example - HireCo hires a cement mixer to Grant for 18 months but does not perfect this security interest by registering it on the PPS Register. Grant wrongfully sells the mixer to Buyer. Buyer takes the mixer free of HireCo's interest under the extinguishment rule. It does not matter that the mixer has "Property of HireCo Hire" painted on it.

Example - HireCo leases 10 trucks to Grant for 6 months. HireCo doesn't register this on the PPS Register. Grant is bankrupted. The security interest "vests in" Grant. The trucks belong to Grant to be sold for the benefit of Grant's creditors. The same outcome applies in the case of corporate insolvency - liquidation or administration - if Grant is a company.

Hire businesses and other owners must also adjust to the idea that they may be competing with other security interest holders - eg their customer's bank - as the New Zealand Bloodstock case shows.

Ownership is no longer any guarantee of recovery of the equipment.

Serial number registration

If the personal property may or must be described by serial number in a PPSR registration, the one-year threshold for a PPS lease is replaced by a 90-day threshold. Goods that may or must be described by serial numbers in a PPSR registration ("serial number registrable") are:

• "motor vehicles" (as defined) - It is important to appreciate that the definition can catch vehicles that travel over 10 km/hour OR have total motor power of more than 200W. Trailers and attachments can also be caught;

• "watercraft" (as defined); and

• "aircraft" (as defined) and aircraft engines.

Just because goods have a serial number does not mean they are serial number registrable. They must fall into one of the above categories.

If the hired equipment is serial number registrable consumer property a security interest can only be registered by serial number.

A security interest over serial number registrable commercial property need not be registered by serial number. Serial number registration is optional in that case. However, choosing not to register by serial number carries the risk of loss of rights to the equipment if there is a wrongful sale or lease. This results from the operation of one of the extinguishment rules.

Example - HireCo registered its PPS lease security interest against GrantCo. The collateral is a petrol-engined forklift truck. A petrol-engined forklift meets the definition of a "motor vehicle" and the security interest is therefore serial number registrable. HireCo does not opt to register the security interest by reference to the truck's serial number and only registers it against GrantCo without specifying a serial number. Bert buys the truck from GrantCo. Bert "takes free" of HireCo's security interest. Even though there was a perfected security interest, the collateral was serial number registrable and no serial number was shown in the PPS Register.

PPSA and ROT sellers

Under a typical ROT arrangement, the seller includes in its sale terms a condition that ownership does not pass until the seller is paid in full for the goods supplied.

These arrangements will now be regarded as "security interests" under PPSA and for sellers to retain protection, they will need to register the arrangements against their customers on the PPS register.

Example - Rotco agrees to supply widgets to Bloggs retaining title until paid. This is a security interest granted by Bloggs to Rotco.

The same risks apply if there is a failure to perfect:

Rotco does not register (perfect) this security interest. Bloggs is bankrupted. The security interest "vests in" Bloggs. The widgets will be available to be sold for the benefit of all Bloggs's creditors.

The government has said that PPSA will make it easier for ROT sellers by bringing certainty to the legal status of ROT arrangements. That is questionable. ROT in practice has become quite settled. In my view, PPSA only adds to the complexity. PPSA will also reduce the extent to which ROT can be used to secure 'all moneys'. This is because the special priority accorded to ROT as a 'purchase money security interest' extends only to the extent of the purchase price for the goods concerned. An 'all moneys' ROT clause, under which title is retained pending payment not just for the price of the relevant goods but also for the price of other goods or other amounts owed, will be less effective under PPSA than is currently the case.

PPSA and commercial consignment

Under PPSA, a "commercial consignment" is deemed to be a "security interest". The relevant definition is as follows:

"commercial consignment" means a consignment if:

• the consignor retains an interest in goods that the consignor delivers to the consignee; and

• the consignor delivers the goods to the consignee for the purpose of sale, lease or other disposal; and

• the consignor and the consignee both deal in goods of that kind in the ordinary course of business;

but does not include an agreement under which goods are delivered to:

• an auctioneer for the purpose of sale; or

• a consignee for sale, lease or other disposal if the consignee is generally known to the creditors of the consignee to be selling or leasing goods of others."

The following is an example of a commercial consignment:

Example: Owner and Grant both deal in diggers. Owner puts 5 diggers on Grant's lot so that Grant can sell them for him. Grant is the "grantor" of a security interest to Owner.

The interest of the secured party under a commercial consignment will normally not be subject to vesting in the grantor if left unperfected at the time of grantor insolvency. However, the other risks of failure to perfect still apply.

Transitional issues

For security interests that are already in place when PPSA starts to operate, a transitional protection period of 24 months applies during which these "transitional security interests" are deemed perfected.

However, if these interests are not actually perfected within the 24 months, they become unperfected with the risks explained above.

Example - HireCo has a crane on hire to Grant Pty Ltd as at the PPSA commencement time. This is a "transitional security interest". PPSA treats it as perfected as at the commencement time. Two years later, HireCo still hasn't actually registered its security interest. The security interest therefore becomes unperfected. Grant goes into voluntary administration - the crane vests in Grant.

Generally, interests under security agreements entered into after PPSA commences will not have any transitional protection.

Example - HireCo has a crane on hire to Grant. Just before PPSA commences Grant returns the crane. The day after PPSA commences, Grant and HireCo sign a new agreement for hire of a crane for 18 months. This new hire is not a "transitional security interest" because it is under an agreement entered into after PPSA starts. It will need to be actually perfected by registration.

The new PPS register

The ASIC charges register each state's Register of Encumbered Vehicles and each state's security interest in goods register and various other state and federal registers are abolished from the start of PPSA.

PPS registration is completed by lodg ng a "financing statement" which is an online form. The new register will be administered by the Federal Government and accessed via the website.

The online register appears simple but in reality there are a number of critical legal facets to the registration process. There are also critical timeframes. For example, if an ROT seller or lessor does not perfect by registration within certain timeframes (in some cases this must be before delivery to the customer), ownership may be deferred to the security interest held by a customer's bank under an "all assets" security.

In my view, it will not be possible for businesses to use the PPS Register safely without a fair degree of understanding of the main PPSA concepts and terminology.

Developing a PPSA action plan

Banks and other financiers are well down the track in assessing the impact of PPSA. These organisations typically have experience in and systems to deal with security registration, priorities and so on.

For other businesses and in particular equipment hire business and ROT or consignment sellers, it will be the case that they have never had to register their interests anywhere and could rely on ownership to protect themselves. These businesses will require specific advice about the impact of PPSA.

Getting "PPSA ready" will typically involve a number of steps which include:

1. Appoint a PPSA project officer - someone responsible for gaining a more detailed understanding of the legislation.

2. Analyse which arrangements give rise to PPSA security interests. For instance, some hire businesses may be able to remain outside PPSA by only entering into short fixed term hires. Other businesses may accept that PPSA applies but decide to accept the risk that flows from not perfecting their security interests. The broad and functional or "in substance" concept of "security interest" means that the application of the law may be undetected without careful analysis.

3. Review documents and systems. Most businesses will be advised to amend their customer agreements and review their documentation processes. Typical changes will include:

• ensuring there is a written agreement that covers (and adequately describes) the relevant personal property is in place;
• contracting out of the requirement that otherwise applies to provide the statement of PPS registration to the customer;
• wording that maximises enforcement rights. Some arrangements may amount to "in substance" security interests which brings them into Chapter 4 of PPSA. Chapter 4 is an extensive regime for enforcing security interests. Appropriate wording in customer agreements can minimise obligations to give notice to the customer of various steps in relation to enforcement and repossession, retention or sale of the hired equipment;
• clauses that preserve confidentiality. PPSA gives certain third parties, including competing security interest holders, rights to obtain a copy of the security agreement and amounts owing. These rights can be minimised by appropriate wording in the agreement;
• providing the ability to recover registration costs from the customer;
• obliging a customer to perfect any security interests it obtains from a third party. This will be a critical issue in the context of sub-hires. The rights of an owner may be lost if the hirer on-hires to a third party and does not perfect its rights against the third party.

4. Develop a system for registration.

5. Finalise an individual approach to the transition to PPSA.

I would expect that many businesses will soon find that their banks seek assurance that PPSA risks are being addressed.

Author: Oliver Shtein

A version of this article has also been published in Thomson Reuters Australian Tax Bulletin January 2012.