Section 64 and Maintaining Access to Finance

What is a Section 64 letter?

Note: It is important to have an understanding of a supplier's right to 'proceeds' in order to properly appreciate the role of Section 64 of the PPSA.  You can get a quick briefing on proceeds here.

Section 64 letters are designed to fix the problem caused when a supplier’s claim to proceeds of on-sale conflicts with a financier trying to get ‘clean’ security for an accounts receivables package (also known as debtor financing).

If a financier is being asked to finance a business’s on-sale of goods it is reasonable for them to want to take security over the money the business will receive from that on-sale.  However, where the original supplier of those goods has a Retention of Title clause and has registered it correctly as a PMSI, they are entitled to the first ranking security right over monies received from the on-sale of their unpaid-for goods.

Unless a compromise is reached the buyer may have his access to finance curtailed and the supplier will possibly run a greater risk of late payment or even non-payment.

The compromise included in Section 64 of the PPSA, involves the financier giving the supplier 3 weeks’ notice of their intention to lodge a registration over their customer’s proceeds from sales.  The registration they lodge at that time will take precedence over the supplier’s – BUT ONLY FOR THE PROCEEDS ELEMENT – and, in return, the supplier’s security rights will transfer from the proceeds of on-sale to the proceeds from the financier’s finance package.

Sometimes the 3 week wait is too much for the financier and their customer and, as a result, the supplier will be urged to discharge their registration, allow the financier time to lodge their registration, then put their registration back in place.  This is NOT beneficial to the supplier and would mean that they would be sacrificing their right to proceeds without any commensurate right to a share in the finance to show for it.

When do I have an interest over 'Proceeds'?

What does ‘Proceeds’ mean?

The term 'proceeds', in this context, refers to money that comes to a buyer from the on-selling of goods supplied to the buyer by the original supplier of the goods.

If a supplier has a Retention of Title right and registers it as a PMSI (see here) they get the opportunity to have their security interest extend to any money their customer receives from on-selling the supplier's unpaid-for goods.

While in most cases (unless they involve a motor vehicle identified by its VIN number, for example) the supplier's right to recover their unpaid goods ends with their buyer's on-sale of those goods, the PPSA allows a supplier's PMSI security interest to 'automatically' transfer to the proceeds of on-sale of those goods as soon as their secured 'grip' over the original goods is lost.

While this can be a useful ‘added extra’, proceeds claims can be messy and, typically, will only be successful when the proceeds monies are received AFTER a liquidator has been appointed to the customer’s business.

I've yet to see rights over proceeds used in a defence against a liquidator's preference claim and, whilst I can envisage some scope for success, I can also imagine that such a defence would not be particularly well received by said liquidator.

Simplifying the Registration Process - Review Recommendations

When the results of the official Review of the PPSA were released earlier this year, I was tempted to hurriedly put out a number of posts describing its recommendations.  However, this temptation was tempered somewhat by the realisation that, not only was it something of a major job trying to sort through 394 recommendations in a 542 page report, it was highly unlikely that any of the report’s recommendations were likely to be implemented in the very near future.  

This was not from of any lack of confidence in the quality of the recommendations but merely because of the sheer number of recommendations being made and the fact that it took well over a year for the last PPSR amendment Bill to be passed addressing only a single issue (not counting the time taken to decide that a Bill was appropriate in the first place!).

Now that I’ve stuck my toe in the water of the Report’s recommendations in my last, catchily titled, post on the Cross-Collateralisationof PMSIs, I thought I’d draw attention to some of the Report’s recommendations aimed at simplifying the registration experience.

 Consumer property or commercial property?  - Recommendations 86 and 87 propose doing away with the distinction entirely.  No more confusion caused by the uninitiated thinking that ‘commercial property’ means the same thing as commercial premises.

Purchase Money Security Interest (PMSI) applies? - The PPSR’s ‘PMSI Box’ is widely misunderstood with many registrations rendered largely ineffective because a secured party didn’t understand what was meant by a Purchase Money Security Interest.  In both Canada & NZ there is no requirement to ‘flag’ a registration as a PMSI but, instead, PMSI priority will be determined by the nature of the security interest itself whenever competing security interests need to be assessed.  Where ROT suppliers are concerned, recommendation 241 proposing the removal of the PMSI Box is one of the biggest (if not the biggest) recommendations contained in the report.

The collateral is inventory? -  Recommendation 88 proposes doing away with the question, finding that it added little value and merely served to create confusion and uncertainty – as well as an opportunity for liquidators to dismiss an otherwise correct registration.

Current assets are subject to control? – On of the least understood of the questions facing anyone trying to lodge a registration against inventory, the Report’s recommendation 89 also proposes removing this question, again finding that it added little value and that it’s absence would be less confusing.

This registration is subordinate to another? – Again, this is found to be merely confusing and absent of value, thus recommendation 90 advocates its deletion.

Proceeds to be claimed? – Recommendation 180 seeks to make it clear that if a security interest over goods supplied is properly perfected by registration then it should automatically apply to any proceeds from those goods, thus recommendation 98 proposes the removal of the proceeds question when lodging a registration.

Giving of Notice Identifier (GONI) – Recommendation 122 suggests doing away with the expression “GONI” on the register and replacing it with a term that more clearly indicates its purpose as the supplier’s internal client reference number.  GONI was always a ridiculous and misleading term for something that was otherwise so straightforward.

In conclusion, should the Report’s recommendations be adopted, lodging a registration in the future will be simply a matter of identifying the grantor/buyer, choosing a collateral class, entering a brief (but suitably vague) description, choosing a registration period and pressing submit. Too easy!!

But, as I said at the outset, don’t expect much to happen in the short term.

PPSA & Real Estate

There seems to have been a flurry of activity over the last month with a number of our clients being pestered to discharge PPSR registrations on the basis that they are impeding the sale of real estate property.

While this is an obvious nonsense it is, unfortunately, being propagated by a number of legal professionals and is becoming such a nuisance that I was asked to draft up a letter on behalf of a client which they could then send to their customers.  

Our client sells building materials which go to form an integral part of the structure of a building and their immediate customers are usually builders who will then be selling the resulting building.

The draft went as follows:

The Personal Property Securities Act 2009 (PPSA) was passed by Government in an attempt to simplify and clarify how security interests are treated across the whole of Australia. 

One of its key elements has been the creation of a national register (the PPSR) where the holders of security interests are encouraged to register the existence of those interests.  As a matter of company policy, we have decided that we will register all our security interests on the PPSR.

Our registration is strictly in relation to a security interest we maintain over the goods we supply in the form of a Retention of Title clause enshrined in our standard Terms & Conditions of Sale.

Our registration on the PPSR is purely a means to safeguard our position against any competing claims from other creditors and should not, as a matter of practicality, change our normal trading relationship with you nor indicate any concerns regarding your value to us as a trading partner.

However, the PPSA is still relatively new to everyone and misunderstandings abound – particularly with organisations which you might think would know better such as banks and solicitors. 

One such misunderstanding may arise when you are attempting to sell real estate property. 

During the sale process, someone (usually a conveyancer) will discover that [Client Name] holds a PPSA security interest against your business and will decide that the real estate sale cannot be concluded until [Client Name] has released and/or discharged its security interest.

If this occurs you should point out to whoever draws this to your attention that the PPSA does not apply to the sale of real estate or to any fixtures attached to such property.

For further confirmation you may direct interested parties to the PPSR’s web site at www.ppsr.gov.au where it clearly states that:

Under the Personal Property Securities Act 2009 (Cth), personal property is defined as any form of property other than land, buildings or fixtures that form part of it or a right (such as water rights), entitlement or authority.

You may also make reference to Section 8(1)(j) of the PPSA which specifically identifies fixtures as an item of property to which the Act does not apply and Section 10 of the same Act which defines the Act’s use of the term fixtures.

Our registered security interest applies to rights we hold to recover unpaid goods that we have supplied up until the point those goods are incorporated into a building and become fixtures. 

After that point our security interest transfers to a portion of any proceeds that may arise from the sale of that property but no longer applies to the property itself.

Please feel free to send a copy of this letter to anyone requiring the release of our PPSA registered security interests as a pre-condition to allowing the sale of real estate to go ahead.  When presented with a request based upon a misunderstanding our inclination is to dispel the misunderstanding rather than perpetuate it by humouring the request.

I have a particular fondness for the last line although I don't doubt that this would be one of the more likely elements to be edited out by anyone choosing to base their own letter on this draft.

Feel free to use the draft as you see fit (although if you want to publish a version on your own website I'd appreciate the credit).

P

Section 64 of the PPSA

OUR CLIENT has a properly registered security interest lodged on the PPSR in respect of a Retention of Title clause included in their terms & conditions with THEIR BUYER.

Because OUR CLIENT’S security interest is in the form of a Retention of Title clause it entitles OUR CLIENT to have designated their security interest as a Purchase Money Security Interest (PMSI) thus giving OUR CLIENT a higher level of priority for their security than might otherwise be the case.

OUR CLIENT’S security interest also extends to any proceeds that might arise from THEIR BUYER on-selling or otherwise using/disposing of the goods subject to the retention of title.

However, as far as those proceeds are concerned (just the proceeds, not the actual goods OUR CLIENT has supplied) THE BUYER’S BANKERS are advising OUR CLIENT that they have a competing claim to the proceeds by virtue of a debtor financing facility they have put in place with THEIR BUYER.  THE BUYER’S BANKERS are suggesting that, in the event of THEIR BUYER entering into receivership or liquidation, their claim on the proceeds will rank higher than OUR CLIENT’S claim.  While this position may be subject to challenge, Section 64 of the PPSA certainly gives them grounds for this view.  In return for being pushed down the priority pecking order for proceeds, OUR CLIENT will automatically have their PMSI rights expanded to include a share in the money being advanced by THE BUYER’S BANKERS in so much as it relates to the sale of product originating from OUR CLIENT.

While I’ve yet to see any examples of this being challenged/upheld in practice, OUR CLIENT should proceed on the basis that, while they have the highest priority security interest over the goods they are specifically supplying, they probably now only have a second level priority over any proceeds that may arise from the subsequent sale of those goods by THEIR BUYER.

No action is required on OUR CLIENT’S part. 

On the one hand, the presence of THE BUYER’S BANKERS’ debtor financing may give OUR CLIENT some additional comfort that finance is being made available to THEIR BUYER to make payments to its suppliers but on the other, if THEIR BUYER does fail, the extent to which their security interest can be stretched to include income from goods OUR CLIENT supplied but which have subsequently been sold by THEIR BUYER has been weakened.

We have seen banks and other financiers try to ‘encourage’ suppliers who have registered PMSI interests to discharge their registrations or otherwise grant releases where the bank is looking to securitise its book debt financing facilities but issuing such notices under Section 64 of the PPSA is the correct way for banks to go about this and better achieve their ends.

As per usual, I have reproduced below the actual text from Section 64 of the Act:

64  Non‑purchase money security interests in accounts

Non‑purchase money security interest in account as original collateral has priority over purchase money security interest in account as proceeds of inventory

             (1)  Despite subsection 62(2), a non‑purchase money security interest (the priority interest) granted for new value in an account as original collateral and perfected by registration has priority over a perfected purchase money security interest that is granted by the same grantor in the account as proceeds of inventory, if:

                     (a)  the registration time in respect of the priority interest occurs before the earlier of the following times:

                              (i)  the time at which the purchase money security interest is perfected;

                             (ii)  the registration time in respect of the purchase money security interest; or

                     (b)  both of the following conditions are met:

                              (i)  the secured party holding the priority interest gives a notice in accordance with subsection (2) to the secured party holding the purchase money security interest;

                             (ii)  the notice is given at least 15 business days before the earlier of the day on which the registration time for the account occurs and the day the priority interest attaches to the account.

Note 1:       This section is subject to sections 57 (perfection by control) and 71 (chattel paper).

Note 2:       The period mentioned in paragraph (b) may be extended by a court under section 293.

             (2)  A notice is given in accordance with this subsection if:

                     (a)  the notice is in the approved form; or

                     (b)  the notice:

                              (i)  contains a description of the inventory to which the notice relates; and

                             (ii)  sets out the effect of subsection (1).

Perfected purchase money security interest in both proceeds and new value

             (3)  If a person has a purchase money security interest in an account as proceeds of inventory that is subordinate to a non‑purchase money security interest under subsection (1):

                     (a)  the person is taken to have a purchase money security interest in both the proceeds of the inventory and in the new value mentioned in subsection (1); and

                     (b)  the purchase money security interest in the new value is taken to be perfected by the registration that perfected the purchase money security interest in the proceeds; and

                     (c)  the new value is taken to be an account for the purposes of this Act (except for the purposes of this section or paragraph 12(3)(a) (account transferee’s interest taken to be security interest)).

             (4)  However, if the new value mentioned in paragraph (3)(c) would be an account for the purposes of this Act in the absence of that paragraph, the paragraph does not prevent the new value from being an account for the purposes of this section or paragraph 12(3)(a).