When does the Grantor take possession?

I recently had cause to read a helpful summary of a decision by the South Australian Supreme Court in the matter of Allied Distribution Finance Pty Ltd v Samwise Holdings Pty Ltd [2017] SASC 163.  While much of the background to the case is a little fiddly, I’ll give a short ‘broad strokes’ summary in order to help demonstrate why this might be a very useful decision for the hire industry.

For those wanting a more detailed look, I recommend the summary HERE  or, for those that want a real thrill, the full text of the judgment can be found HERE.

The case concerned Bill’s Motorcycles – a dealer, selling and servicing Kawasaki motorcycles.  Bill’s had been financing its floor stock with one financier but then struck an agreement with another (Allied Distribution Finance – ADF).  Bill’s stock of 40 motorcycles (secured by the original financier) was bought out by Kawasaki and, effectively, sold to ADF.  Bill’s maintained possession of the motorcycles and ADF lodged a PMSI registration on the PPSR to perfect its security interest over them.

When Bill’s went into administration a couple of months later, there was a dispute concerning those 40 motorcycles between Samwise, the holder of a General Security Interest (AllPAAP) over all Bill’s assets and ADF as a PMSI holder.

While a PMSI will usually take priority over an AllPAAP, in this case, Samwise argued that because Bill’s was already in possession of the motorcycles at the time ADF lodged their PMSI registration,  ADF had failed to meet the time-scale requirements of section 62 of the PPSA.

Section 62, effectively, states that, in order to achieve PMSI priority over inventory items, a registration must be lodged before the grantor obtains possession of the property.

Samwise argued that, as Bill’s had already been in possession of the motorcycles for some time before ADF lodged their registration, ADF was not entitled to PMSI priority.

In his judgment, Justice Blue determined that, in the overall context, the implication of section 62 should be taken to mean that the registration must be lodged before the grantor obtains the type of possession that would entitle them to grant a PMSI interest in the property.

Thus it is the grantor’s possession in the role of PMSI grantor that matters, rather than their mere physical possession of the property.

While this is unlikely to be of any assistance to trade credit suppliers forgetting to perfect their Retention of Title rights in time, it may have implications for the long-term hire industry.

Last year, the Government made changes to the manner in which hires and leases were caught up by the PPSA.  In short, the changes involved leases for less than 2 years no longer needing to be registered on the PPSR.  Where a lease was established for an indefinite period that may or may not extend beyond 2 years, the new legislation only required a registration to be put in place once that 2-year limit was breached.

When I posted about the new legislation, I wrote:

In order to be eligible for PMSI super priority where the collateral being used is designated as a non-inventory item, the perfecting registration must be lodged within 15 business days of the lessee taking possession of the property.

 However, where an indefinite lease is concerned and the lessor doesn’t lodge their registration until it becomes clear the lease may extend beyond the new 2 year qualifying period, that 15 business days period may long since have passed leaving the lessor’s claim to their equipment to fall behind those of other general security holders with registrations already in place.

Justice Blue’s decision in the Bill’s Motorcycles case suggests that, while a lessee may have been in physical possession of property for 729 days, it will only be at the 2 year mark they have possession in the capacity of a grantor of a PMSI right and it should, therefore, be at that 2 year point when the PPSA’s 15 business days countdown for a PMSI eligible registration should commence.

Whether this interpretation is sufficient to also satisfy the Corporations Act’s dreaded section 588FL is another matter! 

Clive Palmer vs the PPSA

I’ve just read an 'excited' article by The Australian, entitled “Clive Palmer firms jump queue of creditors for Queensland Nickel” which you can read here (although you may get caught out by The Australian’s paywall).

The meat of the article concerns the ‘last minute’ registration on the PPSR of security interests against Queensland Nickel by companies in which Clive Palmer has an interest.

“Four days before Clive Palmer’s Queensland Nickel Industries collapsed into voluntary administration, two of his companies staked a claim on all of the refinery’s assets in an apparent attempt to squeeze out redundant workers and other creditors.”

The article goes on to say that,

“Legal experts said the manoeuvre could disadvantage sacked workers, already furious at being denied access to their redundancy entitlements.”

Apparently, The Australian and its ‘legal experts’ are not especially familiar with the workings of the PPSA or the Corporations Act once insolvency practitioners become involved.

Firstly, any creditor who had lodged a security interest on the PPSR prior to Palmer’s recent registrations will benefit from greater priority under the PPSA (at least a dozen of which were registered under the facilities that I personally oversee).

But, perhaps more importantly, in the context of The Australian’s article, are the implications of the Corporations Act for security interests registered within 6 months of a company failure.

While I’ve previously explored this at some length in my post ‘The PPSA vs The Corporations Act’, the short version is that 588FL of the Corporations Act provides a very clear deadline by which a registration needs to be lodged in order to be effective against a liquidator.

If a registration was not lodged within 20 business days of the security interest coming into force or was lodged during the 6 months leading up to the liquidator’s appointment, then “The PPSA security interest vests in the company” and the creditor’s security rights are effectively lost.

So, while opportunistic, last minute registrations may make for a relatively entertaining news story, they don’t make for very effective security.

PPSA & Accessions

To start with, let’s just clarify the applicable definition. 

Where a supplier supplies goods that are installed as part of a building, they become fixtures and, just as would have been the case in pre-PPSA days, the supplier’s retention of title security interest over those goods is, effectively, lost.  However, where a supplier supplies goods that are installed in, or fitted to, a non-real estate piece of property they become accessions. 

In pre-PPSA days, as soon as goods were incorporated into another product they were deemed to have lost their individual identity and the supplier’s security interest over those goods was lost; however, since PPSA the supplier’s security interest can continue in the finished product (section 88 of the PPSA refers).

Moreover, the PPSA’s default priority rules state that the security interest a supplier maintains over their accession takes priority over any claim any other security holder might have to the finished product (section 89).

Now, while section 123 of the PPSA states that a secured party may seize collateral by any lawful method if the debtor is in default under their security agreement, in the case of accessions, the secured party is required to give at least 10 business days’ notice of their intention to remove their product (section 95) and then must ensure that the goods are removed in such a manner as to not cause additional damage to the product in which it is installed (section 92). 

The grantor may apply to the courts for an order postponing the removal of the accession or determining a value to be paid by the grantor to the secured party to allow them to keep the accession in place (section 97).

However, the PPSA is not the only Act that necessarily applies!  In the event an administrator is appointed then the Corporations Act (2001) comes into play.  Once an administrator has been appointed, suppliers/creditors are unable to make claims for property held by their buyer unless they have the administrator’s consent or permission from the court (s440B of the Corporations Act).

Regardless of the super-priority a properly perfected PMSI might give to a supplier of retention of title secured goods, the provisions of the Corporations Act will prevent them from recovering any of their goods without the consent of the administrator.

Although the supplier may not be able to claim back their property immediately, neither is the administrator generally able to sell or dispose of it (s442C of the Corporations Act).  Because the goods are the subject of a perfected PPSA security interest, the administrator must act in the interests of the secured party and not sell or dispose of the goods without either the permission of the secured party or of the courts.

Unfortunately, there is one rather significant exception to this restriction on the administrator on-selling ROT secured property – that is where such an on-sale is in the ‘ordinary course of the company’s business’.

Thus, if you have supplied shafts to an assembler and wholesaler of hammers then the administrator would be perfectly within their rights to sell the completed hammers even though you may have demanded the return of your goods under your perfected PMSI (s442C(2) and (8) of the Corporations Act refer).

The administrator is, however, required to act ‘reasonably’ in exercising their power of sale (s442B) and has some fairly strict rules to follow regarding the manner in which they must deal with the proceeds from such sale (s442CC(2) of the Corporations Act refers).  These boil down to ensuring that the proceeds are applied proportionately to those creditors that hold a priority security interest in those goods.

For example, if you have supplied $10,000 worth of hammer shafts and I have supplied $20,000 of hammer heads and the administrator disposes of the finished product for, say, $24,000 then you will benefit from $8,000 of the proceeds and I will benefit from $16,000 – ie, proportionate to the value of our contribution to the finished product comprising our respective accessions.

To the extent that we are still owed money (your outstanding $2,000 and my outstanding $4,000) we will have to deal with the administrator as unsecured creditors.

The Dangers of Amended Terms & Conditions

For us simple folk, the basic difference between ‘transitional’ and ‘non-transitional’ under the PPSA boils down to the simple question – is this a long-standing customer or a new account?

If a supplier’s trading account was in place prior to the PPSR’s start date on 30/01/2012 then any on-going security interests would be dealt with under the PPSA’s transitional rules, after that date and the transitional rules do not apply.

[My earlier post at http://ppsr-blog.blogspot.com.au/2012/05/challenges-to-ppsas-transitional-rules.html should be referred to for an explanation for identifying a transitional security interest.]

Why is the transitional/non-transitional designation so important?

Well, for one thing, the PPSA provides for a 2 year period during which transitional security interests are deemed to have been perfected without needing to be registered.  This is designed to give trade credit suppliers plenty of time to get around to putting all their long-standing accounts on the register before the end of January 2014 deadline.

So a transitional security interest is basically an existing account that hasn’t yet been registered on the PPSR?

Well, not quite.  When you make a registration on the PPSR one of the first questions you get asked is whether the registration is for a transitional or non-transitional security interest.  So PPSR registered interests may also be ‘transitional’. This is because the rules for determining priority are applied differently depending upon the transitional status of the security interest.

Where you have two equivalent security interests competing for the same collateral, priority is given to the security interest that was registered first; UNLESS one or more of the security interests was a transitional security interest in which case those interests are deemed to have been perfected immediately before the PPSR came into effect.

Now it has been argued that, as the PPSR acts as a notice filing system rather than a transaction filing system, aside from those pesky priority issues, it shouldn’t really matter if a registration is designated as a transitional or non-transitional security interest, what really matters is that the presence of a security interest has been made public and interested parties can be made aware of its existence.  The extension of this argument is that if a security interest was wrongly identified as transitional then an Insolvency Practitioner (IP) could simply ignore its transitional designation and treat the security interest as if it were non-transitional. 

A little like a piece of children’s craft work having its age category mislabelled when being entered into a school craft fair, the piece of work should simply be re-allocated to the correct age category and judged accordingly.

Unfortunately, I haven’t seen any evidence of this argument gaining much in the way of traction and many IPs continue to be quick to pounce on any instance where they believe a registration was wrongly categorised as an opportunity to dismiss a supplier’s claim to secured creditor status.  IPs are effectively disqualifying the child’s craft work from the whole competition rather than assessing it in its correct category.

Ok, it sounds harsh but no-one really expected IPs to be the sort to go around kissing babies and patting puppy dogs and if a supplier can’t tell the difference between a long-standing account and a new account then surely they’ve got to take some responsibility for that?

If only it were that straightforward. 

The issue we are now seeing involves instances where suppliers have made changes to the terms & conditions of their original agreements with their long-standing customers, perhaps to make reference to the PPSA or to clarify how payments are to be allocated, or any of a myriad of sensible variations and amendments.

If any of those changes were introduced after the PPSR came into effect on 30/01/2012 then IPs are arguing that the transitional rules can no longer apply to any subsequent security interests.

That may be understandable if the changes to the initial agreement were done in such a way as to form a completely new agreement but most variations are done so as to maintain the integrity of the original agreement.

That may be so but that might not be good enough under the PPSA. 

Section 308(b) of the PPSA defines a transitional security interest as

…a security interest provided for by a transitional security agreement, if:

(b)  in the case of a security interest arising at or after the registration commencement time:

(i) the transitional security agreement as in force immediately before the registration commencement time [30/01/2012] provides for the granting of the security interest;

The specific wording at issue is the reference to the security agreement “as in force” prior to 30/01/2012.

If we assume that the PPSA’s drafters knew what they were doing (a bit of a stretch I know) then we must consider what inferences need to be drawn from their drafting choices. 

They could simply have referred to a transitional security interest as being one that arises from a security agreement “in force” before 30/01/2012 but instead they chose to refer to a security agreement “as in force” before that date.  While the former would not be without its ambiguities, the choice to include the additional two letters appears to lend support to the suggestion that it is not merely the agreement that needed to be in place before 30/01/2012 but that version of the agreement which gave rise to the security interest in question.

If a later version of the credit agreement was introduced after 30/01/2012 then it would be that later version, it is argued, which would be deemed to have created the security interest and thus the transitional rules would not apply.

That’s an awful lot to read into the inclusion of a single two letter word.

Indeed it is and there is no obvious clarification of intent in the original PPS Bill’s Explanatory Memorandum which simply states that:

“A security interest would be a transitional security interest ….. where the security agreement is entered into prior to the registration commencement time and allows for the creation of the security interest”.

However, if there is one thing we’ve learned since the PPSR began it is that IPs will be only too happy to exploit any chink in a supplier’s registration if it means they can increase the value of the grantor’s assets they get to play with.

Therefore, if a supplier’s Terms & Conditions were amended after 30/01/2012 and that supplier wants to avoid a long, drawn out (and potentially unsuccessful) argument with an IP, they should ensure they have a non-transitional registration in place in addition to any transitional registrations.

Hopefully legal precedent will be established that suggests such a belt and braces approach is unnecessary but, until then, this approach appears to be the best way to avoid the risk of losing security interests and/or priority.

This is almost certainly an issue where suppliers would be wise to obtain their own legal advice.

PPSA & Consignment Stock

Under a Consignment Stock arrangement Company A supplies goods to Company B without passing ownership until such time as those goods are used or sold by Company B – at that point in time a payment obligation between Company A and Company B is created.  Any unused/unsold goods will usually be returned to Company A.

The Personal Property Securities Act treats the structure of Consignment Stock arrangements as providing a security interest for Company A in the goods supplied (PPSA Sections 12(2)(h) and 12(3)(b) refer).

The PPSA goes on to allow for such a security interest to be designated a Purchase Money Security Interest (PMSI) thus allowing Company A a greater priority claim over the goods they  supplied than, say, the holder of a general security agreement over all the assets of Company B (PPSA Section 14(1)(d) refers).

So, as with Leasing arrangements and Retention of Title clauses, it is not necessary for the terms of a Consignment Stock arrangement to specifically describe the agreement as a form of security for it to nevertheless be considered as such in the event of an administrator being attached to Company B.

Unfortunately, this can be something of a double-edged sword. 

Whenever the PPSA provides for an arrangement/agreement to be treated as a security interest it also allows for an administrator to vest the goods/collateral in question along with the rest of the assets of the debtor company UNLESS that security interest has been correctly registered on the PPSR.

Bringing this home quite strikingly was the entry into liquidation last month of Jacksons Rare Guitars Pty Ltd in Annandale, in Sydney’s inner west.  At the time a voluntary administrator was first appointed, Jacksons had over 100 clients who were using Jacksons to sell their instruments on a consignment basis representing almost $850,000 of the total stock.

In a pre-PPSA world the individual consignors could have relied upon consignment notes to prove ownership and claim back their instruments but, since PPSA, if they failed to register their consignment on the PPSR (and I’m not aware of any who did) their precious guitars would be vested by the liquidator with the rest of Jacksons’ stock and sold off for the benefit of, primarily, other creditors.  Unfortunately, it is the post-PPSA scenario that is currently playing itself out in Annandale.

While we continue to bemoan the poor promotion the Federal Government has engaged in regarding letting small and medium sized businesses know about the implications and requirements of the PPSR let us spare a thought for the lack of promotion towards the general public who may first become aware of the Register at the same time as they’re being told that they can’t have their guitar back!

Registering Transitional Security Interests

The introduction of the PPSR required that personal property security interests be ‘perfected’ in order to achieve full effectiveness under the PPSA.  

While this perfection is commonly interpreted to mean registration on the PPSR, the Government has made it clear that security interests arising from security terms in credit agreements already in place at the time of the introduction of the PPSR are deemed to have achieved that perfection via legislation. It is this provision that is referred to as the PPSR’s Transitional arrangements.

In the PPSR’s Fact Sheet on Retention of Title interests the Registrar describes the effect of the Transitional arrangements as follows:

In order to give businesses an opportunity to adjust to PPS reform and the need for registration on the PPS Register in particular, a 24 month transitional period exists from registration commencement time (RCT).

The effect of this transitional period is that ROT suppliers or lessors who have entered into agreements that create security interests in the property supplied or leased before RCT will have two years to register those interests.

It is important to note that it is the agreements that must pre-date RCT, the security interests (for example, by way of supply the goods) may arise after this time. Agreements entered into after RCT are not subject to the transitional arrangements.

It is important to note that the PPS Act does not require a registration to be made in respect of all supplies or leases to the same buyer or lessee. A single registration may cover subsequent security interests in property that is supplied under later agreements

(The full document can be obtained here: http://www.ppsr.gov.au/AsktheRegistrar/FactSheets/Documents/Retention-of-title-and-leasing.pdf)

In effect, registration on the PPSR is not necessary for perfection of the security interests held over a supplier's pre-PPSR client base until 29^th January 2014.

Where Transitional security interests are registered on the PPSR the specific date of that registration is held to be irrelevant in determining any matters of priority.  

When any issues of competing security interests arise in respect of Transitional security interests the relevant date is taken to be the date of the agreement which contained the terms that gave rise to the security interest in question – eg, the date of the signed credit agreement with between supplier and customer.

Where credit agreements are signed after the commencement of the PPSR; however, the situation is completely different.  

When a supplier needs to assert their security interest in respect of a new account (established post-PPSR commencement) their priority against competing security interests will be determined by reference to the date of their registration and the date the credit agreement was formed will be held to be irrelevant.

The PPSR does not charge for registering Transitional security interests and while there is no specific hurry to do so it would be unwise to leave it to the last minute rush as the two year grace period draws to a close.

There have been a few challenges to the interpretation of the PPSA's Transitional rules which I have discussed here but nothing conclusive has been determined as yet.

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).