Focus: Personal property securities reform and what it will mean for M&A transactions
31 January 2012
In brief: Sweeping changes to Australia's personal property securities laws have just come into operation, with far-reaching consequences for business. Partners Steve Pemberton and Greg Bosmans (view CV), and Senior Associate Vida Wongseelashote, report on how M&A transactions will be affected.
- Deal negotiations and confidentiality
- How will due diligence be affected?
- Purchasing property free of encumbrances – what will change?
- Compulsory acquisition and schemes of arrangement
- More on PPS?
How does it affect you?
- Consider confidentiality obligations – it is possible for a party to register its security interest before the transaction documents are signed.
- Due diligence of security interests may become more time-consuming and cumbersome. While in some ways, the PPS Register will provide purchasers with less of a complete picture than before, previously unregistrable security interests will now be visible to purchasers.
- Purchasers will benefit from the new rules reflecting policy that secured parties should bear the risk of not taking steps to protect their security interests.
- Vendors of businesses should review registrations against themselves. Vendors of companies should ensure that the target's security interests are perfected and should be aware of perfected security interests where the target is the grantor of the security interest.
- The extinguishment rules relating to shares under the Personal Property Securities Act 2009 (Cth) (the PPS Act) only apply where the shares are acquired by consensual transaction. Amendments to the PPS Regulations mean that the unclear, but generally accepted, position under the general law – that shares acquired under the compulsory acquisition or scheme of arrangement provisions of the Corporations Act 2001 (Cth) can be acquired free of encumbrances – is not excluded from operating concurrently with the PPS Act.
The changes to the law in relation to security interests in personal property have replaced Federal, state and territory laws with a single piece of legislation, the PPS Act. Under the PPS Act, a party with a security interest in personal property now bears the responsibility of putting the world on notice of its interest – by 'perfecting' that interest – to avoid defeat on the sale of the property, loss of the interest in an insolvency scenario, and loss of priority to other secured parties. 'Perfection' of a security interest in personal property is attained either by possession or control of the property, or by registration of the interest on the new online personal property securities register (the PPS Register). The new laws will significantly affect the buying and selling of companies and businesses.
The concept of a 'security interest' under the PPS Act is very broad. It is an interest in personal property (with some exclusions such as land and fixtures) provided for by a transaction that, in substance, secures payment of money or performance of an obligation. Such a broad concept could capture many things that are not traditionally thought of as a registrable security interest, including some commercial arrangements between a vendor and purchaser under a sale agreement. For example, say that a vendor and purchaser of a business agree that the purchaser will fund the maintenance of a sale asset during the time between signing and completion. To secure repayment of the funds in the event the sale did not complete, it might be agreed that the purchaser will be entitled to the goods produced by the business during the period it was funded by the purchaser, or the proceeds realised from those goods. Alternatively, it might be agreed that the vendor could not sell the business to another party unless the purchaser was repaid in full from the proceeds of that sale. In either case, the purchaser's interest in the goods or proceeds could amount to a 'security interest' capable of registration at the appropriate time.
During negotiations, parties will scrutinise whether the rights and obligations they are negotiating will in fact be security interests under the PPS Act. To get the best priority they will want to ensure such interests are 'perfected' as soon as possible. Since it does not matter if perfection of an interest occurs before or after the security interest 'attaches' to the property (eg before the relevant agreement is signed), it will be possible for a party to perfect its security interest by registering a 'financing statement' before the signing of the transaction documents. To register, the party will only require a belief on reasonable grounds that it will become a secured party. Although the law imposes civil penalties on secured parties who do not correct the PPS Register if the transaction does not go ahead, and while parties' interests may be aligned such that the secured party will not seek registration before signing, the risk of early registration remains. If parties are not careful to manage confidentiality obligations to minimise the risk of pre-signing registrations, scrutiny of the PPS Register could reveal that a deal is imminent or fuel market rumours.
Under the old law, due diligence would involve a search of the ASIC database to find out whether a third party had a registered charge over the vendor's assets. Importantly, the charge instrument would often be filed with ASIC as evidence of the creation of the charge and therefore would usually be available to the public. This made it straightforward for prospective purchasers of a business or company to know which of the vendor's assets were the subject of a registered charge and to determine the extent of the release required at completion.1
Under the PPS Act, secured parties will register their security interests online on the new PPS Register by filing a 'financing statement'. The information contained on a financing statement is basic – the identity of the secured party, the end time for registration, whether the security interest is subordinated to another security interest (optional), and a limited description of the relevant property (the 'collateral'). Most significantly for due diligence, the instrument creating the security interest is not filed on the PPS Register. Searching the PPS Register will only reveal the information provided on the financing statements.
Without the instrument creating the security interest, the level of information about the collateral that purchasers will be able to glean from a search of the PPS Register will fall into one of the following classes:
- all present and after-acquired property;
- all present and after-acquired property, except2;
- financial property;
- intangible property;
- motor vehicles;
- water craft; and
- other goods (ie personal property that is goods not being agriculture, aircraft, motor vehicles or water craft).
If a security interest attaches to more than one of the prescribed classes of collateral, the same security interest may be registered more than once. While this would ensure that a search of any one type of collateral should turn up the security interest, it would also mean that a comprehensive search of the PPS Register will turn up multiple financing statements relating to the same security agreement. This may result in the need to review the search results to 'piece together' the security interest picture, making due diligence cumbersome and time-consuming.
Alternatively, a security holder could choose to register its security interest under the collateral class 'all present and after-acquired property', whether the security interest attaches to one, or more than one, of the prescribed collateral classes (registrations 'migrated' from the previous ASIC register will automatically fall into this class, regardless of the scope of the relevant security interest). There is also nothing to prevent a secured party from registering its interest under this class when in fact the security is only over a small number of assets. Since purchasers cannot see the terms of the security agreement, they may find they need to guess at what is actually collateral. Vendors may find in these circumstances that purchasers will require the comfort of additional warranties that the sale assets are not the subject of a security interest.
On the other hand, a review of the PPS Register should now give purchasers a new ability to see previously unregistrable security interests. Under the old rules, the risk that these 'hidden' security interests would 'emerge from the woodwork' after completion was mitigated by the general law if the purchaser were a 'bona fide purchaser for value without notice', and protection was usually sought from the vendor under the sale contract. However, as a risk that is ultimately borne by the purchaser, this new visibility should provide purchasers with a welcome degree of additional protection.
Previously, ownership and the rule that 'a person cannot give what they do not have' generally protected the holders of security interests in property. The new rules governing taking property free of encumbrances will shift the balance in favour of purchasers. Generally, a purchaser will take sale assets free of a security interest if the security interest is unperfected. As it will always be open to the secured party to put the world on notice of its security interest by perfecting its security interest, the rationale is that the risk of a purchaser acquiring encumbered property should be borne by the secured party rather than the purchaser. It is impractical for the purchaser to become aware of a security interest if the secured party is not diligent in protecting its security interest.
For most property, a thorough review of the PPS Register will be essential to the purchaser taking the sale assets free of encumbrances. If no security interests are registered over the sale assets, then the purchaser should ascertain if a party other than the vendor is in possession or control of the property (or seek a warranty that this is not the case), as possession or control by a third party could suggest perfection of a security interest over the asset. For share sales, this should not be an issue, as a registered security interest can be defeated by a purchaser who takes control of the shares (broadly, possession or control of share certificates, being registered as the owner of the shares, or being in a position to control the transfer of the shares). However, a security interest over shares will not be extinguished by taking possession or control of the share certificates if the purchaser has actual or constructive notice that the dealing is a breach of the security agreement that provides for the security interest.
It is customary for sale contracts to require, as a fundamental term, that the property be sold 'free of encumbrances', and to support this with warranties given by the vendor that it has good title to pass to the purchaser. In theory, if purchasers need only be concerned with perfected security interests under the new rules, then these kinds of contractual safeguards against encumbered title should not be needed by purchasers. However, it is unlikely that these safeguards will disappear any time soon especially if, as is often the case, there is a time lag between signing and completion. Rather, the new rules are likely to give rise to new or modified warranties.
For vendors of businesses, preparing for a sale should involve being aware of registered security interests over the sale assets so as to be in a position to answer purchaser enquiries arising from the PPS Register, negotiate warranties, and arrange the appropriate releases from the secured parties at completion.
Similarly, for vendors of companies, the status of the target's assets as collateral is likely to be of interest to the purchaser. Vendors will likely need to be aware of all perfected security interests over assets of the target, particularly those perfected by control or possession. In addition, for vendors of companies, preparing for a sale should also involve ensuring all of the target's security interests have been perfected, as purchasers may insist on warranties that this is the case.
Purchasers will, of course, still need to ensure that at completion they obtain releases of perfected security interests over the acquired property. In contrast to the use of ASIC Forms 312 (sometimes without an underlying deed of release) under the old system, parties are now more likely to require a deed of release, and a standard form for this purpose has already been circulated within the banking industry. There will be no need for the change in the security interest to be registered on the PPS Register unless the release renders the security interest registration incorrect in some way.
Although the Corporations Act is silent as to whether extinguishment of security interests occurs upon compulsory acquisition of shares at the conclusion of a takeover or otherwise as permitted by that legislation, the generally accepted position under the general law is that shares acquired in this way are acquired free of encumbrances.
Where shares are transferred by scheme of arrangement, the transferee is subject to the general law of priorities that it takes the shares subject to those security interests of which it has notice. It has therefore become customary for the scheme of arrangement to contain a 'no encumbrance' clause and deemed warranty as to good and clear title. At present, however, the prevailing authority is that these contractual provisions remain subject to the general law of priorities, meaning that they are ineffective to the extent the transferee has notice of security interests over the shares.3 Accordingly, schemes of arrangement to effect control of a company are sometimes structured as 'cancellation' schemes where, instead of being transferred, the shares are cancelled – thereby extinguishing any security interests over the shares – and new shares are issued to the entity acquiring control.
Therefore, although not completely clear, it is generally accepted under general law that the acquisition of shares under the compulsory acquisition and scheme of arrangement provisions of the Corporations Act can, in the right circumstances, be taken free of all security interests.
The PPS Act is not intended to exclude or limit the operation of the general law to the extent that it is capable of operating concurrently with the PPS Act. However, section 32(1)(a) of the PPS Act expressly provides that if a dealing in collateral gives rise to proceeds, then a security interest in that collateral will only be extinguished if the secured party expressly or impliedly authorised the dealing or the extinguishment.
Section 32(1)(a) therefore effectively excludes the position under the general law to the extent that shares acquired under compulsory acquisition or schemes of arrangement can be acquired free of encumbrances, because these statutory regimes do not require authorisation, whether express or implied, of the shareholder for the dealing in those shares (provided the statutory conditions have been met).
There are specific extinguishment rules that relate to shares under the PPS Act, but there is concern that, on the drafting of the relevant provisions4, those rules do not apply to shares acquired under compulsory acquisition or a scheme of arrangement. This is because they only apply where the shares are acquired by consensual transaction.
Amending regulations registered on 5 October 2011 have sought to clarify the position. However, because the amendments operate to exclude compulsory acquisition and schemes of arrangement from s32(1)(a), all this means is that the general law position is not excluded from operating concurrently with the PPS Act. As an interim measure, the amendments are welcome clarification that the PPS Act is not intended to exclude the general law protections for transferees under compulsory acquisition or schemes of arrangement. However, given that the general law position itself is unclear, the opportunity should be taken to enshrine it in the legislation, preferably by amending the 'taking free' provisions of the PPS Act relating to shares so that they do not exclude shares transferred under compulsory acquisition or scheme of arrangement.
The reach of the PPS Act beyond financing transactions means that all businesses should think about how they might be affected. For further information visit our dedicated PPS website or contact your relationship partner or a member of our specialist PPS team.
- All company charges, together with all associated lodged documents, on the ASIC register as at 30 January 2012 will be 'migrated' to the PPS Register. This means that it will be possible to continue to see those charge instruments that were lodged with ASIC before commencement of the PPS Register.
- This category can be used where it is convenient to state the item or class of property of the grantor that falls outside the security interest. It can also be useful when a security interest covers property that spans several classes.
- See eg Investa Properties Ltd (2007) 25 ACLC 1186.
- Sections 50 and 51.
- Guy AlexanderPartner,
Ph: +61 2 9230 4874
- Jon WebsterPartner,
Ph: +61 3 9613 8832
- Andrew PascoePartner,
Ph: +61 8 9488 3741
- Chelsey DrakePartner,
Ph: +61 7 3334 3202
- Greg BosmansPartner,
Ph: +61 3 9613 8602
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