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Focus: Personal properties securities reform and the construction industry

10 August 2010

In brief: The Personal Property Securities Act 2009 (Cth) will commence in May 2011. It covers a wide range of transactions, not just security interests. It is not limited to consumer transactions, and significantly alters aspects of commercial law and contracts law. It makes fundamental changes to the way in which securities are taken and enforced over most forms of property other than land. Significantly for those in the construction industry, the legislation will affect retention of title clauses and rights over temporary works and a contractor's equipment. Partners Leighton O'Brien (view CV), Steve Pemberton and Diccon Loxton (view CV) and Lawyer Merav Bloch report.

This is the third in a series of Focus articles that looks at the effect of the new legislation across a range of industries.

How does it affect you?

  • From May 2011, security interests will need to be registered or otherwise perfected.
  • Security interests encompass suppliers' retention of title clauses, principals' rights to use and dispose of contractors' equipment and contractors' rights in respect of temporary works.
  • Failure to register may result in a supplier or contractor being unable to recover its goods and equipment in the event of insolvency of the purchaser and a principal being unable to exercise rights over a contractor's equipment.
  • If you are a customer or recipient of goods or services, a very large number of interests can be registered against your company. You will need to consider the terms of your negative pledge clause.
  • Contractual restrictions on assignments may be ineffective.

What kinds of transactions are affected?

The Personal Property Securities Act 2009 (the PPSA) applies to security interests over personal property.

What is 'personal property'?

'Personal property' includes most forms of property other than land, and includes both tangible and intangible property.

What is a 'security interest'?

The PPSA generally (although not always – see below) takes a 'substance over form' approach to determine what constitutes a 'security interest' so that it regulates transactions that may not generally be thought of as creating security interests.

It defines them generally as transactions that create an interest in relation to personal property to secure payment or performance of some other obligation.

The PPSA gives examples of arrangements that are security interests if interests in property and they secure payment or performance:

  • charges, mortgages and pledges;
  • conditional sale agreements (including an agreement to sell, subject to a retention of title) and consignments;
  • hire purchase agreements;
  • leases of goods; and
  • flawed asset arrangements.

In certain cases, the PPSA deems some transactions to be security interests, even though they do not secure anything. They are:

  • transfers of accounts (receivables for goods or services supplied) and 'chattel paper' (documentation governing certain financial interests in goods, such as a hire-purchase agreement);
  • a consignor's interest in a commercial consignment; and
  • a lessor or bailor's interest in goods under a 'PPS lease'.

A PPS lease is defined as a lease or bailment of goods for more than one year or an indefinite term, or 90 days for serial numbered goods. However, a 'PPS lease' does not include arrangements where the lessor or bailor is not regularly engaged in the business of leasing or bailing goods and it only includes bailments where the bailee (the party which gets possession) is paying the bailor (the party which gives possession and owns the goods).

A PPS lease covers operating leases as well as finance leases. It would include arrangements under which equipment or other goods like scaffolding or construction equipment are provided as part of a service or in connection with the service and the customer obtains possession of the equipment. It would not cover arrangements where the contractor operated the equipment itself.

Examples in the construction industry

There are three clauses, or mechanisms, that are common in construction and procurement contracts that may fall within the scope of the PPSA:

  • retention of title or 'Romalpa' clauses. Such clauses are standard in most procurement and supply contracts. A Romalpa clause essentially provides that ownership of goods does not pass to the purchaser until the price has been paid. This is designed to insulate the supplier against the risk of default (or insolvency) by the purchaser. Absent a Romalpa clause, title would typically pass on delivery of the goods.1 A typical Romalpa clause is clause 20 of AS4911-2003.2 Historically, Romalpa clauses have not generally been regarded as security interests although there have been exceptions, depending on the drafting of the clause or the relevant statute.3 Now, under PPSA, Romalpa clauses will be regarded security interests no matter what care is taken to draft them and so must be registered to be legally protected.
  • a contractor's rights over its temporary works. Most construction projects involve extensive temporary works (such as form work and scaffolding) which are left on a purchaser's or principal's site but which never form part of the works and the title to which never passes. The temporary works may be used over and over again on multiple projects. Contracts do not typically expressly deal with temporary works in any detail. Historically, the nemo dat rule protected contractors in this situation, as the principal could neither effectively sell or grant security over temporary works.
  • a principal's rights over construction plant on take out. It is common for a construction contract to allow the principal to take the work out of the contractor's hands following default and to allow the principal to seize the contractor's plant and equipment. This is primarily to allow it to be used to complete the works. The power often extends to the ability to sell and use the proceeds to compensate the principal.

All of the above are likely to qualify as security interests and trigger the application of the PPSA. Unless they are registered the relevant goods can be lost on insolvency or to other secured creditors.

How does the PPSA affect clauses creating a security interest?

The new regime completely overhauls existing arrangements for the treatment of securities in personal property. It introduces a national (online) system for the registration of security interests and default rules for determining priority in relation to a particular asset. It also contains rules that affect when a security is enforceable, how it can be enforced, and when a security interest will be extinguished.

The legislation will start to apply after the 'registration commencement time', which is expected to occur in May 2011. Some of the major reforms affecting security interest clauses, and some of the issues worth considering in the lead-up to May 2011, include the following.

  • The PPSA establishes an online register for the registration of security interests in personal property. Some security interests currently registered under existing Federal or State registers that are being replaced by the new system will be migrated to the new national register.
  • There are now three steps that need to be completed before a security interest receives the highest degree of protection: 'attachment', enforceability against third parties, and 'perfection'. The requirements for satisfying these steps (using the example of a Romalpa clause), are dealt with below.
    • A Romalpa clause that is not registered may still be enforceable against the purchaser of the goods (or 'grantor' – who grants the retention of title security to the supplier). To be enforceable against the grantor, it only needs to have 'attached'. In the case of a Romalpa clause, attachment occurs where the supplier of goods (or 'secured party') gives value for the security interest arising from the transaction, or otherwise does an act by which the security interest arises. In this context, the value given by the supplier will be delivery of the goods or use of the goods pending payment. Entry into the contract confirming the Romalpa clause will also be an 'act' by which the security interest arises.
    • However, mere attachment does not make the Romalpa clause enforceable against others. Enforceability against third parties requires (a) that it has 'attached' as outlined above; and (b) that it is evidenced in writing. The PPSA makes clear that it is not enough for a clause to refer generally to 'equipment'. The contract must particularise the relevant equipment in more detail.
    • While a Romalpa clause can be enforceable against third parties without being 'perfected' by registration, there are dangers in not taking that step. The holder of an unperfected security interest can lose it:
      • on a sale to a third party buyer, for new value, even if the buyer has notice of it;
      • if the grantor goes into liquidation, bankruptcy or voluntary administration;
      • to perfected security interests in the same property, again even if the holders have notice of it; and
      • to an 'execution creditor' of the grantor (being a judgment debtor who has also issued execution).

In the case of a Romalpa clause, registration should be made before the 10th business day after delivery of the goods. The registration should also contain a statement that the security interest constitutes a 'purchase money security interest', as this will give the interest priority over almost all other registered interests.

    • Under the default rules provided by the PPSA:
      • perfected security interests have priority over unperfected security interests;
      • priority between perfected security interests is determined on a first-in-time basis;
      • perfected 'purchase money security interests' have priority over other perfected interests.

There are, however, many exceptions to these default rules.

  • The PPSA also sets out a number of circumstances where title in assets can pass to purchasers free of an existing security interest, even if it is perfected. For example, a buyer of property that is sold in the ordinary course of the seller's business will take free of a security interest, unless the buyer has actual knowledge that the sale is in breach of the security agreement.

The impact on temporary works

The nemo dat rule may no longer apply and, in the absence of registration, a contractor's title in temporary works may be at risk. Contractors will also need to describe temporary works in their contracts.

What about principals?

Since the decision in Smith (Administrator of Cosslett (Contractors) Ltd v Bridgend County Borough Council [2002] 1 All ER 292, take out powers over a contractor's equipment needed to be registered as a charge to be fully effective (particularly against a liquidator). Most principals, however, do not take such step. The PPSA confirms that registration is required for such powers to be effective.

What about equipment hire?

The PPSA also captures equipment hire arrangements where the lease is for an indefinite term or a period of more than a year. Scaffolding and other equipment hire companies may wish to register their interests to protect against the risk of insolvency by their customers.

Bank guarantees and retention amounts

Bank guarantees and retention money withheld from progress payments, despite often being described as 'security' in construction documentation, are unlikely to fall within the meaning of 'security interest' for the purposes of the PPSA, and so generally will not be affected by it.

Confidentiality – your documents can become public

Certain parties can also request copies of the security agreement which creates the security interest. This can be subject to confidentiality agreements between the parties, but those confidentiality agreements are ineffective to stop the right of access after a default.

Terms of contracts – restrictions on assignment overridden

The law overrides contractual restrictions on the assignments of debts arising under the contract. This means your counterparty may be able to assign to other parties its rights in respect of amounts payable by you under contracts, even though you do not wish to give your consent.

Preparing for the reforms

The New Zealand experience is that parties need much more time than they think to prepare for the reforms. The industry should begin preparing for the PPSA regime in order to protect its interests and minimise disruption to businesses once the PPSA takes effect. Preparations should include, where applicable:

  • First, scoping the task. This will involve both;
    • reviewing existing contracts to identify security interests that will need to be registered once the PPSA becomes effective; and
    • ensuring documentation is suitable for use in future transactions, and in particular checking your standard contract terms.
  • Where necessary, preparing new policies as to requirements for transactions and documentation.
  • Redrafting agreements and charges.
  • Identifying the transactions that will need to be registered.
  • Identifying the assets affected.

Business Impact Scoping Tool

One of the most difficult and time-consuming issues for businesses will be to work out what the PPSA means for that business and to make sure that an organisation and its subsidiaries have identified all the various transactions and products where the PPSA may be relevant. It is easy to miss some of its effects, and this may be expensive. To help with this task, we have created a comprehensive online risk assessment tool that can assist clients to assess their PPS exposure. The Scoping Tool includes a survey of various business and legal units, a risk assessment report and consultation with an Allens team of PPS specialists. If you are interested in hearing more about this tool, please contact your relationship partner or one of our specialist PPS team.

Footnotes
  1. Under the Sale of Goods Act in each jurisdiction, title is deemed to pass 'at the time intended by the parties'. In contracts for the sale of 'unascertained goods' (as is generally the case in construction contracts), title generally passes on delivery of the goods.
  2. This clause and item 28 in Annexure Part A allow the parties to specify when title passes. If nothing is stated, title passes on payment.
  3. For an example of a Romalpa clause which was held not to constitute a security interest, see Associated Alloys Pty Ltd v ACN 001 452 106 Pty Ltd (2000) 202 CLR 588. By contrast, in General Motors Acceptance Corporation Australia Southbank Traders Pty Ltd (2007) 227 CLR 305, the High Court held that a retention of title clause providing for ownership in a car to pass to the purchaser only when the purchase monies were paid in full constituted a 'security interest' for certain legislation.

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