Focus: Personal property security reforms and the manufacturing and retail industries
9 September 2010
In brief: The far-reaching Personal Property Securities Act 2009 (Cth) is due to come into force in May 2011 and businesses operating in the manufacturing and retail sectors will be affected. It covers a wide range of transactions, not just security interests. It is not just limited to consumer transactions, and significantly alters aspects of commercial law and contracts law. Partner Diccon Loxton (view CV) reports on how the changes will affect the manufacturing and retail industries.
This is the fifth in a series of Focus articles that look at the effect of the new legislation across a range of industries.
- Manufacturing, wholesale and retail industry scenarios
- Some concepts
- Steps to perfect a security interest
- Insolvency – unperfected security interests lost
- The register
- Migration of existing registrations
- Priority – new rules
- Enforcement – new rules
- Back office queries
- Confidentiality – your documents can become public
- Terms of contracts – restrictions on assignment overridden
- How can the industry start preparing for the reforms?
- Looking forward
- Business Impact Scoping Tool
How does it affect you?
- The Personal Property Securities Act 2009 (Cth) (the PPSA) establishes a single national law governing security interests and similar transactions with respect to all tangible and intangible assets (including intellectual property) except land and some statutory licences.
- The PPSA will affect not only your financing transactions, but also many other transactions and relationships.
- Interests that were not previously treated as security interests will become subject to the new regime. This includes retention of title arrangements and consignments, and even dealings that do not secure amounts, like operating leases, assignments of receivables and arrangements where equipment is provided as part of a service.
- If you are a supplier of product or services, in order to protect your interests you may need to register them and redraft your supply terms.
- If you are an affected business and you have security interests from your customers and others, you need to assess the cost of taking protective measures against the risks.
- If you are a customer or recipient of goods or services, a very large number of arrangements will be security interests that can be registered against your company. You will need to check those arrangements and consider the terms of your negative pledge clause.
- Restrictions in contracts on assignments may be ineffective.
- Where your business takes 'security interests' (like retention of title terms) and registers, then you will need to consider putting in place records and systems to deal with enquiries and other requirements of the legislation. Your staff will need training and guidance on the new registration procedures and your businesses should compile inventories of existing security interests in order to register them. You will need to develop systems to record and manage future security interests.
- You will need to review your businesses to see how you are affected (and for this we are preparing an on-line scoping tool – and you should be thinking about it now.
- You may want to redraft confidentiality clauses.
The PPSA will have a significant impact on the manufacturing and wholesale industries and some on the retail industry. Below is a list of scenarios that might be caught by the new legislation, but that will ultimately depend on the circumstances in each case.
- Retention of title arrangements: Arrangements where payment is due after delivery, and title to the goods does not pass until payment, will usually constitute security interests. If they are not perfected by registration, then the supplier will lose title to the goods upon its customer entering liquidation, voluntary administration or bankruptcy. It will also lose priority to perfected security interests and parties who buy the goods from its customer will take them free of the unperfected security interest. You can register your security interests ahead of time at the start of the trading relationship. If you do, you will gain protection from insolvency and priority over virtually all other security interests, but your security interest may be lost in the goods (but not the proceeds) if the goods are sold by your customer in the ordinary course of the customer's business.
- Consignments and floor plans: Where goods are delivered on consignment so that the manufacturer or its finance company retains title until the goods are sold by its customer dealer, that will also be a security interest. This will cover such things as floor plans in relation to motor vehicles.
- Leases and hire purchase arrangements by finance subsidiaries: Operating leases and finance leases of equipment to manufacturers and retailers will also be security interests, and likely to be registered by suppliers.
- Equipment supply: Arrangements under which manufacturers and wholesalers supply equipment or other goods to retailers, such as display equipment, coffee machines and signage and the like may be security interests, depending on the arrangement.
- Proceeds and tracing: It is easier to follow security interests (as broadly defined) into proceeds, such as cash receipts, receivables and items in which they are used or mixed with other items for further manufacture. There are complex rules as to how the security interests apply when the goods are affixed to other goods or mixed with, or blended into, other goods.
- Costs benefit analysis: While registration is relatively cheap and easy, it may still be necessary to do a costs benefit analysis, and measure cost against the risk. For example, the relative cost is low when considering high-value items, or low-value items traded under an ongoing relationship. It may be relatively high for low-value items in 'one-off' sales. The level of risk will depend on the level of bad debt experience.
- Assignments of receivables: Assignments of receivables (for example, the cash flows associated with sales contracts) are caught by the PPSA.
- Intellectual property: The PPSA contains specific rules in relation to security interests in goods which have closely associated IP rights and, in some cases, the PPSA may deem IP rights to be covered by a security agreement. Security interests in relation to computer equipment, computer-controlled equipment, copyright material (such as source code, photographs and marketing materials) and other assets with closely related IP should be reviewed in this light.
- Negative pledges: You will need to review your negative pledge clauses. Many arrangements that were not security interests may now be security interests and potentially may breach the clause.
- Retention of title clauses from your suppliers: You will need to check these carefully to ensure that they do not exceed the exceptions allowed in a negative pledge. In particular, some retention of title clauses purport to give security over all the assets of the buyer.
- Export arrangements – may need dual registrations: Particular issues arise when parties are taking security interests from parties incorporated overseas, or over assets overseas. For example, it might be necessary to ensure that a security interest over an asset in Australia owned by a foreign company is registered in the jurisdiction of that foreign company and in Australia.
The PPSA covers security interests in personal property.
What is 'personal property'?
Personal property is any form of property other than land and certain statutory licences. It includes rights under contracts, motor vehicles, shares, equipment, stock, receivables, intellectual property and intellectual property licences.
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'.
A 'security interest' is defined generally under the PPSA as an interest in personal property arising from a transaction that, in substance, secures the payment of money or performance of an obligation.
The PPSA gives examples of arrangements that are security interests if they are interests in relation to property and they secure payment or performance. These include:
- charges, mortgages and pledges;
- conditional sale agreements (including an agreement to sell, subject to a retention of title);
- hire purchase agreements;
- leases of goods; and
- flawed asset arrangements.
In certain cases the PPSA adopts a 'form over substance' approach, and deems some transactions to be security interests, even though they do not secure anything. They include:
- 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 giving value to the bailor (the party which gives possession and owns the goods).
A PPS lease covers many operating leases as well as finance leases. It could include arrangements under which a supplier provides equipment as part of a service, or in conjunction with sales of product. That could include such things as display equipment, coffee machines etc.
Perfection is necessary to preserve the security interest in insolvency and to preserve priority. It occurs when there is one of:
- registration of the security interest;
- possession of the collateral by the secured party; or
- (in the case of certain financial assets) control by the secured party.
Most often, parties will perfect their security interest by making sure it is in writing and registering it.
In order for the security interest to be enforceable, it must be in writing and specify the relevant asset subject to the security interest. That description can be very broad and generic. Motor vehicles, aircraft and ships and some intellectual property are able to be registered by serial number. This is optional in non consumer transactions, but gives extra protection if it is done.
Perfection is particularly important in insolvency because, subject to only a few exceptions, on appointment of a liquidator, bankruptcy trustee or voluntary administrator, unperfected security interests 'vest' in the company. The secured creditor loses its security and becomes unsecured. (This is different from New Zealand's personal property securities law.)
In other words, even if you own an asset, if you are regarded as having a security interest in that asset and you have not perfected it, you can lose the asset on the insolvency of your counterparty and become just an unsecured creditor. This can be quite severe in its effects – for example, an operating lease or equipment supply arrangement where the supplier retains title could be regarded as a security interest. If so, if the customer is wound-up, the supplier could lose its title if unperfected even though little was owed on the equipment.
The PPSA establishes an electronic register. The electronic register is designed to provide a simple, quick and cheap process. The register is a 'red flag' register: that is, it draws attention to the security interest without giving too many details. While registration is generally simple, there will be some traps in deciding how to describe the collateral and the security interest, and also in deciding under which category to file the interest.
The details surrounding the registration process are still being developed, but it is likely that parties will be able to register their security interests online or by SMS. There will be a fee.
Because so many arrangements are security interests, hundreds or even thousands of security interests may need to be registered against any particular company, and so there will be a lot of 'noise' on the register.
Security interests currently registered in some registers, such as the charges register maintained by the Australian Securities & Investments Commission under the Corporations Act 2001 (Cth), will be automatically migrated across. However, there may be problems about the quality of data and secured parties may want to re-register to give more details to gain better protection.
There will be no automatic migration from IP registers like trade mark, designs and patents.
The PPSA establishes a complete set of rules for determining priority between security interests, and also determining under what circumstances a purchaser of collateral will take the collateral free of the security interests in it. These replace the old principles-based approach of the common law and equity.
Most importantly, ownership of the asset can be irrelevant in determining priority disputes.
In relation to priority between security interests, the general rule is that perfected security interests take priority over unperfected security interests.
Another general rule is that perfected interests take priority according to the order of perfection, but there are many exceptions. Most relevant is that a PMSI (a purchase money security interest) ranks first if registered as such within a specified time. PMSIs include the interests of sellers under retention of title terms, lessors in relation to leases and security interests given to finance the acquisition cost of the collateral.
There are some prescriptive rules governing enforcement of security interests. In all cases, except certain consumer transactions, the parties will be able to contract out of most of them. Secured parties may want to redraft their documentation so as to contract out of some or all of the enforcement provisions.
Secured creditors will be required, at very short notice, to answer challenges to their security, and also to provide information on request from certain parties. They will need the systems in place to deal with these.
Certain parties can also request copies of the security agreement that 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. Confidentiality clauses need to be drafted carefully to override the PPSA requirements.
The law overrides restrictions on the assignments of debts arising under 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.
May 2011 seems a long way off but the New Zealand experience is that parties need much more time than they think to prepare. Companies should begin preparing for the PPSA regime to protect their interests and minimise disruption to businesses once the PPSA takes effect. Preparations should include, where applicable:
- Scoping the task. This will involve checking, in particular, your standard terms of supply, as well as your financing arrangements and other potentially affected contracts. Allens has developed a simple online survey for business lines to complete, in order to be able to scope the task.
- Where necessary, preparing new policies as to requirements for transactions and documentation.
- Redrafting standard terms.
- Identifying the transactions that will need to be registered.
- Identifying the assets affected.
To date, the PPSA has been passed and there have been two amending acts to the PPSA. There has been some hope of further amendments to the PPSA, though hope is fading.
The regulations will be significant. A draft has been produced, but not the final regulations.
Despite the uncertainty, it is important to prepare for the inevitable changes that the regime will bring. Allens is working closely with clients to develop procedures to manage the introduction of the new personal property security scheme. If you have any questions about this or any other PPS or manufacturing or retail issue, please contact one of the people below.
One of the most difficult and time consuming issues for businesses will be to work out what PPS means for that business and to make sure that an organisation and its subsidiaries have identified all the various transactions and products where PPS may be relevant. To help with this task, we have created a comprehensive on-line risk assessment tool that can assist clients to assess their PPS exposure. The Scoping Tool includes a comprehensive 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.
- Diccon LoxtonSenior Finance Counsel,
Ph: +61 2 9230 4791
- Jacqueline DownesPartner, Practice Leader, Competition, Consumer & Regulatory,
Ph: +61 2 9230 4850
- John GallimoreConsultant,
Ph: +61 7 3334 3135
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