PPS Reform - Understanding Security Interests: Perfection and Priorities

23 Nov 2011

Our previous update on the Personal Property Securities Act (“PPS”) reforms outlined the following aspects:

Background to the PPS Reform and why it is being introduced;
Terminology used in the PPS legislation; and
How the PPS Register will operate.

The above update can be viewed on the Smith Hancock website: www.smithhancock.com.au under the “News and Updates” tab.

Avid readers of this newsletter would be aware that the commencement date of PPS was originally scheduled for May 2011. It was then deferred to October 2011. The Government has recently, advised that due to IT issues with the PPS register, the commencement date is now scheduled for 31 January 2012 (if not extended again).

This article will focus on security interests and the priorities operating between the different types of security interests, including Perfected Security Interests, Unperfected Security Interests and Purchase Money Security Interests.

The classification of a security interest will have a significant impact on the priority afforded to that security interest and the options available to the Secured Party for enforcement (to be discussed in a future article). It is essential that a sound understanding of the classifications and priorities between competing security interests is gained prior to the commencement of the PPS.

A security interest against a third party requires that certain criteria are met:

- The security interest must have attached to the collateral; and
- The parties must have entered into a written security agreement that describes the collateral and registered that agreement; or
- The secured party must have possession or control of the collateral.

A security interest attaches to collateral when:

(a) The grantor has rights in the collateral, or the power to transfer rights in the collateral to the secured party; and

(b) Either:
i. value is given for the security interest; or
ii. the grantor does an act by which the security interest arises (eg. Execution of a security agreement).

The priorities which apply should enforcement action be taken are broadly:

- Purchase Money Security Interests
- Perfected Security Interests (perfected by means other than control)
- Unperfected Security Interests

Purchase Money Security Interest:
A purchase money security interest (PMSI) is a security interest that differs from a standard security interest in two main ways:

i) How it is created; and
ii) Priority received over other forms of security interests.

A PMSI is created where the security interest is taken in the collateral to the extent that it secures the assistance provided by the Secured Party to the Grantor to enable the purchase or acquisition of rights in the collateral.

The most common instances where a PMSI will be created are:

i) Where a financier advances funds to a grantor for purchase of personal property (eg. A bank provides funding to acquire a tour bus for a bus company. Under the current regime the bank would likely take a fixed charge over the bus).

ii) Where a secured party advances personal property and all or part of the purchase price remains outstanding (covers retention of title issues).

iii) Under a PPS Lease defined in the PPSA as a lease or bailment for a term exceeding 3 months (for motor vehicles, boats and aircraft) or one year for other types of personal property.

iv) In a consignment transaction.

Perfected Security Interests:
A security interest may be perfected by:

- Registration on the PPS Register (refer to previous article)
- Possession (tangible personal property)
- Control (intangible personal property)
- Force of the Act (temporary perfection)

For a security interest to be perfected it must have attached to the collateral and be enforceable against third parties.

Where the collateral is tangible personal property (goods), possession by a secured party is sufficient to perfect the security interest (such as a secured party repossessing goods subject to a retention of title).

Perfection can also be achieved by control but this method only applies to specific classes of “financial collateral” involving intangible property.

The PPS provides temporary perfection provisions (transitional provisions). The transitional provisions will be reviewed in detail in a later article and will affect many.

Unperfected Security Interest:
In simple terms, an unperfected security interest is a security interest which has not been perfected (ie. an unregistered ROT agreement for goods delivered to a customer).

Property Transferred Free of Security Interests:
Perfected security interests are generally enforceable against third parties. The legislation provides additional registration requirements for certain goods, eg. serial number identification for motor vehicles. Where the serial number is not provided in the PPS registration, a buyer or lessee takes the personal property free of the security interest.

Other instances where property is transferred free of security interests includes:

- Where property was sold or leased in the ordinary course of the seller’s or lessor’s business of selling or leasing property of that kind.
- Where the security interest is unperfected, unless the buyer or lessee is a party to the transaction which the unperfected security interest was created.

Priorities
Perfected v Perfected:
Priority between two or more security interests in collateral that are currently perfected is to be determined by the order in which the priority time for each security interest occurs.

“Priority Time”: Earliest of registration, control or possession, must be continuously perfected (i.e. – continuously registered, in control or possession).

Perfected v Unperfected:
A perfected security interest in collateral has priority over an unperfected security interest in the same collateral.

Unperfected v Unperfected:
Priority between unperfected security interests in the same collateral is to be determined by the order of attachment of the security interests.

PMSI v Other Security Interests:
A PMSI is afforded priority over all non-PMSI security interests, except for interests perfected by control. By providing a “super-priority” to PMSI secured parties, the PPSA ensures that secured parties are able to advance money or assistance to the grantor to further develop their business without earlier secured parties having priority recourse to the assets, which would not have been acquired without the assistance of the PMSI secured party.

Secured parties must register their PMSI within specific timeframes to receive the super-priority:

- In the case of inventory, the PMSI must be perfected at the time possession of the goods is obtained; or
- In the case of other personal property, the PMSI must be registered within 15 business days of the grantor obtaining possession of the goods.

The consequences of failing to perfect a security interest are obvious and will result in significant risk to businesses which are not adequately prepared to commence registering, or otherwise perfecting, their new security interests from January 2012 onwards. Existing security interests will lose the perfection provided under the transitional provisions at the end of the 24 month transitional period (i.e. by January 2014).