Review of the Personal Property Securities Act 2009

25 July 2014 Our Ref: KAP PPSA Review Secretariat Commercial and Administrative Law Branch Attorney-General's Department 3-5 National Circuit BARTON ACT 2600 Katherine Payne Special Counsel katherine.payne@hallandwilcox.com.au +61 3 9603 3646 By email: ppsareview@ag.gov.au Dear Sir Review of the Personal Property Securities Act 2009 Hall & Wilcox is a leading Australian independent law firm with offices in Melbourne and Sydney. We act for a variety of clients including, relevantly, in the commercial, banking and finance, and insolvency sectors. We have regular involvement with the practical application of the Personal Property Securities Act 2009 (PPSA), including in relation to lending, commercial transactions and asset sales, asset protection, corporate disputes and insolvency matters. Members of our team have published numerous articles and are frequent presenters regarding the PPSA, including to industry conferences and on behalf of industry bodies. Below we provide our submission to assist in the Government s review of the PPSA and the Personal Property Securities Regulations 2010 (Regulations). We have had the opportunity to review the submissions which have been published to date. We support the substance of many of the recommendations raised in those submissions. In addition, below we address five key matters which, in our experience, have a significant impact upon the commercial application of the PPSA and Regulations. 1 PRELIMINARY COMMENTS Generally, we are supportive of a legislative system which clarifies the rights claimed by secured parties in assets and provides a consistent and transparent regime for the determination of competing claims. Unfortunately, in our experience the Australian regime is poorly understood in the broader commercial market. There is a lack of understanding of the provisions of the PPSA and their consequences, and in some instances, a complete lack of awareness that the regime has been implemented and its effect. This is not confined to one sector or industry. We are frequently faced with confusion by creditors (from a variety of industries), accountants, financial advisors, financiers, and other solicitors. The organisations evidencing such uncertainty range from small businesses to large corporations. Melbourne: Sydney: Level 30 600 Bourke Street Melbourne VIC 3000 Australia. Level 18 39 Martin Place Sydney NSW 2000 Australia. www.hallandwilcox.com.au DX 320 Melbourne DX 753 Sydney T: +61 3 9603 3555 T: +61 2 8267 3800 F: + 61 3 9670 9632 F: + 61 2 8267 3888

In our view, this confusion is the result of a combination of factors, including: the drafting of the PPSA and Regulations, which is complex and adopts language which is often ambiguous and unclear (we refer further to our recommendations at Annexure 1 in this regard); the structure of the PPS Register, which often confuses both secured parties and grantors; and the lack of publicity concerning the existence of the new regime and its effect. This gives rise to frequent misunderstandings regarding matters including: what is required by a secured party to protect its rights; what rights are held by grantors and insolvency practitioners appointed to grantors, including to rectify errors in the PPS Register; and when a registration is defective and the consequences of such defects. Disputes concerning these matters are common. From an insolvency perspective, many creditors lose rights in assets as a direct result of their lack of understanding of the PPS regime. 2 RECOMMENDATIONS ADDRESSED IN THIS SUBMISSION The Secretariat has received many submissions recommending amendments to the PPS regime. We limit our recommendations to five key issues which, in our experience, frequently give rise to confusion and dispute. Annexure 1 sets out in tabular form the relevant legislative sections and our proposed amendments. Below we provide a summary of the issues and their impact. 2.1 Characterisation of interests: Inventory We submit that the requirement to specify inventory be deleted for the purposes of clause 4.1, item 1 in Schedule 1 to the Regulations. Section 153(1), item 8 requires that a financing statement includes details prescribed by the Regulations. Clause 4.1, item 1 in Schedule 1 to the Regulations requires that inventory be included to determine whether collateral may include inventory for the purposes of Part 9.5. Hall and Wilcox Commercial and Administrative Law Branch 25 July 2014 2

The meaning of inventory is unclear and often misunderstood. In our experience, secured parties apply the definition incorrectly by using the definition from section 10, notwithstanding the application of the ordinary meaning of the word in s 341(1B). Equally unclear is the consequence of the incorrect application of whichever definition is used. If the inventory box is ticked on a financing statement when it should not be, it is unclear whether the registration is seriously misleading for the purposes of section 164(1)(a). In this regard, we note that a Canadian Court in Adelaide Capital Corp v Integrated Transportation Finance Inc [1994] O.J. No. 103 considered that a failure by the secured party to record in the financing statement that the collateral consisted of inventory, in circumstances whereby the collateral description did not remedy the defect, constituted a seriously misleading defect. However, it is argued by some practitioners that Adelaide Capital should not be adopted in Australia having regard to the limited purpose of the inventory description under Part 9.5. We recommend that this lack of clarity be addressed by deleting the requirement to specify inventory in a financing statement. 2.2 Definition of interest : Mere contractual rights We submit that the definition of interest in section 10 be amended to restrict its application to proprietary interests in personal property with additional provisions excepting from its application mere contractual rights such as step-in arrangements, pre-emptive rights and options arrangements. Section 10 provides that interest, in personal property, includes a right in the personal property. In our view, it is unclear whether the inclusion of a right in personal property also contemplates mere contractual rights with respect to personal property that are prima facie in-substance security interests. Should the approach of the High Court of New Zealand in McCloy v Manukau Institute of Technology [2013] NZHC 936 be followed in Australia, which is possible, it would appear that security interests for the purposes of the PPSA would also include mere contractual rights such as step-in rights, pre-emptive rights, dilution mechanisms and other similar provisions that are prima facie in-substance security interests. We observe that it is very common for such contractual rights to be structured such that it is exercisable by one party on the default of another party, particularly in joint venture contexts. We are a doubtful that there is any material policy benefit to be derived in requiring registration of such contractual rights to preserve their practical value. Moreover, any policy benefit to be gained would likely be outweighed by the confusion, administrative burden and compliance risk brought about by such a requirement. 2.3 Characterisation of interests: Bailment, leases and consignment (a) Bailments - section 13 PPSA Hall and Wilcox Commercial and Administrative Law Branch 25 July 2014 3

The PPSA recognises that some bailments are, functionally, security agreements. Section 13 of the PPSA deems those bailments to be PPS leases which create registrable security interests. The policy underlying the deeming provision is to ensure that bailment transactions that are not easily distinguishable from finance leases are treated as if they are finance leases. However, the current definition of a PPS lease has the potential to capture bailment transactions which we consider the legislature would not have intended. In the ordinary course of business, it is commonplace for bailments to arise without intending to be or resemble a finance lease, such as the deposit of goods for repair, transportation or storage. The unintended effects occur because section 13 is expressed to apply only to a bailment for which the bailee provides value. This section is confusing. The definition of value in section 10 includes any consideration that is sufficient to support a contract. Whilst we might not necessarily agreed with the argument, it has been contended by some practitioners that value might include the mere promise by a bailee to keep the bailed goods safe from theft. If that contention was correct, then almost all depositors of goods (over an indefinite term or more than 12 months) must register a security interest, failing which in an insolvency event, those goods may be lost. This outcome is not intended by the Act. It is not logical, for example, that a bare depositor of goods would have an inferior claim to its goods than an insolvent warehouseman. By section 13(3), the legislators sought to exclude gratuitous bailments from being characterised as registrable security interests. Further, it is not consistent with the object of the PPSA that it is intended to apply to goods in a bailee s possession merely for transportation, storage or repair. An interpretation of section 13(3) of the PPSA which is more consistent with the intention of the Act is that it requires valuable consideration to pass from the bailee for its use of the goods. Further, the value which passes from the bailee to the bailor must be separate from, and additional to, the fundamental obligations of the bailee. This would clearly exclude gratuitous bailments where the bailor was not receiving any payment for the use of the goods, and bailments where the bailee is in possession of the goods for storage or repair. Accordingly, section 13(3) of the PPSA should be amended so that it applies only to bailments where:- (i) the goods are supplied to the bailee for its own use; and Hall and Wilcox Commercial and Administrative Law Branch 25 July 2014 4

(ii) the bailee pays for that use. The exclusions in section 13(2) should continue to apply. (b) In substance leases - section 12 PPSA Presently, where a lease is for a term of less than 90 days (soon to be 12 months), that lease will not constitute a PPS lease under the PPSA. However, it is not clear whether such a lease may nonetheless be considered a security interest under section 12 of the PPSA. This is often referred to as an in substance security interest. A security interest means an interest in personal property provided for by a transaction that, in substance, secures payment or performance of an obligation. Commentary suggests that the PPSA distinguishes between financing or security leases which are intended to be caught by the Act, and true leases which are not (subject to the 90 day/12 month rules). Factors which may indicate that the arrangement is a security lease include: (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x) automatic vesting of ownership upon completion of the lease term; obligation to purchase; term of the lease itself is longer; the term of the lease is for the commercially useful life of the good; payment obligations and, in particular, whether the lessee is required to pay close to the commercial value of the good; price of an option to purchase. If this is nominal, it is more likely to be a security lease; price to renew the lease; whether the lease is open-ended in term; role of the parties, including who is required to repair and maintain the property; and nature of the contractual remedies available upon default. Hall and Wilcox Commercial and Administrative Law Branch 25 July 2014 5

It is contended that the PPSA will not apply to true leases (which are not also PPS leases) because they do not in substance secure payment or performance of an obligation owed by the lessee. That is, unless the lease has the function of a security, the PPSA will not apply. On this analysis, if the arrangements are for periods of less than 90 days for serial numbered goods (pending anticipated legislative amendment), and 12 months for all other goods, it is unlikely that they would constitute security interests within the PPSA. However, some commentators have suggested that a distinction between a security lease and a true lease does not exist on the wording of the PPSA. Section 12 of the PPSA refers to a transaction that, in substance, secures payment or the performance of an obligation (emphasis added). It is contended that both true and security leases secure an interest of the lessors in the obligation of a lessee to return goods at the end of the lease. On this analysis, both true and security leases secure an obligation and will therefore constitute a security interest within the meaning of section 12. We do not consider that the PPSA was intended to capture true leases. An operating lease does not constitute an in substance security interest. This conclusion is consistent with the operation of sections 268 and 269 PPSA, which provide that: (A) some unperfected PPS leases do not vest in the grantor upon administration/ liquidation; and (B) if the interest has vested, the lessor under a PPS lease is entitled to recover compensation for damages. It would be illogical and indeed unfair that a lessor under a PPS lease was entitled to such protection, but that the interests of a lessor under a true lease (not deemed to be a PPS lease) were at risk. We consider that this outcome might be avoided if the Act was clarified so that the performance of an obligation was expressed to be in the nature of something akin to a payment for use of the goods, such as the consideration which passes from the grantor from the underlying agreement, and not merely an act which is incidental to it (such as returning leased goods at the end of the term). Hall and Wilcox Commercial and Administrative Law Branch 25 July 2014 6

(c) Commercial consignment A similar circumstance to that set out at paragraph 2.3(b) above also arises regarding commercial consignment. The PPSA creates a category of consignment which satisfies the section 10 PPSA definition of a commercial consignment (PPSA Commercial Consignment), namely: the consignor retains an interest in goods that the consignor delivers to the consignee; the consignor delivers the goods to the consignee for the purpose of sale, lease or other disposal; and the consignor and consignee both deal in goods of that kind in the ordinary course of business. Commentary distinguishes between two further categories of consignments which do not constitute a commercial consignment within section 10: security consignment and true consignment. Canadian case law offers a series of indicia to determine whether a consignment is a true consignment rather than a security consignment 1 :- (i) (ii) (iii) (iv) (v) (vi) (vii) Whether the consignee acted as the agent of the consignor in seeking to sell the goods. Whether title in the goods remained with the consignor. Whether title in the goods would pass directly from the consignor to the purchaser of the goods. Whether the consignee had no obligation to pay the consignor for the goods until those goods were sold to the third party purchaser. Whether the consignor had the right to demand the return of the goods at any time. Whether the consignee had the right to return the unsold goods to the consignor. Whether the consignor had the right to stipulate a fixed price or minimum price for the goods. 1 Access Cash Internation Inc v Elliot Lake & North Sore Corp for Business Development (2000) 1 PPSAC (3d) 209 Hall and Wilcox Commercial and Administrative Law Branch 25 July 2014 7

(viii) (ix) Whether the goods were shown as an asset in the books of the consignor but not as an asset in the books of the consignee. Whether it is apparent from the consignee s dealings with others that the goods belonged to the consignor rather than the consignee. Where a consignment does not meet the definition of section 10 (for example, the consignor does not deal in goods of that kind in the ordinary course of business), the PPSA is unclear as to whether the consignment will otherwise constitute an in substance security interest. Similarly to the arguments raised regarding leases and bailment above, some commentators suggest that the mere obligation of the grantor to sell the consigned goods or return them to the consignor confers a sufficient obligation for the arrangement to constitute an in substance security interest. Accordingly, true consignments would constitute security interests and be subject to the PPSA. We do not consider that the PPSA was intended to capture true consignments in section 12. This conclusion is consistent with sections 268 and 269 of the PPSA, which provide that: (A) (B) commercial consignments do not vest in the grantor upon administration/ liquidation; and if the interest has vested, the consignor is entitled to recover compensation for damages. It would be illogical and indeed unfair that a consignor under a commercial consignment (who does deal in goods of that kind in the ordinary course of business) was entitled to such protection, but that the interests of a consignor under a true consignment (who may not deal with goods of that kind in the ordinary course of business) were at risk. 2.4 Maintaining accuracy of the PPS Register: Amendment Demands and defective registrations It is not uncommon for secured parties to refuse to remove a registration, even if that registration is incorrect or there is no collateral to which the interest can attach. This is particularly significant in a sale by the grantor of its business or assets (either by way of an insolvency practitioner appointed to the grantor, or otherwise). Often, there are few options available to the grantor in such circumstances, as we address below. Commercially, the grantor may be held to ransom and required to make an unwarranted payment to the secured party to avoid jeopardising the sale process. Such risk increases if the cost of urgent Court proceedings are not warranted having regard to the value of the secured party s claim. Hall and Wilcox Commercial and Administrative Law Branch 25 July 2014 8

Such conduct can interfere with an otherwise orderly sale of assets or business. In some circumstances, it can endanger the completion of the sale altogether. Such interference is not in the public interest. Further, information on the register can become outdated, with no mechanism by which a grantor can require the registration to be amended to accurately reflect the secured party s rights. We raise the following matters in this regard. (a) The PPSA makes little allowance for registrations which are partially, but not wholly, incorrect. Often, dealings between secured parties and grantors result in a previously accurate registration becoming partially incorrect. For example, assets referred to in the registration may have been released by, or returned to, the secured party. In such circumstances, the PPSA does not enable the grantor to require a secured party to amend the registration so as to reflect the proper position as between the parties. We note in this regard:- (i) Section 151(1) provides that a person must not apply to register or amend a financing statement unless they believe on reasonable grounds that the person described as the secured party is, or will become, a secured party regarding that collateral. Section 151(2) provides that a financing statement which has been registered must be amended if: (a) the person described in the statement as the secured party has never, since the statement was registered, been a secured party in relation to the collateral (emphasis added). Section 151 does not contemplate circumstances in which a financing statement was correct as at the date of its registration, however the person listed as the secured party subsequently no longer holds an interest in collateral. (ii) Section 178 provides the mechanism for a grantor to issue an amendment demand on a secured party. Amendment is authorised if: Item 1: No collateral described in the registration secures any obligation (including a payment) owed by a debtor to the secured party. (emphasis added). Hall and Wilcox Commercial and Administrative Law Branch 25 July 2014 9

Item 2: The particular collateral in which the person has an interest does not secure any obligation (emphasis added). Section 178 does not contemplate an amendment demand regarding a portion of the collateral referred to in the registration. Amendments are only authorised if none of the collateral referred to in the registration secures an obligation. (iii) Section 271 provides that if a person fails to discharge any duty or obligation imposed upon them by the PPSA, the person to whom the duty is owed, and any other person who can reasonably be expected to rely on performance of that duty or obligation, has the right to recover reasonably foreseeable loss or damage. However, as noted above, the PPSA does not impose any obligation on a secured party to amend its registration (either generally, or at the request of the grantor) to accurately reflect an updated security position. Accordingly, there is no basis for the grantor to recover loss or damage occasioned by a secured party s refusal to update its registration. Such loss and damage can extend to the inability of an asset or business sale to complete. Presently, a grantor has the right to require a secured party to amend a registration which was recorded incorrectly in the first instance. From a policy perspective, we submit that a grantor should have a similar right to require a secured party to amend a registration which has become incorrect by virtue of a change in the parties trading relationship. In doing so, the Register should be amended to allow secured parties to make such amendments to their registration. (b) When an administrator or liquidator is appointed to a grantor, it is not uncommon for a creditor to hold a security agreement with the grantor, however the grantor not to be in possession of any assets to which the security agreement relates. Nor will the grantor (via the administrator or liquidator) acquire assets to which the secured party s interest may attach in the future. That is, while the secured party may have a security agreement, there is no collateral to which its interest can attach (either as original collateral or proceeds). The PPSA does not provide an avenue to require the secured party to remove the registration in such circumstances. Having regard to the matters raised at paragraph 2.4(a) above: Section 151 does not enable the grantor to require the secured party to amend its registration to reflect the true security position. Section 178 will arguably not apply on the basis that: Hall and Wilcox Commercial and Administrative Law Branch 25 July 2014 10

o o by reference to Item 1, the registration properly describes collateral, albeit that no such collateral is in the possession of the grantor; and by reference to Item 2, there is no particular collateral in which the secured party may have an interest. As it is not a requirement for the secured party to remove or amend the registration, section 271 will not impose any liability upon that secured party for reasonably foreseeable damages occasioned by its refusal to do so. Further, in our experience the Registrar will generally refuse to make orders requiring the removal of the registration on the basis that a security agreement is in existence, notwithstanding that there is no collateral to which the security interest can attach. This situation can lead to extensive disputes between the insolvency practitioner and the secured party who has recorded the registration, especially if the insolvency practitioner is seeking to sell the assets or business of the grantor within a short timeframe to maximise the return to creditors. Such dispute increases the cost of insolvency and interferes with the orderly and efficient sale of assets or business. (c) Section 164 provides that a registration that describes a security interest in particular collateral is ineffective because of a defect contemplated by section 164 and/or 165. However, section 164 does not contemplate the ability of a registration to be defective in relation to only a portion of the collateral described, and therefore only invalid in respect of that portion. For example, a registration regarding five items of collateral may describe four of those items correctly, however contain a seriously misleading description of the fifth item. In such circumstances, in our submission the registration should only be defective in respect of the fifth (incorrectly described) item. We recommend the amendments set out at Annexure 1 in order to increase the ability of the grantor and Registrar to efficiently address incorrect or redundant registrations and enable asset sale processes to proceed without undue cost and delay. 2.5 Determination of competing priorities The time for determining the priority of competing security interests under s 55 is uncertain. This creates potential conflict because the application of the priority rules at different times may produce different outcomes. Lexis Nexis Personal Property Securities in Australia provides the following example: Hall and Wilcox Commercial and Administrative Law Branch 25 July 2014 11

[I]f there are two unperfected security interests in the same collateral and one of the secured parties registers a financing statement after the grantor defaults and the other secured party has already appointed a receiver, determining priority as at the time of the appointment of the receiver will produce a different priority outcome to a determination of priority at the time after the first-mentioned secured party has registered its financing statement. By way of further example:- In some instances, receivers and managers have sought to determine priority as at the date of distribution, rather than as at the date of their appointment. For example, whereby a receiver and manager: o o o takes possession of debtor assets on behalf of the appointing creditor; realises those debtors and places the proceeds in a bank account controlled by the appointing creditor; and subsequently argues that a supplier who held a PMSI in the debtors accounts as at the appointment date was subsequently subordinated to the right of control now held (by virtue of the conduct of the receiver and manager) by the appointing creditor. In our view, such a contention is contrary to the operation of the PPSA, and further amounts to conversion. However, clarity in the legislation is sought. The PPSA is currently unclear as to the priority determination in the following circumstance: o o o a PMSI holder records a financing statement, however neglects to note in the registration that its interest constitutes a PMSI; an administrator or liquidator is appointed. The creditor is perfected by virtue of its registration, however argument arises as to whether the creditor has waived its entitlement to claim a PMSI priority by virtue of the registration defect; the creditor records a second financing statement, properly noting that its interest constitutes a PMSI. The creditor s priority ranking will differ according to whether its interest is determined as at the date of the appointment of the administrator or liquidator, or as at the date of asset distribution. Hall and Wilcox Commercial and Administrative Law Branch 25 July 2014 12

Many practitioners accept the guidance provided by Canadian and New Zealand case law to the effect that priority is determined at the time that the relevant security interests first conflict. We note in this regard that: In Sperry Inc v Canadian Imperial Bank of Commerce (1985) 50 OR (2d) 267 (ONCA) the Ontario Court of Appeal held that it would be reasonable to conclude that the priority issue between the parties should be resolved as of the time when their respective security interests came into conflict. In Gibbston Downs Wines Limited v Perpetual Trust Limited [2013] NZCA 506, the New Zealand Court of Appeal (while not deciding the issue) observed that a determination of the priorities as at the date of receivership (being the date the respective security interests came into conflict) had much to commend it in the particular circumstances. Similarly, the New Zealand Court of Appeal in Strategic Finance Ltd (in rec and in liq) v Bridgman [2013] NZCA 357 observed that while the New Zealand PPS Act does not explicitly specify the date on which competing priorities are to be determined, the date on which the receiver or liquidator is appointed is generally adopted as the relevant date in other legislation. We recommend that the amendment proposed in Annexure 1 be implemented to provide clarity and avoid the cost and time associated with further disputes on this matter. We further recommend that guidance on the new subsection be given in the explanatory memorandum by reference to the cases listed above. Hall and Wilcox Commercial and Administrative Law Branch 25 July 2014 13

* * * If you have any queries regarding this submission, please contact: Mark Inston Partner mark.inston@hallandwilcox.com.au +61 3 9603 3597 Katherine Payne Special Counsel katherine.payne@hallandwilcox.com.au +61 3 9603 3646 Graeme Scott Special Counsel graeme.scott@hallandwilcox.com.au +61 3 9603 3475 Lachlan Currie Lawyer lachlan.currie@hallandwilcox.com.au +61 3 9603 3536 Yours faithfully [sgd] Hall & Wilcox encl. Hall and Wilcox Commercial and Administrative Law Branch 25 July 2014 14