PPSA ROTs: some practical considerations in insolvency

The Personal Property Securities Act 2009 (Cth) (“PPSA”) commenced on 30 January 2012. One of the numerous fundamental changes brought about by the legislation was the introduction of a “security interest” being “an interest in personal property provided for by a transaction, that, in substance, secures payment or performance of an obligation (without regard to the form of the transaction or identity of the person who has title to the property).”[1]

Among the changes was the requirement to register under the Personal Property Security Register a retention of title clause as a security interest in order that it might not “vest in the company” on the happening of some insolvency event. [2] Previously, such clauses did not require registration to be effective in an insolvency situation.[3]

Apart from one Victorian decision,[4] and two decisions of marginal relevance only,[5] there has been no reported decision on PPSA retention of title (ROT) clauses of significance in Australia to date. That is surprising as many of the issues involved with PPSA ROTs in insolvency are complex, as will be seen.

ARE ROT CREDITORS IMMUNE FROM PREFERENCE RECOVERIES BY LIQUIDATORS?

Background

A registered PPSA ROT is a PMSI[6] which enjoys a “super priority” and which pursuant to section 62 of the PPSA will take priority over other registered security interests provided, relevantly, that in respect of inventory which constitutes goods, the grantor has possession of the goods. In the normal situation involving ROTs that will be the case.

For the purpose of discussion, let us assume that a supply agreement or credit contract was entered into after the commencement of the PPSA on 30 January 2012 and that such a contract, as typically is the case, contains a retention of title clause. A well-drafted ROT clause will be a so-called “all monies” or “all accounts” clause[7] and contain a right of entry to the supplier to enter upon the purchaser’s premises to retrieve the goods should that ever become necessary.

For the reasons which are now advanced, the supplier (seller)[8] cannot be successfully sued under s 588FA of the Corporations Act 2001 (Cth) (“CA”) for receiving a preference. The worst outcome that the ROT supplier might suffer, if the supplier did not bother to register the ROT clause under the PPSA as a security interest, is loss of the value of stock on hand at the company at the date of its financial demise. This is despite the fact that s 588FA is directed to recoveries by a liquidator of preferences which constitute a “transaction” and s 9 of the CA was amended when the PPSA was introduced to specifically incorporate into the definition of “transaction” the following:

“(b) a security interest granted by the body in its property (including a security interest in the body's PPSA retention of title property);”

The PPSA is modelled loosely on the Canadian Personal Property Securities Act 1993 but more directly on the New Zealand Personal Property Securities Act 1999. The writer’s research has uncovered nothing on point in either of those jurisdictions where it appears the issue has ever arisen or been reported in any decision.

Is an ROT a security?

 An ROT clause falls within the definition of “security interest” in s 12(1) of the PPSA (see above). In Hussain v CSR Building Products Ltd [9] Edelman J considered that an ROT clause constituted a “security” in the broad sense of that word.[10] Thus prima facie any payments to the supplier within the 6-month relation back period could not be considered to be payments in respect of “an unsecured debt” which is one of the elements of CA, s 588FA.

What is the position if the ROT is unregistered?

Assume that the ROT clause is not registered under the PPSA and the “purchasing” company goes into liquidation. What is the result of that? Would the holder of a registered General Security Agreement (“GSA”) which covers inventory be then secured over that asset? The answer is likely “yes” as s 267 of the PPSA and s 588FL of the CA provide that an unregistered security interest “vests” in the company, and a GSA will ordinarily cover inventory as being included within the latter part of the expression “all present and after-acquired property”.

What though does this mean for payments made to the supplier in the relation back period? Certain invalidating provisions of the CA are likely to have a retrospective effect while others do not. For example, s 588FP which provides that certain security interests (not ROT interests) are “void, and …..taken always to have been void” would seem to have a retrospective invalidating effect. Others such as s 588FJ of the CA which make a circulating security interest “void as against the company’s liquidator” are less obvious.[11] When however, one comes to sections which provide simply that unregistered security interests vest in the company, it is likely that these do not have any retrospective invaliding effect. The security is not voided: all that occurs is that the property is transferred from the supplier to the company.

An unsecured debt and the value of the security?

Section 588FA(2) of the CA provides that a secured debt is taken to be unsecured to the extent of so much of it (if any) is not reflected in the value of the security. There is an unresolved question of when the value of the security is to be assessed. The two alternatives are first, at the time of the transaction (i.e. when the creditor receives the benefit) or, secondly, at the date of the winding up.[12]

This enquiry is not relevant when one is dealing with ROT security interests. That is because the nature of the “security” in unconventional and does not lend itself to any sensible analysis such as one might undertake when dealing with, say, a motor vehicle or a heavy piece of equipment whose values are more readily ascertainable than inventory which fluctuates according to such variable factors as the quantities supplied from time to time and the quantities sold by the “buyer” from time to time.

Accordingly, it would seem to follow that ROT suppliers with properly registered “all accounts” or “all monies” ROT clauses are immune from attack by liquidators for unfair preference claims.

Can a liquidator disclaim ROT stock?

[Trigger warning: deep breath!] Part 5.6 of Division 7A of the CA deals with a disclaimer by a liquidator of onerous property. Section 568(1AA) provides that the general disclaimer section does not apply to PPSA retention of title property “that is taken to form part of the property of the company because of the definition of property in section 513AA.” Section 513AA which is contained in CA, Part 5.6, Division 1 of the CA (“Winding up generally”), provides that, unless otherwise indicated, the reference to property of a company includes PPSA retention of title property if vested in the company because of PPSA 267 (property subject to an unperfected security interest) or CA, section 588FL (collateral not registered within the requisite statutory time period).

Therefore, if the ROT property has vested in the company,[13] it is not open to a liquidator to disclaim it. This seems an odd result and there is nothing in the explanatory memorandum or parliamentary reading speeches which throws any light on it. The author recently encountered a situation where liquidators had been appointed to a leased hardware store. They had dealt with much of the ROT stock but were left with stock which was obsolete and virtually worthless. They wished to disclaim it but as the relevant security interest had vested in the company, they were unable to disclaim it and had to remove it from the leased premises at significant cost.

Do sections 433 and 561 CA, employee entitlements have priority over PPSA ROT security interests?

The analysis here involves the following considerations [second trigger warning: deep breath!] :

1.     Section 561 of the CA gives priority to employees over “the claims of a secured party in relation to a circulating security interest created by the company.”

2.     What is “a circulating security interest”? Does it include a PPSA ROT?

3.     Section 51C of the CA defines a circulating security interest as a security interest that is, relevantly, a PPSA security interest if the security interest has attached to “a circulating asset” and the grantor has title to the asset.

4.     Section 340 of the PPSA defines a circulating asset, relevantly, as an asset which is inventory or the secured party has given the grantor express or implied power to dispose of the asset in the ordinary course of the grantor’s business.[14]

5.     Attachment will have occurred, at the latest, when the security interest is registered.[15]

6.     With ROTs the grantor is not the party with title to the circulating asset/inventory.

Consequently, section 561 has no application as against a PPSA ROT security interest holder.[16] Similarly, section 433 of the CA dealing with employee entitlements in a receivership, does not apply to retention of title property as it is not property of the company as the grantor does not have title to it.[17]

What is the employee entitlement position with an unregistered ROT but a registered GSA?

In the situation where an ROT clause is not registered, and by reason of s 588FL of the CA or s 267 of the PPSA, the security interest vests in the company upon its liquidation, is that property then caught under a financier’s General Security Agreement (“GSA”) as a circulating security interest, available to meet the statutory employee entitlements? The answer is most likely “yes” as the GSA will ordinarily cover all present and after-acquired property and take priority over the unregistered ROT. This however is subject to the qualification which involves the body of case law which holds that a liquidator’s costs charges and expenses in dealing with issues such as inquiring into and resolving priority questions when the holder of a registered GSA does not intervene and enforce its security, are subject to the liquidator’s equitable lien arising in favour of the liquidator.[18]

Ability of PPSA ROT holders to trace proceeds?

The general rule and exceptions

 The general rule under the PPSA is that a security interest in collateral will attach to the proceeds of sale[19] so long as the proceeds are “identifiable” or “traceable”.[20]

There are however two significant and important exceptions to that rule:

a.      Under section 32(1)(a) of the PPSA, the security interest giving rise to the PPSA ROT will not continue to attach to proceeds if the secured party “expressly or impliedly authorised a disposal giving rise to the proceeds”, as is the case with most ROT arrangements; and

b.     Under section 46(1) of the PPSA, a “buyer”[21] of personal property takes it free of a security interest given by a “seller”,[22] or that arises under section 32(1)(a) (proceeds- attachment), if the personal property was sold in the ordinary course of the seller’s business.

Accordingly, by these provisions, the PPSA ROT security interest is extinguished in the collateral if the ROT clause permits sale and if that is the case it has been suggested that even a sale in the ordinary course of business is not necessary as section 32(1)(a) will still apply.[23]

This position may be different if prior to closing down, the company advertised a “fire sale” or “closing down sale”. In that case, there is some Canadian authority which holds that sale of inventory made by a company which is openly in “financial distress” cannot be in “the ordinary course of business”.[24]

The practical difficulty with tracing in most cases

As stated above, the general rule is that the security interest attaches to proceeds of the collateral so long as the proceeds are “identifiable” or “traceable”. The “identification” of proceeds normally is not difficult whereas “traceability” is. As was stated in reference to the analogous provision to s 31(1)(a) of the PPSA, in the Canadian legislation:

“Identifiable” refers to the ability to point to the particular property obtained by the debtor as a result of the dealing with the collateral, while “traceable” refers to the situation where the collateral is commingled with other property so that its identity is lost”.[25]

There has been no reported case on tracing in the PPSA ROT context in Australia. With commingling of funds which often occurs with the proceeds of ROT stock, the costs of litigation and the uncertainty of the outcome, it is likely that case law will emerge only in relatively clear factual circumstances and where a substantial sum of money is in dispute.

There are certain judicial methods which can be used to assist with a tracing exercise, such as the presumption which arises from Re Hallett’s Estate [26] or the “Lowest Intermediate Balance” rule.[27] These however are cumbersome “remedies” and in most cases are not worth considering from a cost-benefit viewpoint.

Conclusion

The introduction of the PPSA on 30 January 2012 altered fundamentally the Australian law relating to the taking of security over personal property. One of those changes involved making a retention of title provision a “security interest” for the purposes of the new legislation. We have noted above some only of the implications of this change, however, doubtless, many remain and will be tested in the courts in the future.

[1] PPSA, s. 12(1).

[2] CA, s. 588FL; PPSA, ss. 267and 267A.

[3] Unless of course there were some technical issues with the clause e.g. not being an “all accounts” clause and there being an inability on the part of the supplier to identify goods on hand at the date of liquidation which had not been paid for.

[4] Warehouse Sales Pty Ltd (in liq) & Ors v LG Electronics Australia Pty Ltd [2014] VSC 644.

[5] Crossmark Asia v Retail Adventures [2013] NSWSC 1095;Central Cleaning Supplies (Aust) Pty Ltd v Elkerton [2014] VSC 61.

[6] A Purchase Money Security Interest (PMSI).

[7] These clauses provide that property in the goods does not pass to the “purchaser” until payment in full is made in respect of all goods supplied under all invoices. In other words, specific identification of goods to particular unpaid invoices is not necessary.

[8] The terms “buyer” and ”seller” are not defined in the PPSA, however it has been held in Warehouse Sales Pty Ltd (in liq) & Ors v LG Electronics Australia Pty Ltd [2014] VSC 644, that those terms should be construed by reference to the sale of goods legislation in the various jurisdictions.

[9] (2016) 246 FCR 62.

[10] Somewhat surprisingly his Honour reached this conclusion despite the fact that he was dealing with a transitional security interest and s 51 of the CA defines a security interest as a security interest within the meaning of the PPSA and to which the PPSA applies, “other than a transitional security interest”.

[11] See generally G Hamilton, Invalidation of Securities upon Insolvency, The Federation Press 2000, at [2.8] ff.

[12] See generally the discussion by Edelman J in Hussain v CSR Building Products Ltd  2016) 246 FCR 62; P Sise “Now you’re secured, now you’re not”, (2015) 27(3) Australian Insolvency Journal 36; S Russell and B Vass, “Current Issues in Voidable Transactions”, paper delivered at Level Twenty Seven Chambers, 13 September 2013.

[13][13] PPSA S 267; CA S 588FL.

[14] See PPSA section 340(10 and (5) and note that only one of the two alternatives are required for the asset to be “circulating”.

[15] See generally PPSA sections 19 and 20.

[16] The position with the NAB’s GSA may be different but that is discussed below.

[17] This position may be different however if one is not dealing with an “all accounts” ROT clause as in that case title to goods the subject of specific invoices may have been paid for and title would then pass to the company.

[18] See for example, Universal Distributing Co Ltd (in liq) (1933) 48 CLR 171; Stewart v Atco Controls Pty Ltd (In Liquidation) [2014] HCA 15, [22].

[19] PPSA, s .20.

[20] PPSA, S. 31(1).

[21] The terms “buyer” and ”seller” are not defined in the PPSA, however it has been held in Warehouse Sales Pty Ltd (in liq) & Ors v LG Electronics Australia Pty Ltd [2014] VSC 644, that those terms should be construed by reference to the sale of goods legislation in the various jurisdictions.

[22] Ibid.

[23] Warehouse Sales Pty Ltd (in liq) & Ors v LG Electronics Australia Pty Ltd [2014] VSC 644 and commentary by Wappett , Essential Personal Property Securities in Australia, 3rd Ed, Lexis Nexis at PPSA.46A].

[24] Alberta Ltd v Pocklington [2000] 4 AJ No 1350.

[25] Transamerica Commercial Finance Corp Canada v Royal Bank (1990) 1 PPSAC (2d) 61.

[26] (1880) 13 Ch D 696.

[27] For a discussion of these, see J Harris and N Mirzai, Annotated Personal Proprty Securities Act 2009 (Cth) CCH 2ND Ed 2014 at [31.5.3].