Review of the Personal Property Securities Act 2009
Response to Consultation Paper 2
Name: Allens, Ashurst, Herbert Smith Freehills, King & Wood Mallesons and Norton Rose Fulbright AustraliaOrganisation:
We are large Australian law firms which each have significant corporate financing and insolvency practices. Since the inception of the reform process which introduced the Personal Property Securities Act 2009 (Cth) (“PPSA”) and the Personal Property Securities Regulations 2010 (Cth), we have seen them operate in practice in a wide variety of transactions and have advised a wide variety of business clients on them. We regularly undertake registrations and searches on the Personal Property Securities Register. Members of our firms have published numerous articles and contributed chapters to various books in connection with PPSA. We lecture on the PPSA at universities and regularly speak at industry conferences in Australia.
Contact Details:
Helena Busljeta
T +61 2 9296 2541 | M +61 438 640 493
2.2Rights in the collateral
Should bare possession constitute sufficient rights in collateral to support attachment of a security interest and, if so, on what basis?
Comments:
This issue is a subset of a wider issue, a general lack of clarity whichmay be inappropriate for apiece of legislation whose raison d'être is to bring clarity. As observers have noted, the Act does not answer the question as to what "rights" are sufficient. But more fundamentally,the Act does not really answer the question "what is the collateral?" as between a thing and rights or interests in the thing. When used in the Act, sometimes the word seems to be used in the sense of describing the relevant thing:[1] at other times it could accommodate either the thing or the interest in it which is the subject of the security interest. Much of the uncertainty flows from the drafting in s19(2), which itself appears to distinguish the collateral from rights in it, and on its face seems to suggest that rights of any nature in something give the right to create a security interest in it, without any apparent limit.
In commentary, analysis of what are sufficient rights or (to the extent dealt with at all) what is collateral, tends to concentrate on the relevant thing being goodsand then focuses onpossession and ownership.That is a special case as goods are transferable by delivery, and the law has traditionally focused on possession of goods more than title. As we suggest below,in relation to goods and possession it is possible to argue a coherent narrative under the current drafting of the Act, and on policy grounds.
Life can become more complex in many common situations, such as where:
- the grantor is a unit holder of a unit trust, or beneficiary of another trust, where the trustee holds a locomotive;
- the grantor is an owner of a one-twentieth equal co-ownership interest in a racehorse
- the grantor is one of a number of participants in a joint venture, who hold a locomotive and other joint venture assets as tenants in common;
- the grantor is a limited partner in a limited partnership with a locomotive and shares as partnership assets;
- the grantor is the beneficiary under a trust where the trust asset is a beneficial interest in another trust where the trust asset is in turn a beneficial interest in another trust where the trust asset is a share, and the grantor's rights are not an "intermediated security" (or perhaps even where they are);
- the grantor has a specifically enforceable call option over a share or a locomotive.
A survey of overseas authors on the subject[2] indicates unanimitythat while any proprietary interest is sufficient for a security interest to attach,PPSA security interests are generally subject to existing interests in the collateral (other than,presumably,other PPSA security interests – where priority is of course regulated by the Act – and other interests that may lose priority under general law). There is a suggestion in some texts that the security interest onlyattaches to the interest of the grantor in the relevant asset (in which case, presumably, the collateral would be that interest)[3], though this has been criticised[4]. To that extent nemo dat would still be relevant. Debateand discussion, as the paper suggests, focus mainly on the question as to what possession might be sufficient. The difficulty with the broader issue is that there is little guidance in the wording, and it quite possible that future cases may shatter assumptions.
One might say from the language of the Act that the collateral is the locomotive, the horse or the share, (though presumably the security interest is subject to all prior and equal-ranking interests in it). Such a reading might be inconsistent with some of the texts quoted above, which seem to rely on the express saving of general law concepts in s254 and its equivalents. But as mentioned above s19(2) does seem to differentiate between rights in the collateral and the collateral, and taken on its face, seems to indicate that any right in the collateral, however small, allows a grantor to give a security interest which attaches to the whole collateral. No express indication is given as to what the right must be. A further problem with the drafting of s19(2) is its use of the word "collateral" which does little to assist in resolving the inherent circularity in the drafting.
The above reading could also be seen as consistent with the inclusion of the phrase "without regard to…the identity of the person who has title to the property". It might also be consistent with the excerpt quoted with approval by the Supreme Court of Canada, that "The rights of parties to a transaction that creates a security interest are explicitly not dependent upon either the form of the transaction or upon traditional questions of title".[5] But that reading leads to issues, in particular if other holders of prior or equal-ranking interests in the locomotive, the horse or the share, gave security interests over their own interest. On insolvency, if the reading was correct, what would vest in the grantor? It would be strange if, in the examples above, through the processes of the creation of the security interest and insolvency, the grantor received interests in more than it and the secured party had between them at the outset of the transaction, for example if the limited partner in the example received a direct interest in the partnership assets. Also, the secured party can exercise its rights given under the security agreement to sell the collateral, and but for s112, (and maybe despite it[6])could exercise the statutory rights to sell or retain the collateral under s128or 134,in situations where the grantor had no such right, and the holders of other interests are affected.
The solution, we suggest, is to regard the collateral as beingthe subject matter of the transaction. Where the secured party is relying on the grantor and the transaction to obtain its interest in the relevant property, that subject matter could be no more than the grantor's interest in the locomotive, horse or the share, or the interest in them that the grantor is entitled to transfer. In the case of goods where the grantor has possession, then under general law rules the possessor is able to transfer a defeasible title and it is appropriate that the grantor is able to create a defeasible security interest in the goods. Where the secured party had an interest in the relevant asset before the transaction (such as in the case of a lease, retention of title or commercial consignment)the subject matter should be no greater than the secured party's interest in the relevant asset.
As we set out below, we believe that this should be clarified.
It might be suggested that the better way to cut the circle is to rely on "rights" as the limiting feature: personal property can only be collateral under a security interest if the grantor has sufficient rights in it to create the security interest (or sufficient "power to transfer rights" in it to create the security interest). But the Act gives no guidance as to what are sufficient rights. Nor does that satisfactorily deal with the position where the security interest is a reservation of some or all of the secured party's rights, and the grantor is relying on the transaction to obtain rights in the relevant asset (such as a retention of title or a lease).[7]
While we believe it should be clarified, we suggest that at least some aspects of the above solutionare consistent with an interpretation of the Australian legislation, at least insofar as it relates to goods and possession.
On that interpretation s19(5) operates by way of clarification, dealing with some (but not all) situations where the ownership is treated as a security interest. It is strictly speaking unnecessary, for two reasons. First, in all the examples the grantor obtains possession and thus "power to transfer" the asset. Second, the Act clearly regards ownership in the examples described as an interest which will beincluded asa "security interest". Once the relevant transaction arises, the rights arising for the grantor under the transaction (to possess or sell the goods) must be sufficient. For reasons discussed later in this response (see 5.3.1), we do not believe the Australian PPSA does treat the lessee or consignee as the owner, nor does it need to.
In the case of goods,the policy position –one we would suggest, consistent with that interpretation of the legislation–can be seen as relatively straightforward. If the owner's interest is regarded as a security interest, and the grantor purports to create a further security interest over the asset, the relative rankings of the security interests are judged by the priority rules in the PPSA. If the owner's interest is regarded as a security interest[8] and the grantor deals with the asset in a way which engages the "taking free" rules, then the recipient of the dealing takes whatever interest is given under the dealing, free of the interest of the owner/secured party. What interest is given under the dealing is determined on general law principles. If the dealing is a lease, then the lessee can enjoy the lease and the possession granted under it free of the ownership during the term of the lease, but the owner remains owner, subject to the lease. If the dealing is a purchase, then under common law principles the purchaser takes an interest which would normally have been defeasible by the ownership interest, but it can now take free of that ownership interest, so that it cannot be defeased by the ownership interest. It obtains full title. If the owner's interest is not a PPSA security interest, then the security interest created by the possessor should be subject to the interest of the owner.
One interesting area of policy and interpretation is where security interests are granted by different parties with different interests in an asset.
Take as an example where the owner of a painting retains possession of the painting but grants a perfected SSA (a specific security interest) in favour of a bank. Say the owner grants (in breach of the security agreement) a specifically enforceable call option over the painting in favour of a purchaser who has granted a GSA (a general security interest) in favour of a financier. The GSA has an earlier priority time than the SSA, and if over the same collateral would rank ahead of it. We suggest the appropriate policy outcome is that the GSA only affects the rights granted under the option, and there can be no priority dispute between the GSA and SSA regulated by the PPSA. They are over different collateral until the option is exercised and the painting purchasedand so becomes fully subject to the GSA (and the GSA and SSA will only come into conflict when circumstances are such that the SSA continues in the painting). Until then the rights of the GSA holder will depend on the respective rights of the option holder/grantor as against the painting and its owner and the SSA secured party.
Another example is where the owner of a painting the subject of a perfected SSA in favour of a bank grants a short-term lease (which is not security interest) over that painting to a lessee which has granted a GSA in favour of a financierwith an earlier priority time. On the above analysis, the GSA would cover the lessee's rights under the lease and it would cover the painting, defeasible by the owner's interest. The financier as holder of the GSA could only hold security over those rights and over the painting subject to that interest. The owner can exercise any rights it may have to terminate the lease and it can at all times assert ownership (subject to the lease while it is in force) as againstthe lessee(and any purchaser from the lessee). As a matter of policy, the bank with the SSA should be able to have the benefit of those rights as against the lessee,and we think that is the case even if the taking free rules are engaged. When the lessee takes free of the security interest, it only takes what is given to it–its rights as lessee – free of the SSA. A lease does not transfer title in those goods. It only gives a right to possession for its term.
The owner will also be able to exercise those rights as against the holder of the GSA. As a matter of policy, the holder of the SSA should be able to do the same. However, if the collateral for the GSA is the painting rather than the lessee's interest in it, then under current drafting this may not be the case. There would be a priority dispute between two security interests over the same collateral, and the GSA with an earlier priority time may rank ahead of the SSA. If that is correct, the holder of the SSA would have less rights than its grantor. That gives a strange circularity. The holder of the GSA prevails over the holder of the SSA which prevails over the owner who in turn can prevail over the lessee (when exercising rights under the lease) who is subject to the GSA.
Issues become even more stark in the other examples mentioned above, for example: if one security interest is given by one co-owner and another by another co-owner; security interests are given by a trustee and a beneficiary; or security interests are granted by a limited partnerand a general partner in a partnership.
This should be clarified. We deal with a similar issue where the lease is a security interest below.
To return to the specific question, we think that possession of goods should as a matter of policy (and we suggest, interpretation of the current law) be sufficient to allow the creation of a security interest over the possessory rights and also over any rights in the goods that the possessor has the power to transfer, being the goods themselves (even though the title transferred may be defeasible). We think that consideration should be given to amending the legislation to clarify this and the wider issue discussed above. We do not think that the final review report could suffice as clarification. We should say that, as discussed in relation to 5.2.1 below, we do not think that a lessee of a finance lease or other grantor becomes the owner, nor is it necessary for it do so for it to have rights and for s19(2) to operate in its current form.
We suggest that it would assist clarification if s19(2) is amended so that it reads:
"a security interest attaches to personal property when…"
rather than
"a security interest attaches to collateral when…".
This still does not entirely remove the circularity. Therefore we suggest further clarification should be considered. Whatever the language we think it would be useful to insert the following examples in the Act:
"Example 1: a grantor has possession of goods owned by X in circumstances which do not create a security interest. If it sold the goods, then under general law the buyer would obtain defeasible title to the goods defeasible by the interest of the owner X. The grantor is able to grant a security interest in the goods defeasible by the interest of the owner.
Example 2: an owner leases goods under a hire purchase transaction to a grantor. The security interest is the owner's interest in the goods.
Example 3: a grantor has a one-twentieth interest in a racehorse. The grantor grants a security interest in favour of Y in respect of the horse. That security interest can only attach to the one-twentieth interest.
Example 4: a grantor has a specifically enforceable call option over a share, and grants a security interest to X in respect of the share. Until the option is exercised and the grantor becomes the owner of the share, the security interest only attaches to the rights under the call option.
Example 5: an owner X sells goods on title retention terms to a grantor under a transaction which in substance secures payment of money. X's ownership of the goods is a security interest attaching to the goods. Under general law (as buyer in possession or as a party in possession), the grantor can transfer the goods to a buyer. The grantor creates a security interest over the goods in favour of Y. The security interest in favour of Y attaches to the goods, and priority between it and the owner X is determined under the priority provisions of the Act (whether or not the title of a buyer from the grantor would have been defeasible by the interest of the owner X)."