PPSA in Australia: the Year 3 Report is out

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Key points

  • The Personal Property Securities Act, after its first three years in operation, has undergone a detailed review undertaken by Bruce Whittaker.
  • The Report recommends keeping the fundamental architecture of the PPSA, but with many detailed changes to improve its efficiency.
  • If implemented, the recommendations offer significant improvements and streamlining for secured lenders and others using the PPSA.
  • Most notably, registrations for security interests will be simplified, and existing uncertainties about equipment hiring will be ironed out.

Introduction

On 18 March, Bruce Whittaker’s Report on the Review of the Personal Property Securities Act 2009 was tabled in Federal Parliament and released to the public.

The PPSA came into force in early 2012 and completely reformed the process of taking security over almost over all forms of property except land in Australia, establishing a single Register on which information about most security interests is recorded.  The Report completes a year-long detailed review and consultation process on the PPSA.  I wrote more about the process of the review here, a few weeks ago.

If implemented, I believe the Report will considerably improve the operation of the PPSA, to the benefit of anyone who borrows or lends on a secured basis.

Whether or not the Government now implements Mt Whitaker’s recommendations, the Report is an extremely significant statement of the current position, and range of current views, on many issues of current debate in relation to the PPSA.  It will be a valuable resource for secured parties, lawyers, the academic community and the courts.

I certainly hope the recommendations are adopted.  The PPSA has been under intense scrutiny in its first few years of operation, with valuable lessons learned about what works, and what doesn’t.  The recommendations in this Report are exactly the kind of thing that reduces the cost of doing business by removing needless complexity.  If implemented, more businesses will be able to make their own registrations in a greater variety of circumstances without professional help, and security agreements can probably be streamlined.

No one simple solution

The Report recommends many changes.  Most, in isolation, are small, but together they would add up to a significant streamlining of the PPSA.  As the Report says:

There is no one single step that by itself will produce a major improvement to the Act. Rather, improvement needs to come from the making of many small changes.

Altogether there are 394 recommendations.

What are some key recommendations?

 1.  Simplifying the registration process

In my view the most significant proposed reform is to simplify registration, removing much of the current complexity around that process.  This is important because currently the system is too difficult to navigate, leading to mistakes or requiring business to engage professional advisers for things they should be able to do themselves.

Registering information about security interests, by registering a ‘financing statement’, is at the heart of the system established by the PPSA.  A financing statement needs to contain details of three central elements:

  • Grantor (the person who creates the security interest)
  • Secured Party (the person who has the benefit of the security interest)
  • Collateral (the property subject to the security interest) – this is done by specifying a ‘class’ to which the collateral belongs, and possibly extra detail

But registration currently requires considerably more detail than just those three central elements.  The Report recommends abolishing the following fields, which can all cause confusion to users of the Register at present.

  • Inventory – whether the collateral includes inventory
  • Control – whether the collateral is subject to control by the secured party
  • Subordination – whether the security interest ranks after another security interest
  • PMSI – whether the security interest is a ‘purchase money security interest’
  • Proceeds – whether the security interest extends to proceeds of the collateral, and if so, what proceeds it extends to

Apart from the three central elements (Grantor, Secured Party and Collateral), only the following other fields would remain (perhaps it would have been good if the Report had recommended their abolition too):

  • Transitional or non-transitional – whether or not the security agreement was in force before 30 January 2012
  • Consumer or commercial property – whether or not the collateral is used in a business that has an ABN
  • Earlier registration number – linking the registration to other connected registrations (currently this field only allows linkage to one other registration, but this would be rectified to allow multiple linkages)

Further, the collateral class system would be reformed.  There are currently over 20 separate classes that register users must choose between.  The Report would reduce this to six:

  • Four specific classes
    • Serial numbered property (motor vehicles, aircraft, watercraft and numbered intellectual property)
    • Other goods
    • Accounts (and the present definition of accounts would be simplified to align more closely with the concept of ‘trade receivables’)
    • Other intangible property
  • Two general classes
    • All present and after-acquired property
    • All present and after-acquired property with exceptions

And the existing requirement that only one class can be selected in a registration would be removed, so one registration could cover multiple classes.  This would be useful, for example, when taking security over an aircraft (serial numbered property) along with its spare parts (other goods), any receipts from hiring out the aircraft (accounts) and the benefit of its manufacturer’s warranties (other intangible property).

2. Simplifying equipment leasing and the ‘bailment’ trap

Currently, the PPSA requires registration of PPS Leases, which in general terms are:

  • all goods leases which secure obligations – effectively, these are finance leases, usually on a long-term basis, where the lessee gets the economic risks and benefits of the goods, and usually ends up owning it when paid for; and
  • also, operating leases, if they are for more than 12 months (or 90 days or more for certain kinds of goods), or for an indefinite term.

And the concept of ‘leases’ currently extends to cover some ‘bailments’.  The scope of the ‘bailment’ extension is uncertain, and has led to concerns that arrangements such as leaving wheat in grain silos, or goods for storage or repair, could require registration.  (Though, in my view, these fears are probably groundless.)

Both the indefinite term and the bailment extension, in particular, have caught unwary equipment owners out.

The Report proposes the following reforms:

  • 12 month term for all operating leases – the alternative 90 day term that currently applies to motor vehicles, aircraft and watercraft would be removed, so 12 months would be the term for all operating leases
  • removal of the indefinite term – operating leases with an indefinite term would not be PPS leases, and so no registration would be needed, unless and until they actually continued past the 12 month mark
  • removal of bailments – bailments that are not leases would no longer be caught

This would provide a much simpler system for the equipment hiring industry and others who make equipment available in the course of business.  Operating leases would only be caught if they were actually leases, and if they had an initial term of over 12 months, or if the goods were actually in the lessee’s possession for more than 12 months.

3.  Remove exemptions from the collateral covered by the PPSA

Another group of reforms should make it possible for security agreements (documents under which grantors grant security over their collateral) to be streamlined.

Before the PPSA came into force, security agreements often said things like ‘the grantor grants the secured party a mortgage over group A assets, a fixed charge over group B assets, and a floating charge over group C assets; and here are the rules that describe when the floating charge can crystallise into a fixed charge, and the rules for how it can uncrystallise again’.

It was hoped that this could all be changed to ‘the grantor grants a security interest over its assets to the secured party’.

In practice, that hope hasn’t been realised, because some important kinds of property are excluded from the scope of the PPSA, so careful secured parties often want their documents to include both the new ‘security interest’ formulation and the old mortgage/charge wording to catch the excluded property.

The Report proposes that excluded property, including the following, be brought within the scope of the PPSA:

  • insurance policies (except, maybe, life insurance)
  • superannuation interests
  • rights to remuneration
  • perhaps most significantly, statutory licences – eg taxi licences, fishing licences, or gaming machine licences
  • water rights.

The Report recognises that covering statutory licences and water licences will require consultation and agreement with State and Territory governments.

If fully implemented, this has the potential to reduce the security registration systems in Australia down to three:

  • land – this will always remain the province of States and Territories, under the Torrens system
  • mining and oil & gas tenements – these are not usually interests in land, but they are so connected with the underlying land that a separate register akin to the Torrens land register is likely to remain the best solution
  • all other kinds of property – the PPS Register

If this is done, the achievement of document simplification without reference to old mortgage and charge concepts should become possible, reducing security documentation cost and complexity.

4.  Removal of the 20 business day registration rule for companies

The PPSA itself doesn’t set any deadlines for registration.  But if you delay, you may lose priority to another security interest registered ahead of you, or may lose your security interest altogether if the grantor goes into insolvency administration before you register.

For individuals, that is the end of the story.

But for companies, section 558FL of the Corporations Act adds another rule: if not registered within 20 business days, the security interest remains vulnerable to being lost if the grantor goes into insolvency administration within six months after registration does occur.

The rule is a hold-over from now-repealed Corporations Act provisions about registration of company charges, and a trap for the unwary.

The Report recommends its abolition, so that the consequences for non-registration would be the same for company grantors as for individuals.

Who wins, who loses?

Here are some high points, and occasional low ones, for some of the industries affected by the PPSA.

Equipment lessors

Some members of the equipment hiring industry sought complete exclusion of operating leases from the PPSA.  The Report does not go this far, but does make a series of recommendations that will help the industry.

  • 12 months would be fixed as the term triggering the need to register for all kinds of goods, removing the current 90 day period for some property
  • Leases with unlimited terms would not be caught unless and until they actually lasted for more than 12 months
  • Bailments that are not leases would no longer be caught
  • Insolvency administration would no longer trigger complete loss of operating leases not perfected by registration (though they could still lose priority to other security interests)
  • The period for making a priority purchase money security interest registration would be 15 business days for all assets, rather than (as at present) the 15 business day period only being available for non-inventory

Pawnbrokers

Licensed pawnbrokers are currently largely outside the scope of the PPSA.  The Report would reverse this exemption, though they would still not be subject to the rules about enforcement of security.

However, as pawnbrokers generally perfect their security interests by possession, they would not usually need to make registrations (possession and registration are alternative methods of perfection), so coming under the PPSA might not have a significant impact on their day to day operations.

Commercial landlords

Although real property is outside the scope of the PPSA, commercial landlords who lease fitout or other goods along with land and buildings may need to register in order to protect their interests in the goods.

Some members of the industry had sought exclusion from the coverage of the PPSA, but the Report recommends no change.

Banks

Banks (or, at least, those banks which are ‘ADIs’ or ‘authorised deposit-taking institutions’) benefit from some privileges under PPSA at present.  The Report generally recommends these be maintained, though with some adjustment.

  • Banks’ right to first priority security over accounts with themselves, perfected by control (that is, without registration being required) would be retained.
  • Currently, although no registration is required for perfection, registration can be required to prevent the account being a circulating asset (which means it would lose priority to certain preferred creditors on insolvency). This requirement would be removed.
  • Currently, when taking security from an individual, secured parties must use the grantor’s correct name from specified documents, most usually a driver’s licences. Banks, however, have an exemption: they can use the name as recorded in their anti-money laundering/counter-terrorism financing records, even if different from the name on the driver’s licence.  This can make it difficult for others to find the security interests by search.  The Report recommends removing the special AML/CTF rule for banks.
  • A confusing reference to flawed assets being security interests would be removed. A flawed asset arises when a customer agrees not to withdraw money from a bank deposit until the customer has paid all amounts due to the bank.  It wouldn’t normally be considered a security interest, except for an odd reference in the PPSA which currently creates uncertainty for banks relying on the arrangement.

Securitisation and other receivables financing

Receivables financiers benefit from some special rules under the PPSA at present.

  • Under pre-PPSA law, perfecting an assignment of receivables required the financier to give notice to all debtors, and the PPSA replaced this with a simpler process of perfection by making a single registration. The Report recommends retaining this.
  • In a contest with ROT suppliers (who supply goods on retention of title terms, effectively holding security over the goods until they are paid for – or, if the goods are sold before being paid for, holding security over the trade receivables) a financier who has financed those same trade receivables can take priority ahead of the ROT supplier, as long as it has given the correct notices. The Report recommends maintaining this priority benefit, and also making the process of giving the notices easier.
  • The PPSA allows receivables financiers to take security over trade receivables even if prohibited by other agreements. Again, the Report recommends retaining and extending this.

Trading in corporate debt

An untidy question under the PPSA at present is whether substitution certificates, which are documents that transfer interests in syndicated corporate loans, trigger a registration requirement.

The Report recommends clarifying that they do not.

Mining / oil and gas joint ventures

Some interesting issues arise when mining or oil and gas projects are carried out under joint venture or joint operating arrangements.  These relate particularly to the provisions that apply if one participant goes into default.  There are often three different default remedies: a cross charge (a traditional charge granted by each participant to each other participant), a default purchase option (that is, the right to buy out the defaulter, usually at fair market value), or dilution (a right to reduce the defaulter’s interest, in line with the amount of the default).

Cross charges are definitely security interests covered by the PPSA; and default purchase options and dilution probably are.

The Report recommends a few changes.

  • The definition of ‘security interest’ would be narrowed slightly, by deleting the definition of ‘interest’, which might mean default purchase options and dilution fell outside the scope of the PPSA. That would simplify registration procedures for mining companies.
  • Joint venture participants sometimes worry that putting property into the hands of a Manager gives rise to a security interest (though in my view it usually doesn’t) and requires a registration. By removing bailments from the scope of PPS leases, the Report’s recommendations would overcome that worry.
  • Perhaps surprisingly, the Report recommends that registrations could no longer name multiple grantors in a single registration, unless they all owned the collateral jointly. This means if there were six joint venture participants, and they all gave each other a cross charge, 30 separate registrations would be needed instead of six as at present.

Consultants and commentators

The Report recommends further consultation and input on a range of issues.  Some are where further specialist opinion would be desirable, and others where the Report raises a proposed recommendation that might not have been fully discussed in the consultation process.  The issues include the following

  • A question about the theoretical underpinning of how a secured party can exercise rights over the whole of an asset as a result of security granted over only a partial interest (such as a lease) in that asset. The Report describes two competing models to explain this – the ‘unitary model’ and the ‘possessory model’ – and prefers the unitary model, but notes that further comment from proponents of the possessory model would be helpful.  (My own view falls somewhere in between the two models.)
  • A range of matters relating to intermediated securities (eg shares held through an intermediary) and letters of credit.
  • Whether security over life insurance policies should remain outside the scope of the PPSA.
  • How the PPSA should apply to securities lending.
  • Whether perfection by control should continue to give super-priority ahead of other methods of perfection.
  • Whether the special rules for priority of agricultural security interests should be deleted (the Report is inclined to suggest ‘yes’).

These should provide a number of helpful suggestions for experts who would like to publish something on detailed matters arising from the Report.

Finally, in discussing the next steps, the Report strongly recommends that the Government should engage with the private sector (presumably the private legal profession and finance industry) in a collaborative approach in drafting any amending legislation, before releasing draft amendments for public consultation.

Everyone!

Overall, the outcomes if the Report is implemented should be regarded as a win for everyone involved in using the PPSA, most notably because of the simplification and improvements that are proposed for the registration system.

What next?

The ball is now in the Government’s court to respond to the Report and determine whether to proceed with the necessary further consultation and then legislative amendments.

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