Understanding priority and extinguishment

Where two or more persons have a security interest in the same personal property, there are priority rules to decide whose interest in the personal property will prevail. The priority rules require a secured party to take specific steps to protect its interest in the personal property.

There are also circumstances in which a secured party’s interest in personal property may be in effect ‘extinguished’ if the personal property is transferred or leased to a third party. These are sometimes called the ‘taking free’ rules.

Determining Priority

The application of the priority rules under the PPSA depends on the concepts of attachment, enforceability against third parties and perfection. For the purposes of understanding the practical examples relevant to the construction industry it is sufficient to understand that generally:

• ‘attachment’ signifies the point at which personal property becomes subject to a security interest that can be enforced by the secured party against the grantor (once a security interest has attached to personal property, the property is called ‘collateral’).  A security interest will ‘attach’ to personal property when each of the following have been satisfied:
  • the grantor has rights to personal property; and
  • some value has been given for the security interest, (for example where moneys have been advanced by the secured party to the grantor) or the grantor does an act by which the security interest arises (for example where the grantor signs a security document or accepts a supply of goods on retention of title terms);
• a security interest will be enforceable against third parties provided that the security interest is provided by a written security agreement and the secured party has possession of the secured property or the secured party has ‘control’ of the secured property; and
• ‘perfection’ describes the process by which the holder of a security interest obtains the optimal level of protection under the PPSA. A security interest will be ‘perfected’ where the security interest has attached to personal property, the security interest is enforceable against third parties and the secured party either:
  • registers a financing statement on the PPSR;
  • has possession of the property (other than by way of ‘repossession’); or
  • has ‘control’ of the personal property (this category of perfection is only applicable to certain types of collateral such as shares).

In practice the most common form of perfection in a construction context will be registration of a financing statement on the PPSR.

‘Purchase Money Security Interest’ or ‘PMSI’

A PMSI is a special category of security interest that secures an obligation owed by the grantor in relation to the acquisition of personal property (such as the obligation to pay its purchase price). The interest of a supplier on retention of title terms is a PMSI, as is the interest of a lessor of goods under a PPS Lease.

Subject to strict registration requirements, PMSI’s have ‘super priority’ over other types of security interest. The registration requirements include:

• the financing statement must expressly identify the security interest as a PMSI at the time of registration; and
• the PMSI must be registered on the PPSR within the following timeframes:
  • where the personal property is inventory, before delivery of the inventory (in most cases); and
  • where the personal property is not inventory, within 15 business days after delivery (in most cases).

The main types of PMSIs encountered in the construction industry include PPS Leases (such as certain hire-purchase agreements) and the sale of goods on a retention of title basis. For further details regarding what is a PMSI, see section 14 of the PPSA.

Priority rules

The general priority rules are:

• a perfected PMSI has priority over other perfected security interests;
• a perfected security interest has priority over an unperfected security interest;
• competing perfected security interests, the security interest that is perfected earlier in time (either by registration, possession or temporary perfection) except where a security interest is perfected by control which has ‘super priority’ (although this category of perfection is only applicable to certain types of collateral such as shares); and
• competing unperfected security interests, the security interest that attaches earlier in time.

Registration on the PPSR

Registration on the PPSR is usually the most common method of perfection which a secured party will take to protect a security interest. Perfecting a security interest by registering an effective financing statement in relation to a security interest within the prescribed time will give priority over ‘unperfected’ interests, decrease the likelihood that the interest may be extinguished and prevent the security interest from being lost if the grantor becomes insolvent.

There are penalties for registering a financing statement where the person registering the interest does not believe, on reasonable grounds, that it is or will become a secured party in relation to the personal property.

Sometimes multiple security interests may be created under a single document. It is possible to effect more than one registration based on a single document, and it is also possible for one registration to perfect multiple security interests.

What is required to register a security interest?

To register an interest in personal property requires details of the secured party, the other party giving the interest (grantor) if applicable, the relevant personal property (collateral) and a method of payment as there are fees for registration.

There are additional registration requirements for different types of security interests. For example:

• a security interest that is a PMSI must be identified as such at the time of registration (or else it will not have ‘super priority’);
• some personal property may or must be described by serial number (for example motor vehicles or aircraft).

The PPSA contains strict registration requirements which must be complied with in order for a registration to be effective. For example, if a grantor is a body corporate, the registration must be made against its ACN and not its ABN. There have been numerous cases in Australia since the PPSA commenced which have found that a financing statement was not an effective registration (and therefore unperfected) because these registration requirements were not complied with. For example, in Re OneSteel Manufacturing Pty Ltd (Administrators Appointed) [2017] NSWSC 21 registration of a financing statement against the ABN of the grantor (in circumstances where the PPSA required registration against the ACN of the grantor) resulted in a lessee losing significant plant and equipment upon the appointment of voluntary administrators to the lessor.

While the PPSA includes some general rules about what must be included in a financing statement registered on the PPSR, there is no requirement that a financing statement include a specific description of the relevant collateral.  If the collateral description in a financing statement is too narrow, there is a risk that the registration might not cover the relevant asset and therefore not sufficient for the purposes of perfection. Accordingly, when registering a financing statement on the PPSR, it is important to make sure that any collateral description is broad enough to cover the personal property subject to the relevant security interest.

Timing requirements for registration

If perfecting a security interest by registration of a financing statement, then timing of registration is critical. Financing statements for security interests can be registered at any time (including before execution of the security agreement).Failing to register promptly can result in loss of priority or loss of the interest where the grantor becomes insolvent and the financing statement was not registered within 20 business days after entry into the relevant security agreement or at least 6 months before the insolvency event. These timeframes are contained in the Corporations Act 2001 (Cth). There are also special timing requirements under the PPSA for registering PMSIs (see above).

Extinguishment (‘taking fee’)

A security interest in personal property will not prevent a person from transferring or leasing personal property to a third party (even where there is a specific prohibition in a security agreement).

In some cases, the security interest will survive the transfer or lease. In such cases, the secured party may take steps to enforce its security interest (for more details, refer to the next section, Enforcement of security interests).

In other cases, the PPSA will allow the buyer or lessee to take an interest in personal property free of a pre-existing security interest. This effectively extinguishes the security interest at the time of the transaction so that the buyer is protected and takes the property free of the relevant security interest. Two of the most important taking free rules are:

• a buyer or lessee takes their interest in personal property free of any unperfected security interest; and
• a buyer who purchases personal property from a seller in the ordinary course of business (of selling or leasing goods of that kind) and to whom title in the personal property passes takes their interest free from any security interests granted by the seller. The exceptions are if the buyer or lessee:
  • will hold the property as inventory and the personal property comprises serial numbered goods (like motor vehicles); or
  • has actual knowledge that the sale or lease constitutes a breach of the security agreement that relates to the security interest.

There are a number of other provisions allowing persons to ‘take free’ including some rules relating to serial numbered goods and, in particular, motor vehicles. Under the PPSA, the security interest automatically attaches to proceeds arising from the dealing with the property (unless the security agreement provides otherwise). This means that although a third party can take the property free of the security interest, the secured party may be able to enforce its security interest over the proceeds from that sale in certain circumstances.

The PPSR is not a register of ownership interests or encumbrances (other than security interests) and, while searching the PPSR to ensure no security interests exist should form part of any acquisition process, the usual due diligence should still be undertaken to ensure that the vendor is the owner of the property being acquired.

For further details regarding the taking free rules, refer to Part 2.5 of the PPSA.