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    Competing Business Security Interests: When your security may not be as secure as you think pt.1

    Sep 30, 2020 1:20:14 PM

    There are a number of different ways a business or individual may choose to secure their interest in another business. The different methods and whether they are suitable or not depends on the nature of the transaction and the type of asset being secured against. For example: a loan for the purpose of purchasing a commercial property may be secured against that property by way of a mortgage.

    A common method for smaller loans used to purchase personal property (i.e. an asset that is not real estate such a motor vehicle or laptop) for the business, is to secure that interest against that particular personal property. In a similar way, suppliers may secure their credit terms against the personal property that they supply to the business on an ongoing basis. This method is usually entered into a General Security Agreement alongside any loan agreement or by signing particular credit terms. The security is a charge registered pursuant to the Personal Property Securities Act 2009 (Cth) (‘PPSA) on the Personal Property Securities Register (‘PPSR).

    PPSR and PPSA

    While it is easy to determine whether real estate is encumbered by doing a title search to determine what debts have been secured over that particular property, it is not so easy for personal property.

    The PPSA is the law about security interests in personal property, and set up the PPSR which is designed to overcome the practical challenge of determining whether personal property as a debt secured against it and protection for securing that debt.

    There are a number of terms that are used under the PPSA that may be different to those used in other commercial transactions, these include:

    Term

    Equivalent

    Secured party

    The business or person who is having their interest secured i.e. financier, mortgagee, chargee, lender, retention of title supplier, lessor

    Grantor

    The business who holds the personal property the interest is being secured against i.e. borrower, mortgagor, chargor

    Collateral

    The personal property the debt is being secured against

    Security agreement

    The document giving rise to the security interest, i.e. General Security Deed, mortgage, charge etc

     

    A perfected security interest is one that is attached to collateral, be enforceable against third parties and is either registered on the PPSR or in the possession of the secured party. When a party has a perfected security interest they will have a priority interest in relation to other unperfected interests in the event of insolvency of bankruptcy.

    Why does this matter?

    At first glance it is easy to see why you may wish to secure your interest in a business. Clearly you are concerned with being paid back. Though if you have a contract with the business regarding the debt the business owes to you, surely you have an enforceable right anyway.

    This is a correct assumption. However, whether you have an enforceable right or not is typically not the issue that faces creditors. It is who gets paid first, and who only receives some nominal cents in the dollar. As a result, the real value in a PPSR security lies in its priority.

    As stated above, there are many different ways to secure an interest in a business, and there are many ways to protect yourself contractually. Any debt at first instance must be secured. Without some form security the amount owed to you will fall to the bottom of the priority list for a liquidator. However, if the worst should happen, and the business becomes insolvent, how do you ensure that you are paid back first before all other creditors of the business.

    The technicalities regarding the priorities of who is paid in the event of insolvency of a business are vast and complex. So, for the purpose of this article we simply say, if the debt you have is not correctly secured against the business in question, you will not have priority. This is why many individuals and businesses ensure that their security interest is perfected so that they give themselves the best chance at having priority amongst competing creditors.

    Different types of PPSA interests

    The PPSA enables you to secure your interest against a particular personal property, or against all personal property of a business. There are also a number of other types of interests which we will not go into here.

    In general, if your interest is registered against a particular personal property (or group of identifiable personal property) when it comes to priority interests, you will be paid first in relation to that particular personal property.

    If your interest is registered against all personal property of a business, then those who have interests registered against particular items will have priority on those items first, and thereafter you will have priority regarding the other assets of a business.

    For example: let’s look at a technology company. The technology company owns at the time of liquidation as follows:

    1. 10 laptops – sold for $10,000
    2. 10 tables – sold for $3,000
    3. 10 chairs – sold for $2,000
    4. 10 headsets – unfit for resale, as they were damaged in a recent fire.

    Company A has a perfected security interest of $10,000 regarding the 10 laptops.

    Company B has a perfected security interest of $10,000 regarding the 10 headsets.

    Company C has a perfected security interest of $10,000 over the personal property of the technology company generally.

    In this scenario:

    Company A would receive $10,000 following the sale of the 10 laptops. Their security interest is discharged in full, because the liquidator paid them back first when they sold the laptops.

    Company B would receive $0 because the headsets they secured their interest against are no longer worth anything. This is not to say they don’t have a contractual right or further rights against the company, but the only items they were secured against were the headsets, and as a result they no longer have any priority. If the company has other assets and is able to discharge its other secured creditors they may be able to recover the amount owed to them or part thereof.

    Company C would receive $5,000. They had no priority in relation to the laptops, and so the proceeds of the laptops went to discharging the debts of Company A first. However, in relation to the other assets of the Company, Company C has a priority interest and so their debt is paid out as far as possible first. In relation to the remaining amount owed to them, if the company had other assets they would have priority over Company B and other unsecured creditors in relation to payment for their debt from the proceeds of sale of those other assets.

    Take-away

    Consideration should be given as to what type of security interest you will use to secure the debts that you have against a business or to secure the debts of your clients against a business.

    In any event, it is important to secure any debt you may have against a business in some form, and the PPSA can be a useful tool in doing this.

    Beyond what was discussed above, there are other forms of security interests and intricacies in relation to the PPSA which may affect your priority and how secure your perfected security interest actually is. 

    If you have further questions please contact us at frank@franklaw.com.au. 

    This is not legal advice. 

    Andrea Harrold

    Written by Andrea Harrold