Debtor finance in Australia – A guide for financiers, Part 4

The importance of considering competing security interests

In the previous instalment, we looked at the importance of reviewing the terms of the underlying sales contracts. In this instalment, we examine the importance of considering other security interests in the receivables of a seller that may compete with the interests of the financier.

Competing security interests: mind the PMSI

Under the PPSA, a security interest in a receivable purchased by a financier will be deemed to arise in favour of the financier with the seller as grantor. Financiers will often bolster this by requiring the seller to expressly grant a security interest over all purchased debts and related rights under the terms of the facility agreement or security document. In either case the financier’s security interests must then be perfected by registration on the PPS Register.

Too often, however, not enough consideration is given by receivables financiers to the presence of an existing purchase money security interest (PMSI) of a supplier to the seller. Provided the supplier perfects its security interest in accordance with the PPSA, a PMSI in the inventory (and the proceeds of the inventory) can arise in favour of the supplier if it sells inventory to the seller on retention of title terms. To the extent inventory is sold while the supplier remains unpaid, the PMSI will attach to the receivable arising from that sale (being the proceeds of the inventory).

Ordinarily under the rules of the PPSA, the supplier’s PMSI in the receivable will take priority over the (non-PMSI) security interest of the purchaser of that receivable if the two secured parties were ever to compete for that receivable. However, if it is alert to this risk, a receivables financier can potentially use the mechanism under s 64 of the PPSA to ensure that its security interest in a receivable (and its proceeds) should take priority over a supplier’s pre-existing PMSI.

The rules surrounding s 64 are complex and the regime introduced under that section has a number of shortcomings. However, provided that the financier perfects its own security interest by registration, s 64 of the PPSA provides that a financier’s security interest in a receivable (as original collateral) will prevail over an already-perfected PMSI in that receivable (as proceeds of inventory) if notice is given by the financier to the supplier at least 15 business days before the earlier of (i) the day the financier’s security interest attached to the receivable and (ii) the date of registration of the financier’s security interest. ¹ The notice must comply with s 64(2) of the PPSA.

Too often, however, not enough consideration is given by receivables financiers to the presence of an existingpurchase money security interest (PMSI) of a supplier to the seller.

Trent Chugg, Counsel, Ashurst Australia

It is a valuable exercise, therefore, for financiers to carefully check the results of their PPS searches with respect to a seller in order to identify any pre-existing PMSIs (or other security interests that could otherwise include a pre-existing PMSI) registered against the seller before entering into a receivables financing arrangement with them. As a result, it may be appropriate for the financier to issue s 64 notices to one or more secured parties in order to give effect to the protections offered by that section.

Financers should be aware, however, that s 64 is certainly not a panacea for defeating all competing security interests. For example:

• while s 64 enables a receivables financier to defeat a PMSI of an inventory supplier in the circumstances discussed above, it will not assist in defeating an existing non-PMSI held by that supplier covering the same collateral;² and
• there is no requirement that the existing PMSI be registered as a PMSI. Consequently, the holder of, say, an existing all-asset security interest that is in fact a PMSI would also need to receive notice (effectively meaning that a s 64 notice needs to be given to any secured party whose collateral description may cover the inventory and its proceeds).

there is no requirement that the existing PMSI be registered as a PMSI. Consequently, the holder of, say, an existing all-asset security interest that is in fact a PMSI would also need to receive notice (effectively meaning that a s 64 notice needs to be given to any secured party whose collateral description may cover the inventory and its proceeds).

There are also some inherent difficulties with the issuance of s 64 notices in accordance with that section.

Given the complexity surrounding s 64, financiers should consult with their legal counsel when considering its position with respect to the regime promulgated by that section. In view of the shortcomings of that regime, it may be appropriate in some cases for the financier to enter into a subordination arrangement with a supplier.

In the fifth and final instalment of our series, we examine the importance of considering the impact of stamp duty on any receivables financing transaction.

<sub>Notes
1. The financier’s security interest in the receivable will also rank ahead of any PMSI if it is perfected by registration before the PMSI is perfected (by registration or otherwise).
2. In fact, in the Final Report of the Review of the Personal Property Securities Act 2009 tabled in the Commonwealth Parliament in March last year, author Bruce Whittaker recommended that, while s 64 should be retained, the section should be amended to provide that an accounts financier can use the section to take priority over both a PMSI held by an inventory financier in the proceeds of its inventory, and over a non-PMSI security interest held by the same inventory financier in those proceeds (see Recommendation 244 of the Report). A number of other recommendations have been made in the Report in relation to s 64 and s 64 notices</sub>