Step-in rights can be a security interest

The Zealand Decision

Facts

A recent decision of the High Court of New Zealand, McCloy v Manukau Institute of Technology [2013] NZHC 936, concerned a dispute between the receivers of a construction contractor (Mainzeal) and a customer of Mainzeal (Hobson Gardens) regarding equipment that Mainzeal had been using to complete some construction works for Hobson Gardens on Hobson Gardens’ property. The construction contract between Mainzeal and Hobson Gardens was based on the standard New Zealand Institute of Architects’ contract terms. It provided that if Mainzeal went into receivership and the receiver did not take over the construction work, Hobson Gardens could terminate the contract. The contract said, if Hobson Gardens so terminated the contract, that Hobson Gardens would be deemed to be in possession of the contract works, and that Mainzeal’s interest in the equipment would be transferred to Hobson Gardens. Hobson Gardens would then be entitled to use the equipment to complete the works, and to sell Mainzeal’s interest in the equipment and use the sale proceeds to pay money that Mainzeal owed to it.

Mainzeal went into receivership and its receiver, appointed by the Bank of New Zealand, declined to take over the construction works. Hobson Gardens then terminated the contract and asserted that it was now in possession of the works.

The receiver claimed that it was entitled to the equipment under BNZ’s securities. Hobson Gardens resisted this.

Were the step-in rights a security interest?

The receivers argued that Hobson Gardens’ step-in rights were a security interest for the purposes of the New Zealand Personal Property Securities Act 1999 (NZ) (“NZ PPSA”), and that BNZ’s security interest had priority. Hobson Gardens argued that its step-in rights were not a security interest, so that the priority rules in the NZ PPSA did not apply.

The Court held that the purpose and wording of the step-in rights amounted to an in-substance security interest: a “transaction that in substance secured payment or performance of an obligation”. This conclusion was supported by the following indicators:

• the step-in clause was clearly intended to give Hobson Gardens a form of security over Mainzeal’s interest in the equipment; and
• the step-in rights were designed to enable Hobson Gardens to complete the contract works and sell the equipment to cover any liability of Mainzeal to Hobson Gardens resulting from Mainzeal’s failure to complete the works.

Whose security interest had priority?

Where there are two competing security interests, the NZ PPSA provides that a perfected security interest prevails over an unperfected security interest. BNZ had perfected its security interests by registration, but Hobson Gardens had not, so BNZ’s security interests prevailed over Hobson Gardens.

It is worth noting that Hobson Gardens did not perfect its security interest over the equipment by possession, even though it had taken possession. While it is possible under the NZ PPSA to perfect a security interest by taking possession of the collateral, possession will not perfect a security interest if the possession results from seizure or repossession (section 41(b)(ii) of the NZ PPSA). This meant that taking possession as part of exercising its step-in rights did not serve to perfect Hobson Gardens’ security interest as well.

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