The Personal Properties Securities reform is scheduled to commence on 30 January The start date may be further delayed.

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1 Prepared by Jon Denovan and Umniyat Choudhury 21 November 2011 Contents 1. Overview 2. Special rules for property types 3. How the register works 4. Default provisions and procedures (including modification of default provisions) 1. Overview Introduction The Personal Properties Securities reform is scheduled to commence on 30 January The start date may be further delayed. The PPS regime completely replaces the existing schemes for registering security over most types of personal property except real estate. Examples of the type of property covered by the Personal Property Securities Act 2009 (PPSA) are: goods eg cars, ships, planes, mining equipment, farm machinery growing crops IP contractual and other rights debts shares, units, debt securities. An interest registered on the PPS register is called a security interest. The PPS register is not like the Torrens Title system it does not record ownership, and does not guarantee title. It is a register of security interests. Following the introduction of the PPS regime, a traditional fixed and floating charge over a company s assets will be registered on the PPS register instead of being registered at ASIC. Similarly, most types of non-real estate security taken from individuals will be registered on the PPS register. What will change in practice? Real estate financing will generally continue unchanged with mortgages being registered at the relevant Land Titles Office. Most common security documents will only need minor changes to operate under PPS. Loan settlement and registration processes will remain largely unchanged except that lenders or their lawyers or registration agents will register securities other than real property mortgages on the PPS register instead of at ASIC or the other registers. The big change is for businesses which enter into:

2 operating leases (other than short term leases such as car rentals); finance leases; hire purchase agreements (remember consumer hire purchases are converted by the National Credit Code to loans secured by mortgages); sale agreements under which possession is given to the purchaser before payment (often called Romalpa clauses or retention of title). Currently, these interests are not necessarily recorded (except sometimes at REVS in respect of motor vehicles and boats). From PPS commencement, these interests should be registered on the PPS register. Abolition of nemo dat rule Of particular importance is the abolition of the nemo dat rule which in brief provides that a person cannot give better title than the person had. Under PPS, a person who has possession of goods can pass good title to a purchaser even though the person is possession does not own the goods, unless the secured party has registered a security interest in the goods or otherwise perfected their security interest. Perfection Perfection is important because it is relevant to determining priority between competing claims. Perfection can occur by: registration; possession; or control (only applies to a limited class of property). A security interest may be perfected by more than one way at the same time. Due diligence In addition to making their own arrangements for PPS compliance, lenders will want to ensure that their business customers have appropriate PPS arrangements in place. For example, a lender to a leasing company may want to verify that the leasing company is properly recording their security interests on PPS. Purchasers of businesses will want to verify whether the business has appropriate PPS procedures in place. For example, if the business sells on a retention of title basis, does the business properly register its security interest under PPS? Searching It will still be possible and prudent when dealing with companies to search (by their ACN) in order to determine what security interests they have created. It will also be possible to search against individuals but only if you have their full name and date of birth. 2. Special rules for property types Property excluded from the scheme In addition to real estate, other categories of property are excluded from the PPS scheme. These include licenses for gambling, liquor, fishing, exploration, energy, horse racing, mining, tobacco and aquaculture.

3 Migration registers The most frequent security interests (for example, security interests recorded at ASIC and REVS) will be automatically migrated onto the PPSR. Security interests requiring registration (no current register) Lessors, hirers, and sellers of goods on terms may need to record their interest on the PPSR. There is a two year transition period from PPS commencement for finalising new registrations, but secured parties should complete registration as soon as practicable. During the two year period, pre PPS commencement interests are given temporary priority. By the end of the two year period, any continuing security interests need to be registered on the PPSR. Assignment of rentals, insurance, other personal property associated with land mortgages The right to receive rentals is a contractual right owned by the owner of land. The owner of land could assign that right to a third party to secure payment of money. This assignment could potentially create a security interest over the lease contract to pay rental which the third party could register under PPSA. Section 8(1)(f)(ii) PPSA provides that the PPSA does not apply to the creation of an interest in a right to payment, or the creation or transfer (including a successive transfer) of a right to payment, in connection with an interest in land, if the writing evidencing the creation or transfer specifically identifies the land. It would be possible to document a valid assignment of rentals that does not specifically identify the land, and so the assignment of a rental stream could well be subject to PPSA. In addition there is often other personal property associated with mortgages over real estate such as charges over or assignments of insurance, development approvals, fittings, and other chattels associated with the real estate. So, at least for non-residential mortgage lending, it is appropriate to register this security interest under PPSA. The charge over these items may be in the real estate mortgage itself or in a separate charge. Most mortgagees of non residential land take a fixed and floating charge as collateral security in addition to the mortgage over real estate. Accordingly, these mortgagees achieve registrable interest on the PPSA register by virtue of the migration of its fixed and floating charges or registration of a GSA. If a mortgagee has not taken a fixed and floating charge (GSA), there is a risk that the mortgagor could validly assign or charge the rentals and other personal property to a third party. This risk applied prior to the commencement of the PPSA and it was not common to take action to prevent it. However, mortgagees may want to address this issue by registering a security interest in respect of them (at least in relation to nonresidential property). An assignment of the rental would be a breach of the mortgage and the mortgagee would be able to sell the property thereby making the assignment of the rentals of no value (because the right to the rental runs with the land). Should you register all security interests? An unregistered security interest is quite valid (subject to some exceptions on insolvency), although it risks losing priority. Factors that are relevant in considering whether to register are:

4 the nature of the purchaser or lessee (there might be little point in registering security interests against financially strong purchasers and lessees); the period for which the security interest will exist. For example, if retention of title only applies for 14 days, there is little point in registering a specific security interest. However a revolving or circulating security interest may be appropriate to register; the amount secured by the security interest compared to the overall assets of the security holder (if the amount is small compared to the net assets of the security holder then registration may be overly precautious). You will see that it is a commercial decision for the business to decide whether to register security interests in the PPS register as a risk mitigant. This decision needs to be made in respect of both: existing contract parties; and new contract parties. 3. How does the PPS register work? The register Unlike the ASIC register, the PPS register (PPSR) is not a document register and no documents will be lodged at the PPS register. Instead, the PPS register works similarly to REVS ie it comprises of online notification of security interests, not of documents. Accuracy in registering an interest is essential, as a defective notification may invalidate the registration. There are special rules for registering interests in relation to goods with serial numbers or relating to unpaid purchase money see below. A security interest can be registered at any time, but: if the grantor is a company, security interests not registered within 20 days of creation become void if within six months after creation of the security interest a liquidator or administrator is appointed to the company, or the company enters a deed of company arrangement - s267 PPSA and s588fl Corporations Act; if the grantor is an individual, security interests not registered at the time of bankruptcy are void s267; the special priority for PMSIs (see below) is only available if - s62: (a) for inventory comprising goods, registration occurs before the grantor obtains possession of the goods; (b) for inventory other than goods, registration occurs before the security interest attaches to the inventory; (c) for goods which is not inventory, registration occurs before the end of 15 business days after the grantor obtains possession of the goods; and (d) for property which is not inventory and not goods, registration occurs before the end of 15 business days after the security interest attaches to the property. Registration Number A registration number is the unique identifier of a registration in the PPSR. It is allocated by the system when a new registration is created in the PPSR. It will be a minimum of 14 characters but can be up to 20 characters.

5 The registration number cannot be changed on the PPSR and will be publicly available. Registration Token A registration token is a unique authorisation identifier for a specific registration. It is commonly referred to as the token. It is allocated by the system when a new registration is created in the PPSR. When the token is entered with the registration number for a specific registration, the user can access the registration for purposes such as amending or discharging. The token is not automatically reissued or changed when a registration is amended. A user can request a new token to be issued. However, on a transfer, the token is automatically reset and sent to the address for service of the transfer to secured party group. A token is case sensitive and will be private (not publicly available). If a registration token is forgotten, you can request it to be reset via the reset function. You will need to provide the SPG number (see below), access code and registration number. The new token will be sent to the SPG address for service. Change number A change number is a unique number across the system, showing the order of changes to registrations in the system. A change number is allocated to a registration when it is created or amended. The combination of the registration number and the change number identifies a registration at a particular point in time. When a user accesses the history list for a registration, the list of registration events is shown in changed number sequence. A change number will be publicly available. Defects in registration A registration that describes particular collateral will be ineffective because of a defect in the register if there is: (a) (b) a seriously misleading defect in any data relating to the registration; or one of the following circumstances exists -s165: (i) if the serial number is required and the serial number is missing; (ii) if the serial number is not required and a search using only the grantors name does not disclose the registration; (iii) if the registered financing statement indicates that a security interest is PMSI (see below) and the security interest is not a PMSI. It is not necessary to prove that any person was actually misled to establish that a defect is seriously misleading. Registration renewal Registration needs to be renewed: for consumer property or commercial serial numbered property at least every seven years; and for non-consumer property and non-serial numbered property at least every 25 years unless no end time was specified during registration s163 PPSA and s153. Higher registration fees apply when no end time is specified.

6 Renewal only requires a new registration, not a new security document. If a charge over all of a company s property covers serial numbered goods, and those goods are separately identified in the financing statement, the registration will need to be renewed every seven years. If the serial numbered goods are not separately identified in the financing statement, the charge will not need renewal, but the charge over serial numbered goods may be defeated. Purchase Money Security Interest (PMSI) A PMSI is an interest claimed by an unpaid seller of goods. Interests classified as PMSIs are given a superpriority as long as the security is classified as a PMSI when registering and the security interest is registered within the time limits specified above. A PMSI can be held by either the seller or a third party lender who financed the purchase of property. A seller s PMSI will usually have priority over a third party lender s PMSI s63 PPSA. A PMSI will only exist to the extent that money is in fact used to acquire the property. It will be hard to ensure money was so applied if the funds pass through the hands of the debtor or another person first, or if the grantor acquires the collateral before the funds are advanced. So lenders should aim to pay loan funds directly to the seller of the collateral if they want a PMSI. A PMSI can only be registered in respect of property intended to be used predominantly for personal, domestic, or household purposes if the goods are serial numbered s14(2a) What is a Secured Party Group (SPG)? An SPG can comprise of one or more secured parties, but normally it will comprise of only one. Example: Big Bank establishes an SPG of which the only member is Big Bank. The SPG is allocated an SPG number and an SPG access code which only Big Bank and its agents know. The SPG number access code should be kept secure. If you know the SPG number, you can register security interests for the SPG. The users could include employees of the lender, law firms, and law stationers. On registration a security interest is allocated: a registration number (publicly available) like registration numbers under existing registration schemes; a change number (publicly available) the change number indicates the order in which security interests are created and changed, which is relevant to establishing priorities; a registration token (private) a private key needed to deal with the security interest. A verification statement (VS) which includes the registration number and the registration token is sent by the PPSR to the SPG s address for service (AFS) in two separate s from the PPS register. Each SPG can have only one address for service, and so if there are a number of users in a single SPG, the user (eg a panel lawyer) will not receive the VS unless it is the AFS. However, once payment of the registration fee is made, the system confirms that the registration has been submitted and displays the registration number so that the user can verify registration has been completed without needing the token.

7 Anyone knowing the registration number and token for a security interest or the SPG number and the SPG access code can deal with that security interest (eg discharge the interest). As the registration number is public, the token must be kept secure. Anyone knowing the SPG number and access code for the SPG could transfer everything from that SPG to another SPG. Accordingly, the access code needs to be kept secure. Lenders may therefore decide to establish a single SPG, for which law firms and law stationers register security interests. However, these law firms and law stationers will not be told the access code, and so they cannot deal with all the registrations made for the lender. Verification statements The person who receives the verification statement (usually the secured party), as soon as practicable after receipt of the verification statement, must send a statement about the registration in an approved form to the person registered as a grantor s157. Personal Property Securities (Approved Form) Instrument 2011 provides that the notice can be: a copy of the statement in its entirety but: (a) any information provided by the National Exchange of Motor Vehicle and Driver Information System (NEVDIS) may be excluded; and (b) the birth dates of individual grantors must be excluded when the notice is given to a grantor other than the individual to whom the birth details apply; or a document which replicates the information contained in the verification statement (amended as per (a) and (b) above), and states that it is a Notice of Verification Statement provided for the purposes of section 157 of the Personal Property Securities Act 2009 (Cth). This requirement does not apply to serial numbered consumer property, and can be waived for commercial property s157(3). Why does this notice requirement not apply to serial numbered consumer property? Under the PPSR, grantor details cannot be included in a registration against serial numbered consumer property so there is no person registered as a grantor. The notice will need to be sent for new registrations, transfers by secured parties, discharges, and changes of address for service of the SPG. Our recommended system for financiers (ignoring large users who may use B2G) 1. Have one SPG (or if a large organisation, one for each division) so that you can generate reports on all securities. 2. External service providers (panel lawyers, law stationers) use that SPG but don t know the SPG access code or the tokens, so can only deal with securities they are instructed to deal with. 3. Whoever settles the commercial transaction should attend to registration. This accords with existing commercial practice and removes the risk of something slipping through the cracks if functions are split. 4. On discharges either:

8 (a) (b) provide the registration number and registration token to the mortgagor, purchaser, or incoming mortgagee to register lender undertakes (by itself, law firm, or law stationer) to register the discharge promptly after settlement. 5. A notice about registration for new registrations, transfers by secured parties, discharges, and changes of address for service of the SPG must be sent to the grantor. Depending on the content of that notice (not known when this commentary was prepared), this notice may need to use information from the verification statement. If it doesn t, the notice should be sent by the person who registered the dealing. Classes of collateral A financing statement must specify the class of collateral to which the security interest relates. The classes of collateral are: agriculture aircraft all present and after-acquired property [migrated fixed and floating charges will have this class] all present and after acquired property except financial property (defined as chattel paper [writings which evidence a monetary obligation in a security interest in, or lease of goods, or intellectual property], currency, a document of title, an investment instrument, a negotiable instrument) intangible property motor vehicles other goods (ie personal property other than agriculture, aircraft, motor vehicles and watercraft) watercraft More than one financing statement can be registered in respect of a single security interest or a single charge document so as to cover more than one class of goods. For example, a security interest in specific types of property such as motor vehicles may need to be registered when the security is created by General Security Agreement to ensure priority in respect of the motor vehicles. Serial numbers If a security interest relates to consumer property (property held by a natural person which is not used for carrying on an enterprise to which an ABN has been allocated), the following property must be described by serial number: aircraft; motor vehicles; watercraft; and certain intangible property (ie designs, patents, plant breeder s rights, trade marks, or licences over these assets) s153 PPSA and Schedule 1 Part 2 Item 2.2 PPSA Regulations. If this type of property is not described by serial number, the security interest will be void against a buyer or lessee of the property s44 PPSA. Registration by serial numbers is optional for commercial property*, but serial numbers should be stated

9 where possible. This is because a buyer or lessee takes this kind of property free of any security interest if no registration is found after conducting a serial number search only s44 PPSA. *Serial numbers are compulsory for commercial property that is aircraft or parts of an aircraft - s153 PPSA and Schedule 1 Part 2 Item 2.2 PPSA Regulations. Registration by serial numbers is optional for the above when the property is commercial property, but serial numbers should be stated if the serial numbered goods are an important part of the security. A buyer or lessee of personal property will take the personal property free of a security interest in the property if - s44: (a) (b) the regulations provide that personal property of that kind may, or must, be described by serial number in a registration; and when searching the register, immediately before the time of the sale or lease, and using only the serial number of the property to search, the search result does not disclose a registration that perfected the security interest. Exceptions The above will not apply if: (a) (i) (ii) (b) the buyer or lessee holds the personal property: as inventory; or on behalf of a person who would hold the collateral as inventory; or as prescribed by regulations (none prescribed when this commentary prepared) Leases, hire purchase, and retention of title An interest in a lease of goods is a security interest if it secures payment or performance of an obligation - s12(2), and such a security interest may be registered on the PPSR. Owners of goods can record a security interest. This is a novel concept because before PPS lessors, hirers, and vendors of people selling with retention of title (ROTs) did not record their interest anywhere because their rights as legal owner prevailed in almost all circumstances. PPS changes that regime and lessors, hirers, and vendors of ROTs may register their security interest. Although strange, the legal owner claims it has a security interest in the goods even though it is the owner! Priority for future advances Section 58 PPSA gives priority on perfection (usually registration) in respect of all future advances. This rule can be varied by agreement between security holders. This means that the rule in Hopkinson v Rolt will not apply to PPS securities, but will continue to apply for non-pps securities. This rule states that a first mortgagee will not have priority for advances made after the first mortgagee receives notice of a second mortgage. The Personal Property Securities (Corporations and Other Amendments) Act 2010 repeals the whole of Chapter 2K of the Corporations Act. This includes s282 which covers maximum prospective liability, and so PPS securities will not provide for a maximum prospective liability.

10 Fixed and floating charges On migration to the PPS register, all fixed and floating charges will be noted on the PPS register as all present and after acquired property. This is despite the fact that some fixed and floating charges may not be over all property (ie there will be no examination of the specific terms of charges as part of the migration process). Accordingly, the PPS register will be misleading regarding the extent of property affected by fixed and floating charges which do not extend to all property (unless the security interest holder updates the register after migration). There is an exemption to the requirement to keep the PPS Register up to date during the first two year period for transitional security interests. The register must be up to date for transitional interests by the end of the two year transition period or the holder of the security interest risks loosing priority and will be subject to penalties for not keeping the PPS Register up to date. Security over shares Mortgagees will not have physical control over paperless securities and CHESS shares. Section 27 provides that a secured party has control of investment securities if the secured party: is the registered owner; or has possession of script and the right to deal with the securities; or has an agreement with the issuer to control and deal; or has an agreement with the controller of the instrument (possibly the sponsoring broker) to deal with securities as directed by the secured party. Licenses Section 12(5) provides that a security interest does not include licences. However, the definition in s10 of personal property includes a licence, so licences can be subject to a security interest. The result of this apparent conflict is that the grant of a licence does not give rise to security interest, but a charge over a licence does. This is not limited to statutory licenses. Proceeds of sale The PPSA provides that you can charge 'proceeds' from the sale of charged property. Section 31 of the PPSA defines 'proceeds' and requires the proceeds to be identifiable or traceable. Proceeds extends to include produce of livestock and harvest of crops. Cash receipts are capable of being proceeds, however there are very limited circumstances where the cash will be identifiable. Further, under s48 a holder of currency takes the currency free of a security interest if it is acquired with no knowledge (actual or constructive) of the security interest. If 'dealing in' (eg by sale) a collateral gives rise to proceeds, the security interest continues in the collateral and attaches to the proceeds as well, except if the secured party expressly or impliedly authorised the dealing in which case the secured party s security interest in the collateral is extinguished. A security interest over proceeds can be included in the original registration in respect of the original charge or added later.

11 4. Default Setting aside security interests Security interests granted by companies will be extinguished (ie cancelled in full) on the appointment of a liquidator, administrator or entering a deed of company arrangement (critical event) if the security interest is: unregistered s267 PPSA; or not registered within 20 business days from the date the security interest is created and the critical event occurs within six months after creation of the security interest s 588FL Corporations Act unless perfected in some other way (ie possession or control). Security interests granted by natural persons must be registered before the date of bankruptcy failing which it is extinguished upon appointment of the bankruptcy trustee unless perfected in some other way (ie possession or control). s267 PPSA. So, unregistered security interests are valid but will be extinguished if any of these events occur. Security interests by companies and individuals can also be set aside as preferences s588fa Corporations Act and s122 Bankruptcy Act. PPSA default procedures and provisions The PPSA sets out procedures for notices and enforcement on default. These provisions are compulsory subject to a number of exceptions: a number of provisions can be varied in respect of collateral which is not used predominantly for personal, domestic, or household purposes s115 (see discussion below) some provisions don t apply to collateral which is used predominantly for personal, domestic, or household purposes s109(5) (see discussion below) the provisions don t apply to receivers, receivers and managers, or controllers of companies which are grantors s116 the provisions don t apply to deemed security interests under s12(3) s109(1) Procedures for default The secured party (SP) may seize collateral if grantor is in default s123 If the collateral is intangible property the SP must give notice to the grantor (and if the collateral is a licence, to the licensor) s123 If the SP has perfected a security interest by possession or control, the party may seize the collateral by giving a notice to the grantor (ie convert the way you hold the collateral from being a passive mortgagee, to a mortgagee in possession) s124 If the SP seizes collateral the SP must dispose of or retain the collateral s125 Before taking any action, the SP can for a reasonable period secure, store, value, and determine how to deal with the collateral. SP may further delay taking any action if it is reasonable in the circumstances or if the security agreement allows for it s 125 [Security Agreements should allow delayed action] The SP can only dispose of the collateral by private or public sale and must give 10 business days prior notice of disposal of the collateral to the grantor and any other higher-ranking secured party ss128 and 130 Consumer property cannot be leased, unless the SP first buys the property. [Comment: It seems strange that the owner of consumer property that has been leased, cannot re-lease it after regaining possession.

12 Perhaps s128 does not apply when the secured party is owner of the goods]. However, commercial property can be leased as part of enforcement rights if the security agreement allows this. The SP does not have to give the 10 business days notice if the SP believes on reasonable grounds that: (a) (b) (c) (d) they were induced to enter into the security agreement by fraud on the part of the debtor or grantor; or the collateral might perish within 10 business days of the collateral being seized; or there will be a material decline in the value of the collateral if it is not disposed immediately; or the expense of preserving the collateral is disproportionately large in relation to its value s130(5). If the collateral has been disposed of, the SP must provide a statement of account within 20 business days of receiving a request from another SP or the grantor- s132 The SP must give a statement of account if no disposal after six months, and further statements every six months, but only on request from the grantor or other security - s132. For more information contact Jon Denovan, Partner jdenovan@nsw.gadens.com.au