Hirers and lessors beware Keep up or risk your goods and securities slipping through your hands By Karl Hill* Karl Hill While your contracts may be watertight in today s legal environment, unless you make changes before the Personal Property Securities Act 2009 (Cth) (PPSA) takes effect, hire and lease agreements are likely to spring leaks that could cost you dearly. Hirers and lessors need to be proactive about understanding the effect of the PPSA on their current methods of protecting their interests in the goods they lease and hire. Smart companies are preparing now to ensure that their actions keep them at the front of the creditors line in the event of default. What is the PPSA? The PPSA forms a national regime for security interests over personal property and creates a Personal Property Securities Register (PPS Register). Substantive changes will be made to current laws governing personal property securities, which will impact upon equipment lessors. What is deemed as Personal Property? Personal property includes tangible property such as inventory, plant, machinery and equipment, motor vehicles, boats, and household goods. Personal property does not include real property (land), fixtures or water rights. What type of leases and hiring agreements will the PPSA cover? There are two main categories of leases that capture the attention of the PPSA: 1. A lease or hire agreement of goods for a term of a year or more, or an indefinite term; or 2. A lease or hire agreement relating to goods that must be described by serial number (e.g. motor vehicles, aircrafts, watercrafts) for a term of 90 days or more. 1 These are classed as PPS leases. The interest of a lessor under a PPS lease is also a security interest. 2 A lease or hire agreement for any length of time that secures payment or performance of an obligation, even if it is not a PPS lease, may still be a security interest under the PPSA. 3 A PPS lease does not include: 1. Leases by a lessor who does not engage in the business of leasing goods on a regular basis; or 2. A consumer property lease which is part of a lease of land where the goods will be used for the use and enjoyment of the land. Company A purchases a television from D for the purpose of leasing the television to B Company. The companies have an agreement that is signed by both parties in the form of a written contract, called a Rental Contract for a term of 54 months. Both parties signed the contract on 11 July 2011. The television will be delivered to B by D on 18 July 2011. This event will give rise to the commencement of the agreement. Even though the agreement is called a Rental Contract, the definition of a lease will be satisfied and the substance of the transaction will render it a lease under the PPSA. Likewise, if, upon satisfying all obligations under the May 2011 CREDIT MANAGEMENT IN AUSTRALIA 3
Rental Contract, B decides to purchase the television and acquires title to it, the agreement may be a hire purchase agreement. Current methods used by lessors to protect their interests in the goods leased or hired include retaining title or ownership of goods. This will no longer provide adequate protection under the PPSA, as title or ownership of goods will rank behind attachment and perfection of the security interest to the goods, and registration of a lessor s security interest in the goods on the PPS Register. 4 This is because a security interest under the PPSA includes any interest in relation to goods provided for by a transaction that in essence secures payment or performance of an obligation, regardless of title or ownership to the goods. Effect of PPSA on Lessors and Hirers Where a hire agreement is a security interest, the hirer will be unable to continue to rely solely on title to or ownership of the goods when claiming their rights against third parties. This includes other secured parties that do not have a title based interest or an insolvency practitioner such as an administrator, liquidator or trustee in bankruptcy appointed to control assets of the lease. The PPSA will govern the lessor s interests in the goods, and they may lose their right to enforce the agreement if they do not perfect their interest by registration on the PPS Register, regardless of their ownership of the goods. 5 This means that if the lessee becomes insolvent or bankrupt, the lessor will not be protected. Getting ahead of the game. How do I avoid losing my interest in the goods I lease and hire? Take hold of your security interest Attachment Attachment of a security interest will increase the protection of a lessors enforceability rights against third parties. In regards to leasing, security interests are attached to goods when: z The rights of the goods vest in the lessee; and z Value is given for the lease or the lessee does an act by which the lease arises. 6 Where a lease is a PPS lease, the lessee obtains the rights in the goods that are leased to the lessee when they take possession of the goods. Thus, attachment takes place upon delivery of the goods. 7 The rental contract between A and B is a PPS lease. The Rental Contract has been signed by both parties and is in writing. Attachment of the security interest will occur upon the delivery of the television to B on 18 July 2011. Perfection of security interests Perfection of a security interest created under a lease or hire purchase agreement will occur and be enforceable against third parties in respect of the goods leased when: z The security interest has attached to the goods; z The lease or hire purchase agreement is in writing, signed or adopted by the lessee (may be electronic) and includes a description of the goods; 8 and z The lessor has registered their interest in the goods on the PPS Register. Registration or attachment may occur in any order. 9 These three elements must be satisfied in order for the interest in the lease or hire purchase agreement to be perfected. If a lessor registers their interest on the PPS Register prior to attachment, the time the lessor registered their interest will be the relevant time for determining priority of the lessor s interest, not the time of attachment. 10 The rental contract between A and B is a PPS lease. The Rental Contract has been signed by both parties and is in writing. Attachment of the security interest will occur upon the delivery of the television to B on 18 July 2011. A must register its interest on the PPS Register to protect its title and rights of ownership to the television. There are two main exceptions to the transaction being enforceable against third parties: 1. Where more than one party claims to have an interest in the same goods, the PPSA outlines certain priority rules; or 2. Where one or more of the extinguishment rules apply. These rules provide that a transferee of goods may take the goods free from the lessor s title or ownership of them. Keeping yourself at the front of the line. Priority Rules Purchase Money Security Interests (PMSI) PMSI s give rise to a position of super priority in that it will have priority over another security interest in the same goods that has been perfected. A lease is a PMSI if the lessor has acquired the security interest under a PPS lease. 11 A PMSI provides an exception to priority being based on time of registration of a security interest on the PPS Register. A PMSI has super priority as it will have priority over other perfected security interests in the same goods granted by the lease, provided it is perfected by registration stating it is a PMSI. To ensure super priority, the PMSI must be registered within 15 business days of the lessee taking possession of the goods, or where the goods will be used as inventory, before the lessee takes possession of the goods. 12 Provided the interest is perfected within this time frame, a lessor will have priority over Where a hire agreement is a security interest, the hirer will be unable to continue to rely solely on title to or ownership of the goods when claiming their rights against third parties. 4 CREDIT MANAGEMENT IN AUSTRALIA May 2011
The PPSA provides general rules in regards to a party to a security agreement enforcing a security interest in personal property. other parties claiming a PMSI in the same goods who is not the seller, lessor or consignor. As the lease between A and B is a PPS lease, it has a super priority status of a Purchase Money Security interest. To preserve this status, A s interest must be registered on the PPS Register within 15 business days of 18 July 2011, the date of receipt of delivery of the television. Enforcing your rights The PPSA provides general rules in regards to a party to a security agreement enforcing a security interest in personal property. It will not apply to PPS leases that do not secure payment or performance of an obligation. 13 Generally, parties are free to negotiate their rights and remedies with respect to default under a lease, and will not be affected by enforcement provisions unless certain specific provisions apply that are unable to be contracted out of. 14 Where the lease or a hire purchase agreement secures payment or performance of an obligation, and the goods are not used predominantly for personal, domestic or household purposes, a lessor may contract out of many of the enforcement provisions of the PPSA. 15 A has completed all requirements for perfecting its security interest. It has registered its interest on the PPS Register within the timeframe required. The Rental Contract between A and B does not include any clauses that contract out of the enforcement provisions of the PPSA. B falls into financial difficulties and defaults under the lease. A is entitled to enforce the lease and seize the television. However, they must comply with the PPSA requirements dealing with how A is to dispose of or retain the television. The enforcement provisions will continue to apply to the extent that they give rise to, or impose obligations on persons who are not parties to the lease or purchase hire agreement. Lessors should consider which enforcement provision to contract out of when preparing a lease, and be aware of when they will be required to perform certain actions in favour of the lessee and/or third parties. A lessor may seize goods by any method permitted by law by taking possession of the goods. 16 The PPSA incorporates special rules for disposing of, or retaining, goods, including where the leased goods have been attached to other personal property. Can a lessee take goods free of a lessor s title or ownership? (Extinguishment Provisions) What if my interest is unperfected? A lease or hire purchase agreement is generally effective according to its May 2011 CREDIT MANAGEMENT IN AUSTRALIA 5
terms. 17 However, the PPSA contains extinguishment provisions whereby a person whose goods have been transferred may take the goods free of the title or ownership of the lessor. The main implications on lessors are likely to arise where the lessee has sold or leased the goods to a third party. Extinguishment rules in the PPSA apply where the lessee or buyer of goods may take the goods free from the ownership of the lessor if the interest in the goods is unperfected. 18 This means that lessors need to register their interest on the Register to avoid this extinguishment rule applying. Goods described by serial number If the goods may or are required to be described by serial number, and the lessor s interest is not disclosed to the buyer or lessee should they do a search directly before the sale or lease by the reference to the serial number only, the lessee or buyer would take the goods free from the lessor s interest. 19 However, where the lessee or buyer purchases the goods for inventory, this rule will not be applicable. Therefore, lessors should consider whether to register their interest with reference to the specific serial number of the goods or a general registration against the lessor. Motor vehicles Motor vehicles may be taken free of the interest of a lessor by a lessee or buyer if a time period exists between the start of the previous day and the time of the sale or lease where a search of the Register by a serial number reference (usually the Vehicle Identification Number (VIN) does not disclose the lessor s perfected interest. 20 This rule also apples where the motor vehicle is purchased from a licenced dealer. 21 However, this rule will not apply where the lessee or buyer knew of the lessor s interest in the goods, or where the vehicles are purchased or leased for the purpose of being held as inventory. The timing of registration by the lessor is important, as the best protection will be provided if Registration takes place before the lessee takes possession of the vehicle. What if the lessee sells or leases goods in their ordinary course of business? An extinguishment rule applies where the lessee sells or leases the goods in the ordinary course of their business. In this case the lessee may take free of the interest of the lessor. 22 This rule will not apply where the lessee knows that the sale or lease was a breach of the lease between a lessor and a lessee, or where the lessee holds the goods as inventory. What if goods are purchased for personal, domestic or household use? Where the goods are intended to be used for personal, domestic or household purposes, and the value of the goods is less than $5,000, a buyer or lessee may take free of the lessor s interest. 23 However, if; z the goods are required to be described by serial number, or z if the lessee or buyer had knowledge of the breach of a lease between a lessor and lesee; or z if the lessee or buyer believed the market value of the goods is higher than the value of $5, 000, and in fact, it was, the rule does not apply. Where the goods under a lease are sold or leased by the lessee in circumstances giving rise to an extinguishment rule, the lessor s enforcement rights with respect to their interest as owner of the goods are limited to the rights acquired by the lessee from dealing with the goods. If goods are dealt with by sale by the lessee and any extinguishment rule is applicable, the lessor s rights remain in the purchase price of the goods as proceeds. If the lessee has dealt with the goods by way of lease and an extinguishment rule applies, the lessors rights remain in the rent that was payable to the lessee as proceeds. At the end of the lease created by the lessee, the headlessor s interests would re-attach to the goods. What if the lessee goes bankrupt or insolvent and I haven t perfected my interest? An unperfected security interest held by a lessor under a lease or hire purchase agreement vests in the lessee on insolvency. 24 Therefore, the lessor will lose their ability to enforce the lease or hire purchase agreement, including repossession of the goods, if their interest is unperfected. However, the lessor will be entitled to prove for compensation in relation to bankruptcy or winding-up proceedings of the lessee. The lessor will lose their rights in the leased goods and is relegated to the position of unsecured creditor, and thus the lessee (through the liquidator or administrator) is at liberty to deal with the goods. This means there is a real risk of the lessor losing title in the goods that they lease or hire if they choose to ignore the consequences of this vesting provision. Assume A forgot to register their security interest in the lease with B. B has defaulted under the lease. Prior to B defaulting, B signed a contract with the bank which included an all assets charge over B s property. Despite the fact that A, being the lessor, retains title in the television as the owner, under the PPSA, A s unregistered interest will be subordinate to the bank s security interest, which is registered. The bank chooses to enforce its security interest, and A loses its title and interests in the goods. Extinguishment rules in the PPSA apply where the lessee or buyer of goods may take the goods free from the ownership of the lessor if the interest in the goods is unperfected. 6 CREDIT MANAGEMENT IN AUSTRALIA May 2011
Preparation is the key Drafting and registration considerations for lessors. Lessors should consider the following matters when drafting a lease or hire purchase agreement, and registering an interest on the Register: z Whether the lessor is entitled to contract out of the enforcement provisions of the PPSA. If entitled to do so, the extent to which they will contract out of the provisions; z Lessors may have an obligation to provide a copy of the lease when requested by third parties. Therefore, lessors should consider whether confidentiality provisions should be incorporated into the lease; z If the security interest is a PMSI, this should be stated on the financing statement for the registration of the security interest. Lessors should also be aware of the time limits for registration of a PMSI to protect its status of super priority; z When the most appropriate time to register the security interest would be. Registration and attachment may occur in any order. 25 Where particular details such as serial number are not known by the lessor, the lessor may still register their interest and subsequently update registration with the serial number by registering a financial change statement; z Knowing the form, structure and substance of the transaction, including the lessee s intended use of the goods, will limit the detriment of extinguishment or priority rules; z Perfection of the lessor s interest of the goods by registration is paramount to protect their interest as owner of the goods. Overlooking or underestimating the PPSA changes now may leave you vulnerable tomorrow, potentially watching ownership of your goods slip through your hands. As a lessor or hirer, appropriate action should be taken as soon as possible to protect yourself. Adequate and timely preparation, registration of security interest on the PPS Register, attachment and perfection of security interest will increase protection of your enforcement rights under hire and lease agreements. Don t take chances. If your goods are worth protecting it is worth seeking specialist advice to avoid the risk of losing them. *Karl Hill is a Director at Results Legal Solutions. www.resultslegal.com.au FOOTNOTES: 1 PPSA s13 2 PPSA s 12(3)(c) 3 PPSA s 12(2)(e) and (i) 4 PPSA s 273 5 PPSA s 273 6 PPSA s 19(2) 7 PPSA s 19(5) 8 PPSA s 20 9 PPSA s 161 10 PPSA s 55(5) 11 PPSA s 14 12 PPSA s 62 13 PPSA s 109(1)(c) 14 PPSA ss 109, 110, 115 15 PPSA s 115 16 PPSA s 123 17 PPSA s 18 18 PPSA s 43 19 PPSA s 44 20 PPSA s 45(1) 21 PPSA s 45(3) 22 PPSA s 46 23 PPSA s 47 24 PPSA s 267 25 PPSA s 161 May 2011 CREDIT MANAGEMENT IN AUSTRALIA 7