Understanding priority and extinguishment

Where two or more persons have a security interest in the same personal property, there are priority rules to decide whose interest in the personal property will prevail. The priority rules require a secured party to take specific steps to protect its interest in the personal property.

There are also circumstances in which a secured party's interest in personal property may be 'extinguished' if the personal property is transferred or leased to a third party. These are sometimes called the 'taking free' rules.

Determining priority

The priority rules rely on a tiered system based on the concepts of attachment, enforceability against third parties and perfection. For the purposes of understanding the practical examples relevant to the construction industry in Chapter 25.2, it is sufficient to understand that generally:

  • 'attachment' occurs when a security interest in personal property becomes enforceable between the parties (once a security interest has attached to personal property, the property is called 'collateral'). There are provisions in the PPSA describing attachment but attachment will usually have occurred where some value has been exchanged, for example where moneys have been advanced, obligations have been incurred or possession of goods has been passed;
  • a security interest will become enforceable against third parties where there is a written security agreement (or the secured party takes possession or 'control' of the personal property); and
  • 'perfection' occurs when the secured party registers its interest in the personal property on the PPSR (or takes possession or 'control' of the personal property). The concept of 'control' is limited to certain classes of financial instrument.

In practice the most common form of perfection in a construction context will be registration of a financing statement.

'Purchase Money Security Interest' or 'PMSI'

A PMSI is a special category of security interest which may, subject to strict registration requirements, have 'super priority' over other types of security interest. The registration requirements include:

  • the financing statement must expressly identify the security interest as a PMSI at the time of registration; and
  • the PMSI must be registered on the PPSR within the following timeframes:
  • where the personal property is inventory, before delivery of the inventory (in most cases); and
  • where the personal property is not inventory, within 15 business days after delivery (in most cases).

The main types of PMSIs encountered in the construction industry include PPS Leases (such as certain hire-purchase agreements) and the sale of goods on a retention of title basis. For further details regarding what is a PMSI, see section 14 of the PPSA.

Priority rules

The general priority rules are:

  • a perfected PMSI has priority over other perfected security interests;
  • a perfected security interest has priority over an unperfected security interest;
  • amongst the same types of security interest (ie competing perfected interests or competing unperfected interests) the security interest that respectively is perfected or attaches earlier in time has priority (subject to some exceptions for possession or 'control').

Registration on the PPSR

Registration on the PPSR is often a very important step to protect a security interest. Registering a financing statement in relation to a security interest will give priority over 'unperfected' interests, decrease the likelihood that the interest may be extinguished and prevent the interest from being lost if the grantor becomes insolvent.

However, not just anyone can register a financing statement. There are penalties for registering a financing statement where the person registering the interest does not believe on reasonable grounds that it is or will become a secured party in relation to the personal property. Sometimes multiple security interests may be created under a single document. It is possible to effect more than one registration based on a single document.

What is required to register a security interest?

To register an interest in personal property requires details of the secured party, the other party giving the interest (grantor) if applicable, the relevant personal property (collateral) and a method of payment as there are fees for registration.

There are additional registration requirements for different types of security interests. For example:

  • a security interest that is a PMSI must be identified as such at the time of registration (or else it will not have 'super priority');
  • some personal property may or must be described by serial number (for example motor vehicles).

The main categories of commercial property that must be registered by a serial number relate to aircraft.

When registering a security interest, it is important to be specific and to provide as much detail as possible, particularly for equipment that is valuable or has a long lead time to replace. Even if a security interest is registered, it may be lost if it is incorrectly or insufficiently described. For example, in Carson, in the matter of Hastie Group Ltd (No 3) [2012] FCA 719, many secured creditors lost security interests when a company went into administration and the administrators were unable to identify the particular items of plant and equipment to which each PPSR registration related.

Timing requirements for registration

Timing of registration is also important to appropriately protect a security interest. While financing statements for security interests can be registered at any time, failing to register promptly can result in loss of priority or loss of the interest altogether. In addition, a security interest in the personal property of a company that becomes insolvent may not be enforceable against an external administrator unless a financing statement was registered within 20 business days after entry into the relevant security agreement or at least 6 months before the insolvency event. This is a result of PPS provisions that were included in the Corporations Act 2001 (Cth) in conjunction with the PPSA. There are also special timing requirements for registering PMSIs.

Extinguishment ('taking free')

A security interest in personal property will not prevent a person from transferring or leasing personal property to a third party (even where there is a specific prohibition in a security agreement).

In some cases, the security interest will survive the transfer or lease. In such cases, the secured party may take steps to enforce its security interest (for more details, refer to the next section, Enforcement of security interests).

In other cases, the security interest will be 'extinguished' allowing the buyer or lessee to take an interest in personal property free of a pre-existing security interest. This occurs mainly to protect buyers or transferees of personal property in certain circumstances. One of those rules allows a buyer or lessee to take their interest in personal property free of any unperfected security interest. In some cases where the buyer is able to take goods free from a security interest the security interest may attach to the proceeds arising from the sale. The secured party should ensure that its financing statement indicates that the security interest extends to the proceeds.

Perhaps the most important rule is that a buyer who purchases personal property from a seller in the ordinary course of business (of selling or leasing goods of that kind) takes their interest free from any security interests granted by the seller. However, there are exceptions to this general rule – a buyer or lessee would not take their interest free of the security interest if:

  • they will hold the property as inventory and the personal property comprises serial numbered goods (like motor vehicles); or
  • the buyer or lessee has actual knowledge that the sale or lease constitutes a breach of the security agreement that relates to the security interest.

There are a number of other provisions allowing persons to 'take free' including some rules relating to serial numbered goods and, in particular, motor vehicles.

For further details regarding the extinguishment rules, refer to Part 2.5 of the PPSA.

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