In 2015, Bruce Whittaker QC provided his final report titled ‘Review of the Personal Property Securities Act 2009‘ (the Whittaker Review) in which 385 recommendations were put to the Attorney-General based on the drafting and operation of the Personal Property Securities Act 2009 (Cth) (PPSA). The Whittaker Review was the result of a broad industry-wide consultation process which began in 2014. Since the Whittaker Review was published, the federal government has spent time considering various provisions of the PPSA, but to date we have seen very little legislative change. On 16 October 2020 submissions closed for industry feedback on certain of the recommendations made in the Whittaker Review. The federal government has used their first round of industry consultation (since the release of the Whittaker Review) to focus on better understanding industry practice and the commercial realities involved when taking security over financial products for the payment or performance of obligations. In our view, it is curious that the Attorney-General’s department has chosen to start with such a narrow focus, particularly in circumstances where there are so many other well-known and well publicised issues (from both a practical and policy perspective) with the way that many provisions of the PPSA are currently drafted. The reason for this may be that many of the recommendations made under the Whittaker Review are straight-forward and do not require further consultation from the industry, in which case, we eagerly anticipate the PPSA reform to come.
The consultation paper recently released by the Attorney-General’s department (the Consultation Paper) requests feedback from experts in the banking and finance industry on three main topics under the PPSA. Those topics are broadly as follows:
- Whether the distinction made by the PPSA between “intermediated securities” and “investment instruments” is relevant and logical, or should the concepts be amalgamated.
- Whether the current definition of “negotiable instrument” under the PPSA should be more aligned with its common law meaning.
- Whether the steps required to perfect a security interest in financial products by control are appropriate.
Each of the topics above are related by the common theme of “perfection by control”. Where a security interest arises in an asset, the secured party must perfect its security interest in order to preserve its priority in time relative to other unperfected security interests. Perfecting a security interest allows the secured party’s interest as a secured creditor to be recognised in insolvency proceedings (with some exceptions), and enables the security interest to be enforceable against third parties (again, with some exceptions). If a secured party fails to perfect their security interest using one of the 3 methods provided for under the PPSA, the secured party risks having their security interest defeated in the insolvency of the grantor, and also risks losing their security interest to a third party who purchases the asset to which the security interests applies for value and without knowledge of the secured party’s interests.
Depending on the nature of the asset in which the security interest arises, a security interest can be perfected by possession, control or registration of a financing statement on the PPS Register. Perfecting a security interest by possession or by registration of a financing statement on the PPS Register are both relatively straight-forward. Only a security interest in tangible assets can be perfected by possession. If a secured party has possession of a tangible asset over which they assert a security interest, it can hardly be argued that a third party purchaser for value could not have known that the secured party may claim an interest in that asset. The public policy objective of the PPSA – i.e. to create a transparent notice board of security interests – is therefore met. Equally, where a financing statement has been validly registered on the PPS Register and clearly denotes an asset (tangible or intangible) of a grantor (or all assets of that grantor) as being subject to a security interest, there is little room for arguing that a third party purchaser for value was not aware of the relevant secured party’s prior interest (again, there are some exceptions to this rule, particularly where the relevant assets are serial numbered property).
By contrast, perfecting a security interest by “control” can be problematic both in practice, and in terms of aligning this method of perfection with the policy objective of creating a transparent notice board of security interests in personal property. The Consultation Paper notes that perfection by control ought to be considered “a functional equivalent of perfection by possession but in respect of intangible property”. Under section 21(2)(c) of the PPSA, a security interest in only the following types of collateral can be perfected by control:
- an ADI account;
- an intermediated security;
- an investment instrument;
- a negotiable instrument not evidenced by a certificate;
- a right evidenced by a letter of credit that states that the letter of credit must be presented on claiming payment or requiring the performance of an obligation; and
- satellites and other space objects.
Examples of how a secured party would perfect by control over the above collateral types include by agreement between the grantor, the secured party and the intermediary although, as discussed in more detail below, the requirements for such an agreement differ depending on the collateral type. From a policy perspective such “control” would also not be as obvious to a third party looking to take clear title in an asset in comparison to other methods of security perfection (being possession and registration).
And so the question remains, how is a third party to be aware of a security interest in any of the above assets when such security interest is perfected by control only? Although the Consultation Paper notes this difficulty, it does not request industry feedback on whether the ability to perfect by “control” should be removed from the PPSA. Instead, the questions posed by the Consultation Paper relate to problems with the way in which certain financial products are defined under the PPSA – e.g. whether the distinction between ASX listed shares held directly by a person (which would constitute an “investment instrument” for the purposes of the PPSA), or ASX listed shares held through a CHESS account in the name of the same person (which would constitute an “intermediated security” for the purposes of the PPSA) are relevant to the purposes of the PPSA – and how the analysis as to the correct categorisation of these financial products feeds into the ability to perfect by control. However, the Consultation Paper side steps a more pressing issue (in our view), which is to ask why a legislative regime for perfection by control is required in the first place, and how this mechanism is to be aligned with the policy objective of the PPSA to create a transparent and public notice board of security interests in personal property.
In our view, to rely on perfection of a security interest in an intangible financial product by control alone is risky and fraught with error. This is largely because of the problems with the way certain financial products are defined under the PPSA (e.g. the difference between an intermediated security and an investment instrument under the PPSA and the often transient nature of these products in practice), as highlighted by the Consultation Paper. Even once an analysis as to the nature of a financial product under the PPSA is bedded down (and assuming it doesn’t change), the mechanics for perfecting by control in respect of different financial products are inconsistent and at times convoluted under the PPSA. For this reason, we consider it would be extremely unlikely for a banking and finance lawyer to advise a secured party that perfection of their security interests by control alone is sufficient, without also backing up that perfection with the registration of a financing statement on the PPS Register.
As an example of some of the complexity and inconsistency, one of the ways in which perfection by control of an “intermediated security” can be achieved is with an agreement in writing between the grantor, the intermediary and the secured party, provided the agreement has the effect that the intermediary must comply with the instructions of the secured party in relation to the collateral, without also seeking the grantor’s consent, or may only comply with the grantor’s instructions in relation to the collateral if the secured party also approves (see PPSA s26(2)). By contrast, perfection by control of an “investment instrument” can be achieved by an agreement in force between the secured party and the grantor to the effect that the secured party can initiate or control sending instructions by which the investment instrument can be transferred or otherwise dealt with (even if the grantor retains the right to originate instructions to the issuer of the investment instrument).
In our view, the only circumstances in which perfection by control does not create issues from a policy perspective or with complex mechanics for achieving “control” under the PPSA, is the rule for perfecting a security interest by control in an ADI account. To this end, the PPSA simply states that only the ADI (i.e. the authorised deposit-taking institution with which the account is held) of a bank account can have perfection of a security interest in that account by control. However, in circumstances where a bank will also have a banker’s lien under common law, the argument that perfection by control needs to be retained in the PPSA becomes even less compelling. As a final note, removing the concept of perfection by control from the PPSA will have the added benefit of removing the confusion caused by having two different meanings of “control” under the PPSA generally – i.e. “control” for the purposes of perfection of a security interest under sections 25-29 of the PPSA, and “control” for the purposes of determining whether the asset to which the security interest has attached is a circulating asset under sections 341 and 341A of the PPSA.
We expect the outcome of the Consultation Paper to be known sometime in the near future. If you have any questions about this article, please reach out to Zina Edwards, Nicholas Edwards or Abigail Cowled.