Submission to the Review of the Personal Property Securities Act 2009: Consultation Paper No 2
Name: Professor Sheelagh McCrackenOrganisation: University of Sydney
Background/Expertise/Interest in PPSA Review: Academic teaching, researching and publishing in this field
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2.2 Rights in the collateral
Should bare possession constitute sufficient rights in collateral to support attachment of a security interest and, if so, on what basis?
Comment:
The following Comment is based on ongoing current research and draws on arguments explored in more detail in two academic articles.[1]
[1.1]Two initial issues of terminology arise in this context:
-the meaning of ‘collateral’. PPSA s 10 defines ‘collateral’ as the personal property to which the security interest is attached and ‘personal property’ as property other than land or certain stated rights, entitlements and authorities.
In stating that possession under the stated transactions amounts to ‘rights in goods’ for the purposes of s 19(2)(a) (‘rights in the collateral’) when the grantor obtains possession of the goods and that those rights are sufficient to enable the security interest to attach to the ‘collateral’, PPSA s 19(5) seemingly envisages the security interest attaching to more than simply the grantor’s possessory interest in the goods.
-the meaning of ‘possession’. Does ‘bare possession’ as used in the Consultation Paper refer to “legal possession” on the one hand, or simply to “physical possession” or “custody” on the other hand? The latter fall short of legal possession. PPSA appears to contemplate legal possession as a basis for attachment, given that that is the nature of the possession that arises under those transactions explicitly mentioned in ss 12(2) and (3) when the owner retains title and the grantor has possession.
[1.2] To the extent that the interest of legal possession that the grantor has under an ‘in substance’ security interest[2]or under a ‘deemed’ security interest[3] is acknowledged to be sufficient rights for the purposes of PPSA s 19(2) and for the resulting attachment of the security interest of the vendor, lessor or consignor to the secured goods, that interest should, it is submitted, equally be sufficient rights for the purpose of a third party’s security interest attaching to the same goods – eg the security interest of a bank holding a GSA over the property of the purchaser, lessee or consignee.To alter the attributes of the grantor’s possessory interest according to the identity of the secured party seems problematic at a conceptual level.
[1.2.1]Section 19(5) currently contemplates possession of goods as constituting sufficient rights in the goods for the purposes of s 19(2(a). It does not distinguish between the situation where the security interest is taken by the original vendor, lessor or consignor and the situation where it is taken by a third party, such as a bank with a general security agreement. Such a conclusion is supported by current case law in Australia.[4] It also finds support in New Zealand[5] and Canadian[6] authority.
[1.2.2]In purporting to limit possession capable of grounding a security interest to possession obtained under a transaction with a secured party who owns the collateral, the Consultation Paper aims to achieve a ‘more intuitive result’. It would appear, however, to represent a significant departure from the ‘priority-based approach’ generally evident in PPS style legislation.[7]
[1.2.3] The Consultation Paper refers to the granting of a security interest by ‘the person …. treated by the Act as if it were the owner of the collateral, by virtue of being the grantor of another security interest over it’. It is submitted that the introduction of a notion of deemed ownership is not supported by the language of s 19. The same outcome is more simply achieved through recognition that possession arising under a s 19(5) transaction is sufficient to enable the security interest of a third party to attach as well as that of the vendor or lessor.[8]
[1.3] If it is acknowledged that legal possession amounts to sufficient rights as a matter of construction of s 19(5),[9] nothing more appears required for the purposes of s 19(2)(a). It is important to stress that under s 19 attachment occurs on the fulfilment of the specified criteria. Although the term ‘grantor’ infers a notion of ‘grant’,[10]attachment as described by s 19(2) appears to be an automatic occurrence once the relevant criteria are satisfied.
[1.4]Canadian and New Zealand case law suggests, however, that the grantor should be deemed to be the owner and that the grantor should be regarded as having not only a possessory interest but also a statutory proprietary right.[11]The New South Wales Supreme Court adopted this position in Re Maiden Civil (P&E) Pty Ltd(Re Maiden Civil).[12] As a matter of statutory construction, however, the fact of the grantor’s possessory interest in the goods appears - by reason of operation of s 19(5) and hence by operation of law- to ground the security interest in the goods.
[1.4.1]It can thus be argued that the deeming of ownership is not a necessary step in applying s 19(5).[13] In Re Maiden Civil the approach was adopted on the basis that:[14]
The Commonwealth Parliament, in enacting legislation that was modelled on the New Zealand and Canadian legislation, should be taken to have intended the same approach, which was by then well-established in Canada and New Zealand, to apply.
The Court made, however, no reference in this context to differences in the legislative frameworks.
[1.4.2]Concerns expressed in Canadian case law[15] about how to resolve competing claims of an unperfected lessor and a grantor’s trustee in bankruptcy are addressed differently under the PPSA where the lessor’s interest vests in the grantor under s 267. A trustee in bankruptcy can in those circumstances succeed to the title to the property as the grantor clearly has title.
[1.5]Interestingly, a more general approach has been suggested recently by Professors Cuming, Walsh and Wood. In the second edition of their leading text, they observe:[16]
It is the view of the authors that to avoid thwarting that legislative intention, a deemed debtor by virtue of that status must also be deemed to have or retain sufficient rights in the collateral to support attachment of a competing security interest. It is unnecessary, in other words, to rely on a deemed debtor’s possessory rights, or to search for retained proprietary rights in the context of a sale of accounts…. to satisfy the requirement.
It is not clear that an Australian court would follow this approach. PPSA does not operate in isolation. The analysis of the grantor’s ‘rights in the collateral’ has implications for dealings under general law. It is submitted that it is important to be able to identify and explain the interests of the parties.
[1.6]The construction of s 19(5) gives rise to two further questions:
-can legal possession arising other than under a s 19(5) transaction be sufficient?
-can rights other than possessory rights be sufficient to enable a security interest to attach and if so, how is the term ‘collateral’ to be interpreted in this context?
Legal possession arising other than under a s 19(5) transaction
[1.7] Section 19(5) omits certain transactions which are clearly regarded by the PPSA as constituting security interests, such as a finance lease and hire purchase. The possession of the grantor who has legal possession under these transactions is contemplated as sufficient, despite the absence of mention in s 19(5). That possession should, it is submitted, be sufficient.
[1.7.1]The proposed amendment to s 19(5) would address this issue insofar as it specifically refers to those other in-substance transactions. However, there appears no basis from the current wording of s 19(5) to suggest that the provision should be limited to ‘security interests in favour of a secured party that owns the collateral’. As argued at [1.2] above, there is no reason to distinguish possession according to the identity of the secured party.
[1.7.2]While Canadian lawyers seemingly conceive of the equivalent to s 19(5) as dealing only with deemed security interests,[17] the inclusion of ‘conditional sale’ in s 19(5) differentiates the Australian provision and raises the question of whether s 19(5) may therefore have a different role to its Canadian equivalent.
[1.8]Legal possession may arise by other means eg by stealing goods[18] or by leasing or receiving goods under a bailment in circumstances where those latter transactions do not amount to a PPS lease and hence do not constitute security interests. It can be argued that that legal possession should be sufficient to ground a security interest, but that the interest of the secured party should be defeasible to that of the owner.[19] The owner’s interest is not characterised as a security interest, and hence the priority conflict between the owner and the secured party of the thief, lessee or bailee is not determined under PPSA, but by common law. Such an outcome would enable a grantor to use assets in its legal possession to facilitate the raising of finance (the use of assets said to be amongst the aims of PPS-style legislation)[20] without destroying the owner’s interest.[21]
[1.8.1]The success of such an argument would depend on recognising that s 19(5) plays a confirmatory or timing role and that as a matter of policy a possessory interest should be sufficient to ground a security interest. It would, it is submitted, be preferable to base that policy argument on the explicit statutory recognition in s 19(5) that possession can be sufficient and to argue by analogy on the basis that it facilitates the borrower in using assets to raise finance. It would also be possible to run a similar argument on the basis of concerns over ostensible ownership and the potential misleading of a third party, but recent research into the role of ostensible ownership conducted for the purposes of Consultation Paper 1 would suggest that that argument would be controversial. Ultimately, it is a matter of policy as to whether legal possession should generally be recognised as an interest capable of grounding a security interest.
[1.8.2]The Consultation Paper queries, as a matter of common sense, the outcome where an owner (whose own interest is not a security interest) has given a security interest over property that is, or subsequently becomes, leased. It is concerned by the possibility that a secured party of the grantor who had perfected first by registration would have priority over the owner’s secured party, also perfected by registration, under the default priority rules set-out in s 55.
If the transaction between the owner and the grantor were an in substance security interest or a deemed security interest, this is clearly a risk that the owner’s secured party runs. Default rules under s 55 determine the outcome, despite the fact that the grantor of each security interest is different.
If the transaction between the owner and the grantor is, however, not a security interest, the potential for conflict between the owner’s secured party and the grantor’s secured party depends on whether the grantor’s possession under a transaction that is not a s 19(5) transaction (and not any other form of in substance security interest) is sufficient to cause the security interest to attach to more than the possessory interest.
If it does so attach, the owner’s secured party takes on the risk that it may not have priority. Exposure to that risk may be rationalised on the basis of a legislative intention to enable a ranking of all security interests in the particular property. It is the risk a secured party runs by reason of the legislation giving priority between two security interests perfected by registration to the first to register. It is a consequence of the widening of the priority rules under s 55 to include interests given by different grantors.
[1.8.3] Discussion of the outcome should take into account the operation of PPSA s 112. This provision, peculiar to the PPSA, may in any event cut down the remedial action available to the grantor’s secured party. Its impact was however questioned in Re Maiden Civil.
[1.8.4] The Consultation Paper also asks why s 19(5) is needed if bare (in the sense of ‘legal’) possession is sufficient. As discussed in [2.1], it would appear that the Canadian equivalent is explained as having been introduced to clarify the position and is not regarded as strictly necessary.
Rights other than possessory rights
[1.9] PPSA is silent on what other rights are contemplated by s 19(2)(a). As a matter of principle, it can be argued, for example, that a person with an equitable interest would have ‘rights in the collateral’. The critical question is, however, to what it should attach – in other words, how in this context is the phrase ‘attaches to collateral’ to be understood?
[1.9.1]As a matter of policy, should a resulting security interest attach only to that equitable interest? The ambiguity in the term ‘collateral’ and the absence of an equivalent of s 19(5) make the issue particularly problematic and difficult to resolve without some guidance.
[1.9.2]As a matter of policy, one approach might be to recognise that legal possession (or at least legal possession arising under a s 19(5) transaction, as extended) grounds a security interest in the goods, but that interests other than legal ownership and legal possession ground only a security interest over those lesser interests. The ramifications of such an approach require, however, more detailed consideration.
Impact of loss of possession or other rights in the collateral?
[1.10] A further question,not directly raised in the Consultation Paper, is whether the grantor must retain those rights. In other words, is it sufficient for the grantor originally to have had rights but then to lose those rights other than on a dealing which gives rise to proceeds? (If there is such a dealing, s 32 becomes the governing provision.) What happens if there is a loss of the legal possession which has grounded the original attachment of the security interest?
Although s 19 refers to the security interest being enforceable against the grantor if the security interest ‘has attached’ to the collateral, ss 20 and 21 refer to the security interest being, respectively, enforceable against a third party and perfected if the security interest ‘is attached’.
[1.10.1]This issue arises directly in the situation where there is an outright legal transfer of an account, which is a deemed security interest under s 12(3).The provision appears to contemplate the transferor parting with its rights. It suggests that what is critical is the original legal ownership of the transferor.
Interestingly, debate in relation to the transfer of an account has to-date tended in Australia to focus on whether the transferor retains any rights or the power to transfer rights which enable a subsequent transfer to take priority as a perfected security interest in circumstances where the security interest arising by reason of the original transfer is unperfected. This discussion seemingly proceeds on the assumption that the first security interest continues to be attached despite the outright transfer.
[1.10.2It has been argued that the transferorcan be shown, as a matter of statutory construction,to have the power under the PPSA to transfer rights.[22] If that argument is accepted and the first limb of s 19(2)(a) thereby satisfiedwith respect to the creation of the subsequent security interest, then such may also be sufficient rights to enable the original security interest to continue to be attached.
[1.10.3]It is tentatively submitted, however, that it is not necessary to delve into such argumentation for the purpose of addressing the issue of attachment of the original deemed security interest. As a matter of statutory construction, in making attachment a pre-requisite to both enforceability against third parties and perfection, the reference in ss 20,21 to ‘is attached’ may be understood as meaning that the security interest should be enforceable as against the grantor as stated in s 19(1). Under s 19(1) that occurs when the security interest ‘has attached’. In using ‘is’ rather than ‘has’ with respect to ‘attached’ in ss 20 and 21, the drafter is arguably simply confirming that a particular event has occurred, namely that the grantor has had the rights or the relevant power.
Other arguments can be raised in support of such a construction. In the case of a mortgage or an assignment by way of security, the grantor’s rights in the collateral change from original ownershipto an equity of redemption. As a matter of contract law in Australia, it is possible for a grantor to agree to renounce its right to redeem, provided that the reliance on the contractual provision is not unconscientious.[23] Furthermore, the PPSA - unlike its counterparts in Canada and New Zealand - permits parties to contract out of the statutory right to redeem pre-default.[24] Both common law and the PPSA thus appear to envisage the possibility of a security interest over property in which the grantorno longer retains rights.
[1.10.4] The same question arises in relation to a transfer of shares under a securities lending arrangement which functions in the cash driven market as functionally equivalent to a secured loan. On the basis of the reasoning set out in [1.10.3], it is contended that the original ownership of those shares constitutes sufficient rights to enable the security interest to attach and the fact that ownership is transferred under the arrangement does not render the security interest unattached.
[1.10.5]This is a preliminary view based on current research. Further research is required to explore its ramifications.
2.2 Rights in the collateralProposed recommendation 2.1: That s19(5) be amended to clarify that it applies to all security interests in favour of a secured party that owns the collateral, where the security interest is founded on the grantor's possession of the collateral.
Do you agree with the proposed recommendation? / Yes/No In part.
Comment:
[2.1] The equivalent ofPPSA s 19(5) in Canadian legislation, which stems from Saskatchewan legislation, is typically said to have been introduced in order to resolve any doubt as to whether the interest of a grantor under deemed security interests might be sufficient to enable attachment to occur.[25] The provision would bring the deemed security interests in line with in substance security interests, such as conditional sales and finance leases. This reasoning was based in turn on the view that recognition of these latter transactions as security interests required the buyer or lessee necessarily to be regarded as the owner on the basis that ‘A secured transaction is inherently a relationship in which the debtor owns the collateral and the secured party has only a charge on the debtor’s title’.[26]
[2.1.1] That reasoning assumes that ownership is required to enable a security interest to attach. That was clearly the case at common law in order for a grantor to grant a security interest. As noted at [1.3], PPSA s 19(2) does not however talk in terms of ‘granting’; but rather in terms of the security interest attaching.
[2.1.2] S 19(5), like its Saskatchewan counterpart,[27] simply states that possession is sufficient. It does not expressly confer ownership. That has come through judicial interpretation.[28] For the reasons noted at [1.4], it does not appear necessary under the Australian legislation.