The Legal and Constitutional Affairs Legislation Committee has recommended that the Personal Property Securities (Corporations and Other Amendments) Bill 2010 (Cth) (Bill) be passed without any amendment. This raises a significant number of issues for secured financiers.
As mentioned in our March 2010 update, the Bill was referred to the Senate Committee for inquiry.
The Senate Committee received 11 submissions (including from the Attorney General itself) in respect of the Bill. Although a number of issues raised in the submissions were of a technical nature, they are likely to have significant adverse practical consequences to secured financiers.
The purpose of this update is to highlight the main issues arising from the Bill, which will need to be considered by secured financiers involved in asset financing.
Practical issues
The Bill raises a number of potential concerns for financiers in relation to existing transactions.
Under the transitional provisions contained in the Personal Property Securities Act 2009 (PPSA), as amended by the Bill, existing 'security interests' will be deemed to be perfected for a period of up to 24 months after the registration commencement time under the PPSA. The actual period of deemed perfection may be reduced in certain circumstances.
One of the perceived benefits of the transitional rules was to enable financiers with existing security interests to rely on the laws in place prior to commencement of the PPSA for existing securities without having to register those securities on the PPS register.
As a result of the drafting of the Bill, this benefit may not actually be achieved.
The main sources of concern revolve around the following:
Section 52 of PPSA
Section 52 of the PPSA provides that a buyer or lessee of, amongst other things, goods for new value takes the goods free of a security interest that is temporarily perfected or a transitional security interest which is perfected as a result of the operation of the transitional provisions, if the security interest is not otherwise perfected at that time, unless the buyer or lessee has actual knowledge that the sale or lease constitute a breach of the security agreement.
The effect of this section is that unless an existing security interest (which would include a lease, bailment or hire purchase arrangement which, under current law, does not require registration), is registered in Senat e Committ ee recommends Bill to be pa ssed without amendment accordance with the PPSA (other than as a result of the transitional provisions), the secured party may lose the goods the subject of the arrangement in the circumstances referred to in the section.
Absence of required detail in existing registrations
For certain classes of goods, the PPSA requires that serial numbers be recorded in the financing statements under which the security interest is to be registered on the PPS Register.
In the case of many existing security interests, such as fixed and floating charges, it is not likely that serial numbers for these types of goods will be included.
Accordingly on migration of an existing security which would require inclusion of serial number details under the PPSA but which, under existing law, are not required, the deemed registration for the transitioned security interest may be regarded as defective and/or misleading. This would impact on the priority of the security and may take away from the perceived benefit of the transitional provisions.
Issues relating to Purchase Money Security Interests (PMSI's)
In order for a PMSI to obtain super priority under the PPSA (other than in relation to inventory), it must be perfected before the end of 15 business days after the day the grantor, or another person at the request of the grantor, obtains possession of the collateral. In addition, financing statements applicable to a PMSI needs to note that the security interest is a PMSI.
In respect of transitioned security interests which are PMSI's, either of these requirements may not be satisfied which may have the result that the super priority applicable to a PMSI will not apply to a transitional security interest which was granted in the context of financial accommodation used to acquire the collateral.
Given that the Senate Committee made no recommendations for changes to the Bill, the aforementioned issues must now be addressed by the finance community to determine the best ways of minimising risks. The PPSA does provide for a number of mechanisms by which financiers can minimise the above risks and we are currently considering these for a number of clients. To the extent that any issue was seen as worthy of review, it appears the Senate Committee has postponed any such review to be part of the review of the whole operation of the PPSA regime, which is to occur three years after commencement of the PPSA.
Unintended Tax Consequences
A further issue raised in our submission to the Senate Committee, and to which the Attorney General indicated it was unable to comment, relates to potential unintended tax consequences flowing from the operation of the priority rules, extinguishment rules and vesting rules applicable under PPSA and the amended Corporations Act.
Introduction
In circumstances where financing is provided by way of a lease or hire purchase arrangement, the lessor or financier retains title to the leased or hired asset. Under current law, the lessee or hirer does not obtain any title to the property and if the lessee or hirer become insolvent, the lessor would normally retake possession of the asset. Any security granted by the lessee or hirer to other financiers would not extend to the asset, as the asset is not the property of the lessee or hirer.
Under the PPSA, leases and hire purchase arrangements (and consignments) are generally treated as security interests. PPSA defines a security interest as any interest in relation to personal property provided for by a transaction that, in substance, secures payment or performance of an obligation (without regard to the form of the transaction or the identity of the person who has title to the property).
Under the PPSA system, in order for the holder of a security interest (which will include a lessor or finance company that hires equipment under a hire purchase arrangement) to have priority over other security interests and be able to enforce its security interest in insolvency, a security interest must be perfected. This would generally require that the security interest be registered on the PPS Register.
In the absence of a lessor or finance company perfecting its security interests, it will be possible for other security holders (that have a perfected security over all the assets of the lessee or the hirer) to take the asset, the subject of the lease or hiring arrangement, and sell it on enforcement of their security interest. In addition, should the lessee or hirer enter into administration or be wound up, the administrator or liquidator will be entitled to treat the assets, the subject of the lease or hiring arrangement, as if it was the property of the lessee or hirer and therefore deal with it free of the security interest held by the lessor/ finance company.
A PPS regime has existed in New Zealand since 2002. In the case of Waller v. Bloodstock, the Court held as follows:
Tax Concerns
Failure to register the interests of a lessor or finance company under a lease or hire purchase arrangement can result in the assets, the subject of that arrangement, being dealt with by the lessee or the hirer (or a chargeholder under a perfected security interest, administrator or liquidator of the lessee/hirer) resulting in appropriation of the asset. The PPSA is silent as to the tax consequence of such dealing.
It is therefore unclear whether there would be a notional disposal by the lessor/finance company when the asset is appropriated by the security holder and if so, at what value. If the asset is appropriated by a third party, how is this to be treated for tax purposes in the books of the lessor/ finance company or the books of the lessee/hirer?
Although the assets, which are the subject of these arrangements, will generally be depreciating, if the value of the asset is greater than the tax value to the lessor/finance company, there may be a taxable profit arising from such appropriation in circumstances where the lessor/finance company may actually have made an economic loss as a result of the appropriation.
Would a deduction be available for the economic loss suffered by the lessor/finance company?
These and other questions are not addressed in the PPSA.
The tax consequences of the above activity will depend upon the nature of the security interest. The tax laws treat the position of the owner on the one hand and the lessee/ hirer on the other differently depending upon whether the 'security interest' is a luxury car lease, a hire purchase arrangement or a lease of property (not being luxury car) where there is no 'right' to purchase.
The tax outcomes will depend on the precise terms and nature of the arrangements. The law is not entirely clear in many circumstances as it does not contemplate the asset being appropriated by a third party (as is the case in the circumstances mentioned above as a result of the operation of the PPSA).
Such appropriation may have adverse tax outcomes in some circumstances such as where bad debt deductions are not available to the lessor.
GST consequences
There are currently special rules in the GST law dealing with mortgagee sales and sales by insolvent entities. However, these rules do not contemplate the situation where the lessor or financier has not 'perfected' their security interest by registering on the PPSA Register and other security holders seize the asset and sell it to enforce their security interest.
Since the GST law does not specifically address this situation, it is not clear which party has the GST liability on the sale of the leased goods. The policy of the GST law in these circumstances is that the security holder selling the goods should have the GST liability. In contrast, the likely outcome under current rules is that the lessor or financer remains liable for GST on the sale, despite the fact that the lessor or financier does not receive the sale proceeds. It is likely that amendments to the GST law would be necessary to overcome this deficiency in the current GST rules.
A further GST issue that arises is whether the security interest holder can claim GST credits on sale expenses (such sale advertising costs, legal expenses etc). The position under the GST law is not clear (and conflicting private GST rulings appear to have been issued by the Australian Tax Office). Recent amendments to the GST insolvency rules have only created further uncertainty regarding this issue.
Conclusion
It is clear that the adverse consequences to a secured party of not perfecting the security interest created by a lease, hire arrangement, bailment or other retention of title arrangement under the PPSA may extend beyond the loss of the asset over which the secured party has title to potentially suffering adverse tax consequences.
We do not believe the potential adverse tax consequences arising from the PPSA have been considered. Given that the new personal properties securities regime is intended to operate as from May 2011, it would appear that there needs to be some focus now given to this aspect of the reform to ensure that any unintended tax consequences are overcome.
What happens now?
The Federal Government is clearly intending that the PPSA, including the amendments proposed by the Bill, will take effect from 1 May 2011. Despite numerous concerns being raised with the Senate Committee, these have not been addressed by any changes to the PPSA and accordingly the finance community will now have to consider the best way of minimising the risks arising from the legislation as drafted.
As there is less than one year left before the PPSA commences, financiers, suppliers and all other entities (including small business) need to understand the impact of PPSA on their business and make the changes necessary to ensure that they are PPSA compliant and to minimise the risks associated with the drafting of the PPSA in relation to existing securities.
PPS Implementation Timetable
To assist those impacted by the PPSA, the Federal Attorney General has released a PPS Reform Program Schedule of Activities. We recommend that you review the Schedule as it will assist you in preparing for the commencement of the new PPS regime.
We look forward to assisting you in this work. Please do not hesitate to contact any of our PPS Team to discuss how we can assist you in dealing with this challenging and significant change of law.
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This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances.
