Australia: Personal Property Securities Interests: Franchising update

Summary

The new law

The Personal Property Securities Act (PPSA) replaces the existing law on the how security is taken over assets (except for land and buildings). Franchisors have just over a year to prepare for the commencement of the new regime in May 2011 and will need to start preparing now to ensure that they are protected when the regime commences.

While the PPSA is intended to 'reduce red-tape for business', in the short term it means more work for franchisors, because they will need to take steps to protect their interest in their goods if the franchisor:

• provides goods on credit to a franchisee;
• leases goods to a franchisee;
• wishes to sell a franchise business to a franchisee on a deferred payment basis and protect its interest in capital equipment provided to the franchisee; or
• acquires goods from suppliers on a credit, lease or similar basis.

Why should you register a security interest?

Registration is simple and cost-effective. It gives the franchisor rights in the relevant goods (whether they be stock items or non-inventory items). Once that security interest is perfected, all subsequent security interests will rank behind, subject to limited and specific exceptions.

If a franchisor fails to comply with the PPSA or does not register a security interest in its goods (or fails to do so quickly enough), it could have significant adverse consequences for the franchisor.

What you need to do

If your franchise business is involved in the activities referred to above, you need to consider:

• how to ensure that your interest in goods that you provide on a credit or lease basis is enforceable;
• reviewing your security documentation and terms of trade to ensure that they will continue to be enforceable after the PPSA commences; and
• the implications of your security interests being made public on the new public electronic register.

Potential pitfalls for franchisors

Losing title to goods if a franchisee defaults

If a franchisor provides goods to a franchisee on a credit or lease basis but does not register its security interest in the goods there are a number of adverse consequences to the franchisor which may arise:

• if the franchisee's financier does register its security interest in the franchisee's assets, then if the franchisee defaults, the financier's security interest will take priority over the interest of the franchisor;
• if the franchisee becomes insolvent or enters into administration, title to assets leased by the franchisor to the franchisee will transfer to the franchisee; and
• if the franchisee were to deal with the leased assets or assets provided on credit, in certain circumstances the third party transferee of the assets may take them free of the franchisor's interest in the asset.

If the franchisor had registered its security interest (a simple step that we can assist with), the above adverse consequences could be avoided.

Selling a franchise business

Similar principles apply where a franchisor sells a franchise business to a franchisee and the franchisee is only required to pay the purchase price by instalments.

The franchisor will need to consider registering a security interest over the capital equipment and assets of a business in order to ensure that if the franchisee defaults in its payment obligations (or becomes insolvent or enters into administration), the franchisor will prevail over the franchisee's bank or its liquidator or administrator. While the usual commercial considerations will apply, the arrangements will need to comply with the PPSA.

The risks when acquiring goods

Franchisors will also need to be alert to security interests over goods that they wish to acquire from their suppliers. It would be prudent for franchisors to review their arrangements for acquiring goods in order to ensure that clear and unencumbered title to goods is actually acquired by the franchisor or its franchisees, as the case may be. It may also be prudent to check the register (a cost-effective step that we can assist with) to ascertain whether prior interests are registered in the goods to be acquired. What is a security interest and how is it registered and perfected? Under the PPSA, a security interest is any interest or right related to personal property that secures payment or performance of an obligation. Security interests include, for example: " supply of goods on credit to a franchisee on terms containing a retention of title or 'Romalpa' clause; and " leases of goods to a franchisee on terms that permit the franchisor to repossess the goods on default by the franchisee.

Under the PPSA, a security interest must attach to personal property to be enforceable and be perfected to have priority over other security interests and avoid the above consequences on insolvency and administration. Registration on the national PPS register will be the most common form of perfecting a PPS interest.

Securing priority and super-priority

Under the PPSA, where goods are provided on credit or a franchisor funds the franchisee's purchase of plant and equipment (or other goods), the security interest that the franchisor can take will generally be regarded as a purchase money security interest or a PMSI. The benefit of a PMSI is that it provides the franchisor with super priority, which means that the franchisor's interest will generally have a 'super-priority' and defeat other persons' interests.

In these circumstances, the franchisor's super priority will generally defeat a registered general security interests, such as a bank's charge over the assets of the franchisee's business.

The PPSA has specific requirements for attachment and perfection of PMSIs with which franchisors will need to comply. For example, for certain goods, such as non inventory goods (which will include plant and equipment in most cases), a franchisor must register a PMSI within 10 business days after the franchisee obtains possession of the goods in order to have super priority.

Our expertise

While the PPS reforms are new to Australia, similar reforms have been implemented in New Zealand, a number of Canadian provinces and in the United States. DLA Phillips Fox in New Zealand and DLA Piper in North America actively assisted a range of franchisors with Board and senior management briefings, training materials, redrafting documentation and advice on transitional and implementation arrangements. With this experience, we are uniquely well placed to assist franchisors in Australia prepare for the effect of the PPSA in a quick and cost effective manner.

DLA Phillips Fox is currently assisting Australian franchisor clients to manage the impact of the PPSA. Please contact one of our Franchise team members below if you would like more information.

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