By Lachlan Commins, Patterson Houen & Commins, Lawyers, Sydney.
As a lessor, you need to have at least some basic understanding of five key provisions of the PPSA and how they operate to affect your rights and obligations. If you haven’t read Part 1 of this article, you can get to it here. If you’re up to speed, please read on.
Section 12 – “Meaning of security interest”
This section sets the benchmark and is the keystone for the rest of the Act, because it determines among other things whether your particular lease makes you the holder of a ‘security interest’ under the Act. To this extent, the section is a ‘threshold’ provision. If your lease meets the section’s criteria, you are deemed the holder of a ‘security interest’ and your rights and obligations under the lease will be determined by the Act. If not the transaction will be outside the scope of the Act.
Categories of leases subject to the Act
Your lease will be covered by the Act if it falls into one (or both) of two categories, being:
- An in-substance lease (defined in Section 12); and / or
- A PPS lease (defined in Section 13).
Whether you are an “in-substance lessor” or a “PPS lessor” remember…
As a lessor, perhaps the most important concept to grasp is where you have an in-substance lease or a PPS lease, that for the purposes of the Act, you are the HOLDER OF A SECURITY INTEREST and nothing more. This concept is made plain in the first sub-section to s12 which defines a ‘security interest’ as:
…an interest in 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).
What this means is, as a lessor your security interest does not entitle you to any special priority on account of your ownership ‘title’ to the leased goods; you are just the holder of a ‘security interest’ over the leased goods as opposed to their legal owner (despite the terms which may be included in the lease). Under the PPSA all ‘security interests’ are created equal and entitle their holder to the same sets of rights and obligations.
The key to securing the priority of your security interest is to register it on the PPSR as soon as possible.
An in-substance lease is a lease in the form of a typical lease, but which has the effective purpose of ‘securing’ the lessee’s payment obligations to the lessor. To this extent, the lease resembles a hire-purchase agreement or a retention of title sale in which the owner or vendor (as the case may be) effectively retains it’s title in the goods (hired or sold) as a form of security against default in payments to be made by the hiree or the purchaser.
For example, if your lease is a standard commercial lease but includes an option or other incentives for the lessee to make an outright purchase of the leased goods at some stage during or at the expiration of the lease term, then it could be said that the purpose or effect of the lease, considering how it operates in substance as opposed to how it appears in form, is to secure the periodical payment by the lessee of the effective “purchase price” of the goods (plus interest) over time.
In the example above, your ‘security’ as lessor is your right under the lease to move in and repossess the leased goods if the lessee defaults. You are able to do this legally because under the terms of the lease, your title in the goods is preserved despite the goods being in the possession of the lessee, who is only entitled to have title in the goods transferred to it if the requisite payments are made and its option exercised.
Whether or not a lease is an in-substance lease for the purposes of the Act, can only be determined on a case-by-case basis and will be dependent on the terms of and the factual scenario surrounding each lease including the nature of the relationship between the parties.
Section 13 – “Meaning of PPS lease”
Under the current law a lease of personal property for:
- A term of more than one year; or
- An indefinite term (even if the lease can be determined by either party within a year); or
- A term of up to one year but automatically renewable at the end of the term with the result that the consecutive terms amount to more than one year; or
- A term of up to one year but the lessee with the permission of the lessor has retained possession of the leased goods for a period of more than one year;
then the lease is a PPS lease, and the lessor is deemed holder of a ‘security interest’ under the Act.
Importantly, a PPS lease is deemed to be a ‘security interest’ whether or not it in substance secures the payment or performance of an obligation by the lessee to the lessor. That is, unlike the in-substance lease discussed above, it is not the nature, purpose or effect of the lease that gives rise to the ‘security interest’ but the duration of the lease and ultimately the length of unbroken possession of the leased goods by the lessee.
This has had dire consequences for some unfortunate lessors but a change is in the air which will mean less pain for lessors.
As of March 2017 an amendment Bill is before Parliament which once passed into law will provide that:
- A PPS lease must be for a term of more than two years (as opposed to the current one year); and
- leases for an indefinite term (which are caught by the current definition) are excluded UNLESS they actually last for more than two years in which case the lease becomes a PPS lease only after the two year period has elapsed.
Don’t be too complacent though because the changes will only apply to leases entered after the amending Act comes into force; that is, leases entered before the enactment date will continue to be defined by the current rules for their duration.
Section 19 – “ Enforceability of security interests against grantors – attachment”
There is a tried and tested Latin phrase used affectionately in property law: nemo dat quod non habet. In other words, “no person can give what he or she does not possess”.
Let’s break this concept down: a lessee is entitled at law under the lease to have possession over the goods for the lease term (subject to the due performance of its obligations under the lease), but cannot purport to sell or assign those goods to another (without the prior consent of the lessor) as to do so would be to assign an interest in the goods which is greater than the interest held by the lessee.
But don’t get comfortable yet because s19 of the Act turns this concept on its head. Under the PPSA, a lessee in possession of leased goods pursuant to an in-substance lease or a PPS lease has sufficient rights in those goods (referred to as ‘collateral’) to grant a third party an enforceable security interest over those goods.
For example, a lessee under an in-substance or PPS lease may grant a bank a charge covering the leased goods to secure a loan (a charge being a recognised ‘security interest’ for the purposes of the Act). In that case, the lessor and the bank will have a concurrent PPSA ‘security interest’ over the same goods (the ‘collateral’) which compete on the same footing (subject only to the rules of ‘perfection’).
Assuming that the bank perfects their security interest in the collateral before you as the lessor, if the lessee defaults vis-à-vis the bank, the bank may then exercise its powers under the charge and appropriate (take possession, sell and realise the proceeds of) the leased goods. As the holder of a perfected ‘security interest’, the bank is entitled to do this DESPITE THE FACT that the lessor is the owner of the goods.
The upshot is that a lessee with mere rights of possession has been able to grant an interest to another party which, when enforced, results in that party being able to exercise full proprietary rights in the goods (the ‘collateral’) which, somewhat ironically, the lessee never could have exercised under the lease itself.
Remember: REGISTER YOUR INTEREST AS LESSOR ON THE PPSR IMMEDIATELY AFTER ENTERING A LEASE. YOUR OWNERSHIP OF THE GOODS IS NOT ENTOUGH TO PROTECT YOU VIS-A-VIS ANOTHER SECURITY INTEREST HOLDER WHO HAS REGISTERED ITS SECURITY INTEREST IN THE SAME GOODS BEFORE YOU!
Section 55 – “Default priority rules”
Section 55 of the Act sets out the default priority rules of competing security interests under the Act. Importantly, in any priority contest between two or more security interests granted over the same collateral:
- A perfected security interest has priority over an unperfected security interest;
- A perfected security interest has priority over another perfected security interest if it was the first in time to be perfected.
Essentially, a secured party can perfect its security interest by registering its security interest on the PPS Register through the registration of a compliant ‘financing statement’. To do this, the secured party will need to have a written and executed security agreement describing the collateral and the extent of the security interest granted over the collateral; in the case of a lease, this will be the written lease agreement itself.
Section 55 is subject to other specific priority rules contained elsewhere in the Act. For instance, a perfected security interest over collateral goods that secures repayment of the purchase price used to acquire those goods (referred to as a ‘purchase money security interest’ or a ‘PMSI’) generally takes priority over other perfected security interests over the same collateral which are not PMSI, regardless of when they were perfected.
Section 267 – “Vesting of unperfected security interests in the grantor upon the grantor’s winding up or bankruptcy etc”
Section 267 of the Act is entitled “Vesting of unperfected security interests in the grantor upon the grantor’s winding up or bankruptcy etc.”. As the title suggests, if a secured party fails to perfect its security interest before the grantor of the security interest becomes insolvent, the secured party will lose its security interest along with any claim it has to the goods themselves.
Accordingly, if a lessor fails to perfect its security interest in the leased goods (the collateral) and the lessee becomes insolvent, the lessor’s ownership interest in the goods will effectively be extinguished along with its security interest. The lessor’s interest is now said to have ‘vested’ in the lessee and be available to satisfy the claims of the lessee’s creditors.
In this context, the steps which must be performed by the secured party to perfect its security interest are the same as those described above with respect to priority.
A tale of three cases…
A trilogy of cases highlights the operation of the Act. They are:
- Maiden Civil (P&E) Pty Ltd (in liquidation) (receivers and managers appointed) v Queensland Excavation Services Pty Ltd;[i]
- White v Spiers Earthworks Pty Ltd; and[ii]
- Forge Group Power Pty Ltd (in liquidation) (receivers and managers appointed) v General Electric International Inc.[iii]
The following sequential events are common to the facts and outcome of each case:
- The lessor leased (or hired) equipment to a lessee pursuant to a lease agreement;
- By operation of the Act, the lessor took a security interest in the equipment pursuant either to an in-substance lease or a PPS lease;
- The lessor failed to perfect its security interest in the equipment by registering it in accordance with the Act;
- The lessor held at all times an unperfected security interest in the equipment;
- The lessee became insolvent;
- The lessor’s unperfected security interest in the equipment vested in the lessee;
- The lessor’s ownership title in the goods was effectively extinguished;
- The equipment was appropriated by receivers appointed to the lessee in satisfaction of claims by the appointing creditors.
What you should do to protect your interest in leased goods?
Do not delay. Perfect your security interest immediately after its creation by registering it on the PPS Register. Don’t make the make the same mistake that the lessors in the above cases.