Taking account of accounts: good things for the receivables finance industry in the government’s response to the PPSA review

Originally published in the Australian Banking and Finance Law Bulletin – Volume 39, Number 9 (November 2023) at pages 146 to 150.

Introduction

Eight years ago, Bruce Whittaker made 394 recommendations to the Federal Government to improve the operation of the PPSA (PPSA Review).^[1] These included a handful of recommendations in relation to section 64 of the Australian Personal Property Securities Act 2009 (Cth) (PPSA). It also included a recommendation in relation to section 81 of the PPSA. Last year, we bemoaned the failure of the Australian Federal Government to implement the recommendations of the PPSA Review.^[2]

At long last, we have the Government’s response to the PPSA Review. On 22 September 2023, the Government released an exposure draft of the Personal Property Securities Amendment (Framework Reform) Bill 2023 (Amendment Bill). The Government is seeking comments on the proposed reforms to ensure that the amendments are relevant, effective and suited to the current needs of the Australian commercial environment. Public consultation on the Amendment Bill closes on 17 November 2023.

The provisions in the Amendment Bill relating to sections 64 and 81 of the PPSA are positive for the receivables finance industry and are to be welcomed, given the importance of the industry to the Australian economy, including in the FinTech market.

Section 64 of the PPSA

What does the section do?

A supplier of goods on a retention of title basis has a PPSA security interest against the recipient of those goods.  The supplier would usually perfect its PPSA security interest by making a registration on the Personal Property Securities Register against the recipient.  The supplier’s registration would usually cover the goods supplied by it to the recipient. Further, by the operation of the PPSA and the registration processes under the PPSA, the supplier’s registration would almost invariably extend to the “proceeds” of those goods. “Proceeds” includes any receivable arising from the recipient’s on-sale of the goods to a third party.

Section 64 of the PPSA gives a receivables financier a mechanism to obtain priority over a supplier’s prior or later-registered purchase money security interest (PMSI) to the extent that the PMSI relates to the proceeds of goods that are “inventory”.^[3]  In other words, a receivables financier is given the ability to ensure that – as against a PMSI-holding supplier of goods to a recipient– the receivables financier obtains a priority security interest over the receivable arising from a recipient’s on-sale of those goods, if they are inventory.^[4]

If the requirements of section 64 are satisfied, there are two ways in which a receivables financier can obtain priority under section 64.  First, it will obtain priority over a supplier’s PMSI that is registered after the receivables financier has registered its security interest over the account that is the proceeds of the inventory supplied by the supplier.  This is a significant benefit to the receivables financier.  Absent section 64, so long as the supplier had properly registered its PMSI within the time limits specified in section 62 of the PPSA, the supplier’s PMSI would generally have priority over the receivables financier’s security interest over the account despite the fact that the security interest over the account was registered first.  Secondly, if it issues a valid notice under section 64, a receivables financier will obtain priority over a PMSI that was registered before the receivables financier has registered its security interest over the account that is the proceeds of the inventory supplied by the supplier.^[5]

Proposed changes to section 64

Priority over non-PMSIs

Section 64 presently does not allow the receivables financier to take priority over earlier security interests held by the same inventory supplier which are not PMSIs. Today, a supplier who holds a PMSI over inventory may avoid the effect of section 64 as follows.

• Rely on an earlier perfected security interest that is not a PMSI over the relevant inventory. A receivables financier would not have the benefit of section 64 to obtain priority over the supplier’s earlier-perfected security interest.
• Alternatively, rely on an earlier perfected express non-PMSI security interest over the proceeds of sale of the inventory as “original collateral”. This means that the supplier will take a security interest directly over the account arising from the sale of the inventory, without relying on the fact that the supplier’s security interest over the inventory will extend to the proceeds of that inventory. If the supplier makes a separate (and timely) registration against the recipient of that inventory in the “accounts” collateral class, a receivables financier would not have the benefit of section 64 to obtain priority over the supplier’s perfected security interest.

The Amendment Bill proposes to overcome this issue for receivables financiers. If enacted in its present form, it would amend section 64 to allow a receivables financier (accounts financier) to take priority over both PMSIs and non-PMSIs granted by the same grantor in inventory to another person (inventory financier). This is in line with Recommendation 244 of the PPSA Review.

How does an accounts financier’s interest in accounts take priority over an inventory financier’s security interest under the amended section 64?

An accounts financier’s interest will take priority over an inventory financier’s (PMSI or non-PMSI) security interest if either of the following conditions are met.

Amended subsection 64(1)(a): In the case of an inventory financier’s PMSI,^[6] both of the following conditions are met:

• the accounts financier’s interest is registered on the PPSA before the registration time of the inventory financier’s PMSI; and
• the accounts financier’s registration describes the collateral as an account,^[7] in accordance with the regulations for the purposes of describing collateral and proceeds.

Amended subsection 64(1)(b): In the case of an inventory financier’s security interest (whether it be a PMSI or a non-PMSI), both of the following conditions are met:

• the accounts financier gives notice in accordance with subsection 64(2) to the inventory financier; and
• the notice is given at least 15 business days before the day the accounts financier’s interest attaches to the account.

Commentary on amended subsection 64(1)(a)

The changes to this subsection are consistent with Recommendation 246 of the PPSA Review.

Presently, section 64 provides that an accounts financier will only defeat PMSIs by means of registration if the registration is made before the earlier of the registration time for the competing PMSI, or “the time at which [the competing] PMSI is perfected”. This poses some uncertainty as it is difficult for an accounts financier to know if a PMSI was perfected by means other than registration (e.g. perfection by possession). The removal of the reference to the time at which the PMSI is perfected makes it clear that an “accounts” registration will have priority over an inventory financier’s PMSI if the “accounts” registration is made before the inventory financier’s PMSI registration.

Section 64(1)(a) also makes it clear that an “accounts” registration should be made by the accounts financier to claim priority. This change is consistent with Recommendation 247 of the PPSA Review.

Commentary on amended subsection 64(1)(b)

The changes to this subsection are consistent with Recommendation 248 of the PPSA Review.

Presently, section 64 refers to notice being given by “the secured party holding the priority interest” at least 15 business days before the earlier of the day on which the registration time for the account registration occurs and the day the priority interest attaches to the account. This means that a security interest cannot be registered by the accounts financier until 15 business days elapses after it has issued section 64 notices to the relevant inventory financiers.

The drafting outlined above gives rise to what the PPSA Review described as the “rolling 15-business day problem”^[8]. That is, an inventory financier may register a fresh PMSI against a recipient of inventory during the 15-business period after an accounts financier has issued its section 64 notices but before the accounts financier has made its accounts registration against that recipient.  This requires accounts financiers to undertake PPSA searches at the end of the 15-business day period to identify whether any fresh PMSIs have been registered during that period. If fresh PMSI’s have been registered, the accounts financier has to issue a fresh section 64 notice to the new PMSI holder and wait a further 15 business days before making its accounts registration. This is a significant practical issue for accounts financiers.

The rolling 15 business day problem has been addressed in the amended subsection 64(1)(b). The amended provision would permit the accounts financier to make its accounts registration at the same time as it issues its section 64 notices, on the basis that its security interest will not “attach” until the expiration of 15 business days from when the notice is given. As a result, account financiers no longer need to make multiple PPSA registrations to address the rolling 15 business day problem.  Account financiers, will, however, need to pay careful attention to how their documentation addresses “attachment” given the increased relevance of that concept under the amended subsection 64(1)(b).

Under the proposed new regime, suppose that an accounts financier makes its accounts registration and issues its section 64 notices on day 1. If an inventory financier registers a new (PMSI or non-PMSI) security interest during the 15-business day period commencing on day 1 – i.e. after the accounts financier issued its section 64 notice and made its accounts registration – it appears to us that the priority of the inventory financier’s new security interest vis-à-vis that of the accounts financier will be assessed as follows.

• If the inventory financier’s security interest is a PMSI, the accounts financier’s accounts registration would have priority over that PMSI by the application of the new subsection 64(1)(a) discussed above.
• If the inventory financier’s security interest is a non-PMSI, the accounts financier’s accounts registration would usually have priority over that non-PMSI by the application of ordinary PPSA priority concepts.^[9]

On a separate drafting issue, as noted above, the present subsection 64(1)(b) indicates that the section 64 notice must be given by “the secured party holding the priority interest”.  This implies that the accounts financier must hold its interest before it gives the notice. But that is inconsistent with the requirement that the security interest not attach to the account until the notice period has expired.^[10] This issue has been rectified in the proposed subsection 64(1)(b) which now merely provides that the section 64 notice must be given by the accounts financier.

What should an accounts financier’s notices state?

The Amendment Bill adopts Recommendation 251 of the PPSA Report in providing clarity as to the notices given by the accounts financier. Notices given by the accounts financier should include statements to the effect that:

• the accounts financier may be acquiring a security interest in accounts that are proceeds of inventory in which the inventory financier may also hold a PMSI and other security interests; and
• section 64 provides that the accounts financier’s interest will have priority over the PMSI^[11] or non-PMSI^[12] granted by the same grantor to the inventory financier in relation to accounts which are the proceeds of inventory and to which the accounts financier’s interest attaches at least 15 business days after the day the notice is given.

If the Amendment Bill is passed in its present form, account financiers will need to review their pro forma section 64 notices and their section 64 processes more generally to ensure that they are consistent with the amended section 64.

Other amendments to section 64

The Amendment Bill proposes that subsection 64(3) be amended by replacing the words “is subordinate to” with “has a lower priority than”. This amendment is proposed for consistency with the terminology of the PPSA and with market terminology in this context – it is not intended to change the scope of section 64.^[13]

Section 81 of the PPSA

Section 81 of the PPSA facilitates the transfer of accounts in some instances even if the agreement giving rise to the accounts restricts or prohibits the transfer of those accounts. The PPSA Review noted that measures similar to section 81 are to be found in international conventions,^[14] as well as the personal property security legislation in Canada.^[15]  There is no comparable measure in New Zealand, either in its personal property securities legislation or other legislation.

A contract for the sale of goods or provision of services may include a prohibition on assignment. It was intended that section 81 of the PPSA would override the prohibition (except in the case of construction contracts and contracts for the provision of financial services), so that a receivables financier can obtain title to the account. Unfortunately, section 81 restricted the provision to a term which prohibits a transfer for “currency due or to become due”. The prohibition will rarely be in that form, given the definition of “currency” in section 10 of the PPSA.^[16]

The Amendment Bill proposes to amend section 81 by rephrasing and simplifying the current section 81 while retaining a similar meaning and applies where an account is the proceeds of inventory or arises from the granting of a right or providing a service in the ordinary course of a business.^[17] The amended section 81 no longer overrides restrictions or prohibitions on the transfer of accounts arising from rights granted under financial services contracts, but continues to override restrictions or prohibitions on the transfer of accounts arising from construction contracts.

The words “currency due or to become due” have been deleted, in line with Recommendation 272 of the PPSA Review.

Absolute assignments of accounts versus assignments by way of security

An issue concerning accounts which was not addressed in the PPSA Review and is therefore not addressed in the Amendment Bill is the proper interpretation of subsection 340(4A) of the PPSA. Where subsection 340(4A) applies, the usual PPSA rules about treating an account that is the proceeds of inventory as a “circulating asset” (unless the secured party has control over the asset) will not apply.

Subsection 340(4A) applies “if a grantor grants a security interest provided for by a transfer of an account”.  In other words, if a grantor grants such a security interest it will be a security interest in relation to a non-circulating asset and not a circulating asset.  This will in turn mean that the security interest will not be a “circulating security interest” for the purposes of 51C of the Corporations Act, which will have important consequences for the priority of the security interest vis-à-vis employee entitlements and other entitlements in the insolvency of the grantor.

It is unclear whether the “transfer” of an account referenced in subsection 340(4A) is limited to an absolute transfer of an account by way of sale or, additionally, extends to a transfer of an account by way of security also.

Accounts financiers take absolute transfers of accounts by way of purchase. However, they may also take transfers of accounts by way of security (like other financiers) in some circumstances.  The widely used PPSA Model Clauses for General Security Agreements proposed by 5 major law firms in 2013 provide an option for a secured party’s security over accounts to be effected as a transfer by way of security.^[18] The note accompanying that model clause explains that: ^[19]

“The secured party may prefer a transfer by way of security (or mortgage) in respect of Collateral that consists of accounts [because] the PPSA provides that a security interest provided for by a transfer of an account … is not a circulating asset: s340(4A).  [The option to characterise the security interest over accounts as a transfer by way of security] is intended to enable the secured party to argue that it has a non-circulating security interest in contractual rights that constitute accounts… under s340(4A) (such as debts) even if the secured party has not taken steps under Part 9.5 of the PPSA to control any relevant contractual rights (for example, by requiring all amounts received in payment of debts to be paid into a collection account and requiring the secured party to be a signatory to any withdrawals) and has not registered that it has taken control.  It is unclear whether such an argument will succeed and if the secured party wants to be certain that it has a non-circulating security interest over the contractual rights such as debts, the secured party should take control and register that it has control.” 

It has been 10 years since the PPSA Model Clauses were first released. We believe that, over time, it has become clearer that the “transfer” referenced in section 340(4A) of the PPSA is an absolute or outright transfer of the kind obtained by accounts financiers (or similar) where there is an actual purchase of accounts by the accounts financier  (or similar). That is, the “transfer” referenced there does not cover the case where the transferor of the account has an equity of redemption. Hamersley Iron Pty Ltd v Forge Group Power Pty Ltd (in liq) (Receivers and Managers Appointed)^[20] appears to confirm that “transfer” in section 340(4A) means an outright transfer (i.e. a transfer that is not by way of security), and not a transfer by way of security.^[21] In the Court’s detailed and closely reasoned judgment, there are numerous other references to “outright” transfers in contradistinction to “transfers by way of security”, that is, transfers provided for in a transaction that, in substance, secured payment or performance of an obligation.^[22] 

The Amendment Bill essentially replicates subsection 340(4A) of the PPSA in a new subsection 51CA(5) of the Corporations Act.^[23]  For the sake of certainty, we suggest that the subsection should be amended to clarify that “transfer” means an absolute or outright transfer and not a transfer by way of security (noting that the grantor would continue to have an equity of redemption in the latter instance).