The Attorney-General has recently determined the registration commencement time for the Personal Property Securities Act (“PPS Act”) to be 30 January 2012. Consequently there is limited time to prepare for the new legislation, including addressing the potential impact the PPS Act will have on asset protection structures commonly employed by professional advisors in their own businesses and by their clients.
This structure typically involves a corporate group structure, where assets used in conducting the business are held in one or more “Asset Holding Entity/ies”, separate to the “Trading Entity” which is carrying the risks associated with trading a business. The Asset Holding Entity will lease/hire/rent the assets to the Trading Entity, to enable it to carry on its business. This structure protects those assets in the event the Trading Entity becomes insolvent as ownership vests with the Asset Holding Entity, as set out below.
Under the PPS Act, such arrangements will be deemed security interests (defined as a PPS lease) and require perfection under the PPS Act, usually by registration on the PPS Register. Failure to perfect will negate these asset protection strategies due to the following:
- An unperfected security interest vests in the grantor on the grantors insolvency (section 267 of the PPS Act); and
- A perfected security interest has priority over an unperfected security interest, where there are competing security interests (section 55(3) of the PPS Act).
There are a number of pre-conditions to be able to perfect a security interest, including that there is a written security agreement signed or adopted by the grantor (Section 20). From our experience many asset protection structures as set out above are loose arrangements which are generally not formally documented. This is perhaps understandable given many of the examples we see are small to medium family companies, and the law as it currently stands dictates that ownership of those assets is paramount (as opposed to possession under the PPS Act). Under the current legislation the assets are therefore generally not at risk on an insolvency event of the Trading Entity, assuming ownership can be proven.
This position will change when the PPS Act commences, due to the effect of the vesting provisions on insolvency (Section 267) and the priority rules for competing security interests (Section 55(3)). Based on the foregoing, asset protection structures as set out above must be documented in writing and perfected by registration on the PPS register. The PPS Act contains strict timelines for registration on the PPS Register which must be complied with.
The practical effect of not doing so is that, upon insolvency of the Trading Entity, ownership of the assets will be transferred automatically to the company in administration/liquidation or the bankrupt estate and the asset protection structure will provide no protection to such assets. The assets would also be lost to a secured creditor who has a competing security interest (such as a bank), provided that creditor perfected their security interest in compliance with the PPS Act.
Specific Concepts and Transitional Provisions
The discussion above is a brief summary of how traditional asset protection measures may be exposed under the PPS Act. A number of concepts have been addressed in this article which warrants further explanation, including:
- What is a PPS Lease; and
- Pre-conditions to perfecting a security interest (including the requirement that there be a written agreement).
There are also transitional provisions contained in the PPS Act which appear to provide some relief for existing arrangements that are in place prior to registration commencement time, due to the concept of “temporary perfection”. These issues are discussed in further detail below:
What is a PPS Lease
PPS Lease is defined in Section 13 of the PPS Act. In simple terms, a PPS Lease means a lease or bailment of goods:
- For a term generally greater than 12 months; or
- For goods that may or must be described by serial number (in accordance with the regulations) generally for a term of 90 or more days.
There is little doubt that the asset protection structure as set out in this article will meet the definition of a PPS Lease in most circumstances.
Perfecting a Security Interest
There are a number of pre-conditions to be able to perfect a security interest. These pre-conditions include enforceability of security interests against third parties, as set out in Section 20 of the PPS Act. Enforceability against third parties is satisfied where the security interest is attached to the collateral (Section 19) and:
- the Secured Party possesses the collateral (Section 24), but not by repossession. This is likely to apply in limited circumstances;
- the Secured Party has perfected the security interest by control (Sections 25 to 29). This is limited to certain financial collateral; or
- there is a written security agreement signed or adopted by the grantor (Section 20).
Given the nature of asset protection structures set out in this article, a written security agreement will be the best, and potentially only, means of meeting the criteria for perfecting a security interest.
Effect of the Transitional Provisions
It would appear that the transitional provisions in the PPS Act will apply some relief for existing arrangements that are in place prior to registration commencement time. The transitional provisions provide “temporary perfection” for 24 months from registration commencement time. The security interest must be perfected (usually by registration) within 24 months to maintain continuous perfection.
The concept of temporary perfection is a mechanism employed by the PPS Act to provide temporary protection for a security interest in existence prior to registration commencement time, where it was considered as a policy matter that it would be appropriate to do so.
Section 307 of the PPS Act defines a transitional security agreement as “a security agreement that is in force immediately before the registration commencement time, and that continues in force at and after that time.”
Security agreement is defined in Section 10 of the PPS Act as:
“(a) an agreement or act by which a security interest is created, arises or is provided for; or
(b) writing evidencing such an agreement or act.”
The words “or act” would appear to extend the definition of security agreement beyond mere written documents. This is different to the requirement for a “written security agreement” in s 20(2), being one of the criteria for a security interest to be enforceable against third parties (for agreements entered into after commencement of the PPS Act). Accordingly it would seem that a secured party may be able to argue that an unwritten arrangement constitutes a “security agreement” for the purposes of the transitional provisions.
Therefore, it appears that it may not be necessary for temporary perfection that the security interest satisfies the requirement to make it enforceable against third parties, and accordingly:
- the absence of a written agreement may not preclude a secured party taking advantage of the transitional provisions providing temporary perfection, if the secured party can establish that there was “an agreement or act by which a security interest is created, arises or is provided for” in force; and
- the secured party may also be able to register a transitionally perfected security interest within the 24 months to maintain continuous perfection from the time immediately before the registration commencement time.
In summary, asset protection structures as set out in this article will fall under the ambit of the PPS Act and require perfection on the PPS register (usually by registration). In addition:
- arrangements in place prior to registration commencement time may enjoy temporary perfection, even if not documented in writing, and may be capable of maintaining continuous perfection if perfected within 24 months of registration commencement time. However it is strongly advisable that legal advice is sought on any arrangements which are in existence prior to registration commencement time; and
- arrangements entered into post registration commencement time must be documented in writing and perfected by registration on the PPS register. As noted above, the PPS Act contains strict timelines for registration on the PPS Register which must be complied with.
It is evident the provisions are quite complex, and it is therefore advisable that all businesses review their asset protection structures and strategies to ensure they can withstand the commencement of the PPS Act. This will include ensuring all existing arrangements qualify for temporary perfection under the transitional provisions (and are subsequently perfected within 24 months to maintain continuous perfection). It is also critical that any ongoing asset protection advice properly considers the impact of the PPS Act.