A company has bank funding under a GSA (General Security
Agreement) but is strapped for cash. The shareholders come to
the party by purchasing a big slice of the company's inventory
which they allow the company to keep and continue to sell to its
usual customers, buying it back from the shareholders as
If the company goes into receivership or liquidation, who has
the best claim to that inventory? The shareholders as owner or the
bank under its GSA?
A common practice
We've seen versions of this scenario many times recently in
To date, the cases have turned on whether the sales were in the
ordinary course of business, in which case the goods are
transferred from seller to buyer free and clear of any security
interest, such as the bank's GSA.2
We have been surprised by some of the courts' decisions,
particularly when the sales appear, commercially, to be more in the
nature of a financial arrangement than in the ordinary course of
A tougher response from the court
The High Court decision in Carey v Smith3 is
tougher in its approach and should give comfort to those who take
orthodox security interests, such as banks. It found not only that
the sale was outside the ordinary course of the company's
business, but that it was in effect a financial transaction and
therefore, a security interest under the PPSA.
The shareholders entered into a sale and buy-back arrangement to
help the company, which was not at that stage in financial
difficulty, but needed working capital to harvest and stockpile an
unusually large peat crop.
The court found that the sale was not in the ordinary course of
the purchasers under the sale and buy-back agreement were not
usual customers of the company, and indeed were related to it
the sale was a one-off, in that inventory was not usually sold
in such a quantity and in an unprocessed state
exclusive possession remained with the company until two years
after the sale, during which time the company was able to sell the
inventory to its usual customers
at the end of the two year period, the purchasers had the
option to "put" the remaining inventory to the company,
which was then obliged to purchase it (this factor was particularly
significant for the Judge)
there was no evidence that the sale or buy-back price matched
the purpose of the transaction was to meet a particular cash
flow need. The transaction was initiated and negotiated by the
company's chairman, not a manager or sales representative
there was no advertising, and
the acknowledged intention of the sale was to provide security
to the purchasers. Their honesty in this regard was perhaps
disarming. They were described in the agreement as
"investors". In evidence, one said:
"I thought that by buying
[the inventory] I would have something to sell if the put option
was not exercised".
The new normal?
While some of the other judgments approached the ordinary course
of business question in a similar way, this is the first judgment
to take up the suggestion, in at least one academic article,4 that
such transactions are, in reality, financing transactions and not
In the Carey case, the Court found that the substantive purpose
of the transaction was to provide funding. It was therefore, in
substance, a security interest. The High Court here is protecting
and upholding the power of a GSA. Financing transactions will not
in the future be so easily described as sales, so as to remove
assets from the reach of the GSA creditor.
Get expert advice
Perhaps the lesson of the case to would-be providers of extra
funding is best summed up by comments in the judgment itself:
director], who thought of the idea of the sale and buy-back
agreement, was not legally qualified, and he said in evidence that
he was not familiar with securities like the bank's
It seems that neither [the
director], nor [the shareholders] recognised the need for caution
and, in particular, for sound legal advice before they proceeded to
implement the idea".5
1See for example Tubbs v Ruby  3 NZLR
551 and Stockco v Gibson  NZCCLR 29. For Chapman Tripp's
articles on those cases click
2Section 53 PPSA.
3 NZHC 2291.
4Mike Gedye, A Hoary Chestnut Resurrected: The
Meaning of 'Ordinary Course of Business' in Secured
Transactions Law (2013) 37 MULR 1.
5See the Judgment at paragraph 93, but note
that the Court is incorrect in suggesting that registration at an
early stage may have led to the agreement withstanding scrutiny as
a purchase money security interest. Section 53 would still have
operated, and in any event registration before possession by the
debtor (required under section 74) may not have been
The information in this article is for informative purposes
only and should not be relied on as legal advice. Please contact
Chapman Tripp for advice tailored to your situation.
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On December 22, 2016, the Financial Services Agency of Japan published a report summarized by the Working Group on Financial Markets of the Financial System Council, titled . . .
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