Why has asset-based lending been growing so rapidly in Australia? What are the top five issues asset-based lenders should consider when including Australian entities and collateral in an ABL transaction? Chris Redden, a partner with Norton Rose Fulbright Australia in Sydney provides the answers.
There has been a significant increase in the recent past in the use of ABL in Australia across a broad range of sectors, often as part of U.S. or London-led global ABL financings. Many of these global ABL facilities are coupled with either term loans or note issuances and have been used with great success for financing acquisitions by both companies and private equity firms.
Traditional borrowing base financing has been offered by many Australian financial institutions for some time. However, the entry of the large North American banks to the Australian ABL market is now a very noticeable trend with the issues discussed in this article being relevant to global ABL transactions involving Australia.
The Growth of ABL in Australia
ABL has become a mainstream lending product and it has expanded its global reach from North America to include London, Europe, Asia and Australia. Sponsors have become increasingly aware that ABL offers significant benefits when compared to cash-flow financing including the following:
- The price differential in the current market favors ABL structures in comparison to secured cash-flow lending.
- The ABL product offers flexible revolving financing which can flex with the seasonal or operational requirements of the borrower.
- Cash-flow based financings generally include one or two financial covenants including a senior debt or total debt to EBITDA covenant. In contrast, ABL facilities will include only a fixed-charge coverage covenant (in many cases on a springing basis where the borrower's unused loan availability falls below an agreed threshold amount).
- A borrower can leverage off its global business by including global assets in the borrowing base.
Market forces in the U.S., combined with increased robustness of the U.S. economy, increased M&A activity and the growth of ABL in London and Europe, have had a significant impact on the use of ABL in Australia.
The introduction of the Personal Property Securities Act 2009 (Cth) (PPSA) from January 30, 2012 has also had a significant impact on the growth of ABL in Australia. The PPSA is based, in a large part, on Canadian legislation and Article 9 of the U.S. Uniform Commercial Code. North American asset-based lenders have taken significant comfort from the familiarity of the PPSA regime in terms of obtaining perfected security interests in the kinds of collateral which form the backbone of ABL transactions – accounts receivable, bank accounts and inventory.
ABL facilities can and have been used in Australia across a broad number of industries including retail, online directories, agriculture, mining and plastics and have proven to benefit both mid-sized and larger companies. Given this inherent flexibility and the benefits outlined above, it is easy to see why ABL is growing in Australia at a fast pace.
The Top Five Issues for Asset-Based Lenders in Australia
The top five issues that need to be considered by asset-based lenders in the context of Australian transactions are:
- What borrowing/guarantee structure will be used?
- All assets security or specific asset security?
- How will the asset-based lenders obtain "control" over ABL priority collateral?
- What priority security interests does an asset-based lender need to consider?
- What rights does a supplier on "retention of title" terms have?
Borrowing and Guarantee Structures
With many businesses in Australia owned by global organisations headquartered in North America or Europe where ABL is very common, there is a strong trend towards including the Australian operations into the global borrowing base to increase the available leverage and borrowing capacity. In many cases, the Australian operations are substantial and have warranted their own distinct tranche and a separate Australian borrowing base, with some sized over US$100m.
In Australia it is common to see the following structures used in cross border ABL transactions:
- Australian companies as borrowers under a separate AUD tranche on the basis of a distinct Australian borrowing base;
- Australian domiciled assets being included in a global borrowing base with no Australian companies as borrowers but with the Australian companies as guarantors; and
- Australian domiciled assets being included in a global borrowing base with Australian companies included as borrowers and guarantors.
Where guarantees are provided by Australian companies, corporate benefit issues can arise. However, the nature of an ABL transaction does not create any specific or additional issues that do not already exist for any global secured financing and the risk posed by this issue is generally manageable if all guarantors and borrowers are within a wholly-owned group1.
All Asset Security or Specific Asset Security?
In many ABL deals, the security granted in Australia by the Australian company covers all of its assets. The primary reason for this is to ensure that the secured party can avoid being adversely affected by the statutory enforcement moratorium which applies to secured creditors and others on appointment of an administrator to an Australian company (Administration Risk).
During the moratorium (which could last for a number of months), secured creditors cannot enforce security except with the consent of the administrator or with leave of the court2. However, there is an exception for creditors who hold security over the whole, or substantially the whole, of the assets of the company. This exception allows enforcement of the "all assets" security, as long as enforcement begins during a 13 business day "decision period'' after the commencement of the administration3.
Administration Risk is not a remote risk. Voluntary administration is likely to be the first port of call for directors of an Australian company which is or may be insolvent. By appointing an administrator as early as possible, the directors seek to reduce their risk of personal liability for debts incurred by the company whilst insolvent4. Directors have a defense to a claim for insolvent trading if they can show that they took all reasonable steps to prevent the insolvent company from incurring the relevant debts, including by appointing an administrator5.
Security over all assets is not always easy to obtain. In some cases, the Australian company will:
- seek to exclude certain collateral from the collateral package on the basis that it is either non-core to the ABL lenders or there are contractual restrictions which prevent that company from granting a security interest over the relevant collateral; or
- request that the asset-based lenders only take a security interest over the ABL "priority collateral" (essentially accounts receivable, bank accounts and inventory) on the basis that the asset-based lenders should only take security over assets which are included in the borrowing base.
The issue with both of these approaches is that exclusion of any assets may result in the security being over less than "substantially the whole" of the company's property (with the potential loss of the exception to the statutory moratorium referred to above). There is very little judicial guidance as to what constitutes "substantially the whole"6. This results in lenders taking a conservative approach and insisting on all assets security.
Where the Australian company insists on providing security over specific assets, asset-based lenders can seek to address the Administration Risk by taking what is known as a "featherweight security interest". In this situation, the usual form of security is taken over specific agreed collateral (e.g. ABL priority collateral) and a featherweight security is taken over all other assets of the company. The featherweight security is light-touch and limited in that, absent the appointment of an administrator, the company may deal with the secured property freely (as is the case where security is "floating") and the security can only be enforced on the appointment of an administrator.
The featherweight security interest is a particular mechanism which has been developed to deal with Administration Risk and although commonly used in Australia, its effectiveness has not been tested in an Australian court. As a result, this approach should only be used in circumstances where all assets security is not available7.
How will the ABL lenders obtain "control" over priority ABL collateral?
The advantage of controlling particular collateral
On insolvency of a corporation governed by the Corporations Act, certain unsecured creditors are required to be paid from the proceeds of "circulating assets" ahead of creditors with security over those circulating assets. Examples of these priority claims are detailed below and include certain employee entitlements as well as some costs of an administrator and liquidator (depending on the timing of enforcement of the relevant security). Clearly, wherever possible, a secured creditor will want to ensure that its secured property is not circulating assets.
A secured party can prevent an asset from being a "circulating asset" if the secured party:
- has made an effective registration on the PPSR recording its control; and
- has the requisite level of control over those assets8.
What are Circulating Assets?
The definition of "circulating assets" in the PPSA has two limbs9. Assets will be circulating assets if:
- they fall within the list of assets deemed by the PPSA to be circulating (and the secured creditor has not satisfied the control and registration requirements with respect to those assets); or
- the secured party has given the grantor express or implied authority for any transfer of the personal property to be made, in the ordinary course of the grantor's business, free of the security interest.
In an ABL transaction, the assets material to the financing will fall within the first limb. The assets deemed by the PPSA to be circulating assets are as follows10:
- an account (i.e., receivable) that arises from granting a right, or providing services, in the ordinary course of a business of granting rights or providing services of that kind (whether or not the account debtor is the person to whom the right is granted or the services are provided);
- an account (i.e., receivable) that is the proceeds of inventory;
- an ADI Account (i.e., a bank account with an Australian authorised deposit taking institution ( ADI)) - other than a term deposit;
- inventory; and
- a negotiable instrument (which is defined to include cheques, bills of exchange, promissory notes and certain letters of credit).
The Statutory Requirements for Establishing Control
As noted above, personal property is not a circulating asset if secured party has control of the property and registers that control.
A secured party has control of property if:
- it has control of the property within the ordinary meaning of the term "control";11 or
- it satisfies specific statutory tests for establishing control of various types of personal property which are described below.
In an ABL transaction where receivables, bank accounts and inventory underpin the borrowing base, it is critical to protect the priority of the security over those assets by establishing control where possible.
Control of Bank Accounts (ADI Account)
The statutory test
There is a prescriptive statutory test for control of an ADI account12.
A secured party will have control of an ADI account:
- if one or more of the following applies:
- the secured party is the ADI;
- the secured party is able to direct disposition of funds from the account without further consent by the
- the secured party becomes the ADI's customer with respect to the account; and
- if the secured party is not the ADI – depositing an amount in the ADI account does not result in any person coming under a present liability to pay the debtor or a related body corporate of the debtor.
If the secured party is the ADI then the test for control is easily satisfied under paragraph (a)(i) above (assuming paragraph (b), discussed below, is also satisfied).
Many foreign asset-based lenders do not have Australian branches, with the result that the account bank and the secured party are separate entities. In this situation, the test for control under paragraph (a)(ii) above is satisfied by the foreign secured party and the company entering into an appropriately drafted account control deed with the relevant ADI. The key purposes of the account control deed are to:
- establish control for PPSA purposes;
- protect the priority of the security interest held by the secured party as against any security interest which may be obtained by the ADI in the account; and
- obtain the ADI's agreement not to exercise other rights with respect to the account such as rights of set-off and rights to combine accounts.
Even where the secured party is the ADI, an account control deed is sometimes required in syndicated ABL transactions because of the different roles of the ADI as both secured party and account bank. This is not necessary from a control perspective and market practice in Australia at this time is generally not to require an account control deed in these circumstances.
Does the Account Need to be a Blocked Account?
The requirement above (if the secured party is not the ADI – depositing an amount the ADI account does not result in any person coming under a present liability to pay the debtor or a related body corporate of the debtor) has created some uncertainty in the market. However, it is generally accepted that the provision is there as an anti-avoidance mechanism rather than a requirement for a blocked account. In addition, the express statement in section 314A(2) of the PPSA that "a secured party has control under subsection (1) even if the grantor retains the right to direct the disposition of funds from the account" makes it clear that the account does not need to be fully blocked (eg subject to "full dominion" as is the case in the UK with respect to fixed charges13).
It is therefore generally accepted in the Australian market that control can be established by "springing dominion", i.e., although the account is not blocked at the outset, the secured party will retain the right to give notice directing disposition of the funds out of the account to the company and the ADI after an event of default or a cash dominion event.
However, at the date of this article, there is no judicial authority supporting springing dominion in Australia and as such, many lenders in the receivables lending market and many foreign ABL lenders prefer to have full dominion over the primary collection account (i.e., full control from the outset) with springing dominion over other accounts such as disbursement accounts.
Control of receivables (accounts)
There is a prescriptive statutory test in the PPSA to determine whether a secured party has control of accounts14. A secured party will have control of accounts if:
- the secured party, and the person to whom the relevant accounts are owed, have agreed in writing that amounts paid in discharge of the relevant accounts must be deposited into a specified ADI account (this is usually reflected in an undertaking in the primary credit agreement);
- the usual practice is for such amounts to be so deposited (this is typically taken to be satisfied on the facts and standard business operation, however, it is noted that there may be an argument that one-off payments or a new obligation to deposit amounts into the ADI account do not establish a "usual practice" thus leading to a degree of uncertainty);
- the secured party controls the ADI account (see above); and
- the deposit of any such amounts into the specified ADI account does not result in any person coming under a present liability to pay:
- the person to whom the relevant account is owed; or
- if the person to whom the relevant account is owed is a body corporate – a related body corporate.
As with the statutory test for control of an ADI account (see above), the inclusion of this last requirement has created uncertainty, particularly where the secured party is not the account bank with respect to the ADI account (since in that situation, an equivalent provision also applies in respect of the ADI account itself. This is another reason for lenders to consider obtaining "full dominion", at least over the primary collection accounts.
Control Over Inventory
This has proven the most problematic of the three categories of ABL secured property from a PPSA perspective. A secured party has control of inventory if:
- the secured party and the grantor have agreed in writing that the grantor:
- will specifically appropriate the inventory to the security interest; and
- will not remove any specifically appropriated inventory without previously obtaining the specific and express authority of the secured party to do so; and
- the grantor's usual practice is to comply with the agreement15.
It is unclear, in the absence of judicial guidance, whether the secured party must specifically and expressly consent to each and every disposal of inventory (which in many cases would be unworkable) or whether there could be some degree of batching. It is, at least, generally accepted that a pre-agreed blanket consent at the outset will not work.
While it may be possible from a commercial perspective to control particular inventory in the event that the value of that inventory warranted specific consent to a disposal, it is accepted that it would not be practical for a lender to control all inventory of a grantor and ABL lenders do not seek to do so in Australian ABL transactions. Without such control, inventory will be "circulating assets" and therefore subject to the priority risk referred to above.
The two meanings of "control": control over circulating assets vs. perfection by control
The PPSA uses the concept of "control" in two distinct ways. Firstly, a security interest over certain assets may be perfected by control16 (i.e. it does not need to be registered to achieve perfection) and secondly, assets which are deemed by the PPSA to be circulating assets will not be circulating assets if the secured party has satisfied the requirements referred to above17. These two concepts of control can sometimes be confused. In ABL transactions, the main focus is on control over "circulating assets". However, perfection by control is relevant to security over ADI accounts.
Perfection by registration is the most common method of perfection and is available for all kinds of collateral. Perfection by control (where available) enhances the priority position of the security interest beyond what it would have by registration alone18. The kinds of assets which can be subject to perfection by control include ADI accounts, shares, units and other marketable securities, letters of credit and certain negotiable instruments19.
However, even where a security interest is perfected by control, it is prudent to make a registration in respect of the interest as well. This is because control can be lost in certain situations and having a registration ensures that the security interest will not become unperfected if control is lost20. It also enables the secured party to ensure that the security interest will be perfected in respect of all proceeds from the original collateral21.
Perfecting a security interest over an ADI account by control provides the secured party with priority over any other security interest in the ADI account, including prior registered interests22. A secured party can only perfect a security interest in an ADI account by control if the secured party is the ADI with which the account is held23.
In ABL transactions, this will not always be the case and registration may be the only method of perfection available. In that situation, any potential priority competition between the asset-based lender's security in the ADI account and a security interest held by the account bank (which would be perfected by control) is addressed contractually with the account bank in an account control deed. Where the secured party wants to ensure that the ADI account is not a circulating asset, that contractual arrangement would also include the provisions referred to above.
Liabilities which rank in priority to a secured creditor
In Australia certain statutory liabilities may rank ahead of a secured party with a security interest over certain collateral classes. These include:
Employee entitlements - under Australian corporate insolvency legislation24 where property of the company available for payment of unsecured creditors is insufficient to meet certain employee entitlements, those employee entitlements must be paid from the proceeds of "circulating assets" of the company in priority to the claims of a creditor with security over the circulating assets.
This is of significant concern to asset-based lenders in Australia, as employee entitlements can constitute a significant liability of the company (depending on the nature of its business). Asset-based lenders need to understand the nature and quantum of the relevant entitlements, ensure the reserve covers such entitlements and obtain regular reports as to the status of such entitlements (usually via the borrowing- base certificate).
As noted above, even if control is established over ADI accounts and accounts receivable, security over inventory, where it may not be possible to exert the requisite degree of control, can be affected by this priority rule.
Administrator's / Liquidator's / Other Person's fees for realisation - this priority only applies where an administrator, liquidator or other person has realised the assets of the company. The priority will only arise in respect of the specific assets sold, including assets subject to a non-circulating security interest if the secured creditor has elected not to take enforcement action in respect of that asset. This will not usually arise as a secured party will appoint a receiver in Australia to realise the assets of the company on enforcement.
Administrator's debts - there is priority for an administrator, for debts and liabilities it has incurred as administrator, as well as its own remuneration, over the company's assets which are circulating assets subject to a security interest, except to the extent it relates to debts incurred by the administrator for the repayment of money borrowed without the secured creditor's written consent.
Tax – There is no general priority for taxes but there is priority for the Commonwealth government (via the Australian Tax Office (ATO)), where the secured creditor (or its attorney or receiver) exercises its power of sale over an asset of a company, and Goods and Services Tax (GST) is occasioned on that sale.
Whilst not, strictly speaking, a statutory priority, the commercial effect is the same, as the secured creditor becomes liable to pay to the ATO GST on any sale by it of that company's assets. This may reduce the amount available to the secured creditor where there is a shortfall on sale, or the sale is for an amount equal to the amount owing to the secured creditor, as this amount will be reduced by the amount of GST (1/11th of the sale price) payable on sale).
Similarly, where assets subject to the secured creditor's security are sold by a liquidator or administrator, that liquidator or administrator is likely only to sell subject to agreement from the secured creditor to allow the liquidator or administrator to deduct GST from the sale proceeds.
Rights of a Supplier on "Retention of Title" Terms
Retention of Title (ROT)
Under the PPSA, a supplier who retains title to goods pending payment of the purchase price has a security interest in those goods. This kind of security interest is one of a number of interests classified by the PPSA as a "purchase money security interest" (PMSI).25
The interest of a person who holds a PMSI and makes an appropriate registration on the PPSR within applicable time limits is given priority over competing security interests in relevant the goods and proceeds from those goods (but only to the extent that the PMSI secures unpaid purchase monies).
In order to qualify for this special priority position, the registration made by the PMSI holder (in this case, the supplier) would need to:
- disclose that the security interest is a PMSI;
- if the goods are inventory in the hands of the purchaser, the PMSI would need to be registered prior to the purchaser obtaining possession of the goods;
- if the goods are not inventory in the hands of the purchaser, the PMSI would need to be registered within 15 business days of the purchaser obtaining possession of the goods26.
As a practical matter, it is not necessary to make a registration in respect of each supply. One PMSI registration against a purchaser can cover all goods supplied to that purchaser during the trading relationship (provided the ambit of the registration is sufficiently broad).
Unlike in the U.S. and Canada, the holder of a PMSI over inventory in Australia is not required to give notice to any other secured party who has a prior registered security interest. As such, unless the asset-based lenders conduct additional searches of the PPSR during the term of the facility the lenders will not be aware of any PMSI's which may have been registered against the ABL obligors after the date of the initial searches conducted by the asset-based lenders.
Competing security interests in "proceeds" of inventory
The holder of a PMSI will have a perfected PMSI in any ADI account which constitutes "proceeds" of the property the subject of the PMSI. If the registration in respect of the PMSI is broad enough, the PMSI holder will also have a perfected PMSI in other proceeds of the secured property, including accounts receivable.
In the context of an ROT supplier, this means that the supplier may have a perfected PMSI in both the goods and any proceeds from a dealing with the goods. This gives rise to a potential priority dispute with any asset-based lender holding a security interest in the same proceeds (e.g. receivables and ADI accounts).
The priority rules applicable to PMSIs give the PMSI holder priority in respect of the proceeds, as well as the goods supplied (subject to the PMSI registration requirements referred to above having been satisfied and the proceeds being identifiable and traceable as proceeds of the goods). However, there are two exceptions to this position as follows:
ADI accounts: A security interest in the ADI account which is perfected by control (i.e., a security interest held by the account bank in the ADI account) will take priority over the holder of a PMSI in the ADI account27. In this sense, perfection by control is paramount and trumps the PMSI's super priority.
Accounts (i.e., accounts receivable) which are proceeds of inventory: A non-PMSI (such as security over receivables taken by an ABL lender) in an account receivable as original collateral (ie not as proceeds of other collateral) which satisfies the following requirements will take priority over a PMSI in the account receivable as proceeds of inventory. Priority is available to the non-PMSI holder if:
- the non PMSI in the account is granted for new value; and
- the non PMSI is perfected by registration; and either:
- registration of the non-PMSI occurred before the earlier of:
- the time the PMSI is perfected; and
- the registration time of the PMSI;
- the holder of the non PMSI gives a notice (known as a section 64 notice) in the required form to the PMSI holder at least 15 business days before the earlier of:
- the day on which a registration on the PPSR is made in respect of the receivable (by the non-PMSI holder); and
- the day the non-PMSI holder's security interest attaches to the receivable28.
This rule allows a non-PMSI holder to gain priority against later PMSI holders on a "first in time" basis and to gain priority over prior PMSIs by complying with the notification requirements. This is largely consistent with the NZ PPSA and some of the Canadian PPSAs. However, the Australian PPSA is alone in allowing a non-PMSI holder the ability to have priority over an earlier registered PMSI.
In practice, section 64 notices are not always issued since doing so can, among other things, result in suppliers changing their terms of trade in a manner which can adversely affect the borrower group as the suppliers react to their loss of priority. Many asset-based lenders choose instead to address the priority risk in respect of prior registered PMSI holders through the application of appropriate reserves.
The growth of ABL in Australia has certainly been impressive in recent years and this growth only appears to be accelerating. The flexibility of the ABL product and its unique ability to operate across borders makes it very attractive in today's global business world where corporate borrowers have business interests across many different jurisdictions and where the world is their marketplace.
With Australia being a stable and attractive place to invest and with many international businesses having interests in Australia, Australia has become a very hospitable new frontier for the ABL industry. It is certain that we will continue to see the rise of asset-based lending in Australia.
1 Corporations Act 2001 (Cth), s 187.
2 Corporations Act 2001 (Cth), s 440B.
3 Corporations Act 2001 (Cth), s 250A(3).
4 Corporations Act 2001 (Cth), s 588G.
5 Corporations Act 2001 (Cth), ss 588H(5) and (6).
6 In NAB v Horne and Vrsecky as joint and several administrators of Australian Property Custodian Holdings Ltd (Administrators Appointed) (Receivers and Managers Appointed)  VSCA 280, the Court of Appeal agreed with the Supreme Court of Victoria in the first instance, that a charge over 68 per cent of the assets of the company did not represent "the whole or substantially the whole" of the assets of the company.
7 See Re Croftbell Ltd  BCLC 844 where an English Court upheld the use of a featherweight debenture where an administration of a company could only be commenced by order of the Court following a notice of application by a person with a floating charge over the whole or substantially the whole of the company's property or a receiver appointed by that person.
8 Personal Property Securities Act 2009 (Cth), s 340(2).
9 Personal Property Securities Act 2009 (Cth), s 340(1).
10 Personal Property Securities Act 2009 (Cth), s 340(5).
11 Personal Property Securities Act 2009 (Cth), s 341.
12 Personal Property Securities Act 2009 (Cth), s 341A.
13 See Re Spectrum Plus Ltd  UKHL 41 14 Personal Property Securities Act 2009 (Cth), ss 341(3) and (4).
15 Personal Property Securities Act 2009 (Cth), s 341(1).
16 Personal Property Securities Act 2009 (Cth), s 21(2)(c).
17 Personal Property Securities Act 2009 (Cth), s 340.
18 Personal Property Securities Act 2009 (Cth), s 57.
19 Personal Property Securities Act 2009 (Cth), s 21(2)(c).
20 Personal Property Securities Act 2009 (Cth), s 21(2)(a).
21 Personal Property Securities Act 2009 (Cth), s 33.
22 Personal Property Securities Act 2009 (Cth), ss 57 and 75.
23 Personal Property Securities Act 2009 (Cth), s 25.
24 Corporations Act 2001 (Cth), Part 5.
25 Personal Property Securities Act 2009 (Cth), s 14.
26 Personal Property Securities Act 2009 (Cth), s 62.
27 Personal Property Securities Act 2009 (Cth), ss 57 and 75.
28 Personal Property Securities Act 2009 (Cth), s 64.