Australia: Is a non-circulating security interest really non-circulating? Lessons from Re Amerind

In Australia, secured creditors only enjoy absolute statutory priority over employee and administrator costs over non-circulating secured property.

The introduction of the Personal Properties Securities Act 2009 (Cth) (PPSA) brought significant changes to the regime for the classification of circulating and non-circulating assets, including the creation of a new set of rules in relation to the creation of non-circulating security interests over debtors and inventory.

Various attempts have been made to draft provisions which create non-circulating security interests over inventory and debtors relying on the provisions contained in the PPSA. If a non-circulating security interest is successfully created, then this has the potential to meaningfully change the outcome of an insolvency scenario for secured creditors.

The Victorian Court of Appeal's decision in Commonwealth v Byrnes and Hewitt [2018] VSCA 41 (Re Amerind) has sparked much discussion since it was handed down earlier this month. While the bulk of the decision concerns the application of the priority regime in section 433 of the Corporations Act 2001 (Cth) (Corporations Act) to the assets of trading trusts, it has broader implications for financiers and advisors in understanding the approach that will be taken by the Courts to the characterisation of circulating and non-circulating assets.

The simple lesson is that, as at the date of appointment, a purportedly non-circulating security interest will only be non-circulating if the secured creditor has restricted the grantor's ability to use assets in the ordinary course of their business and the formal requirements under the PPSA have been met. This has significant practical implications for secured creditors and insolvency practitioners who are called upon to adjudicate on claims.

THE CHARACTERISATION OF CIRCULATING AND NON-CIRCULATING ASSETS – SOME BACKGROUND

Many financing transactions are priced based on assumptions as to the position of the key statutory priority creditors – employees and voluntary administrators for their fees and expenses in an enforcement scenario.

The statutory priority creditors enjoy priority to the claims of the secured creditor over circulating assets. The key circulating assets are inventory and accounts (debtors). Often, claims can exceed or substantially erode the value of debtors and inventory held by insolvent corporations. Accordingly, the characterisation of assets as circulating or non-circulating is often the subject of substantial controversy.

Prior to the PPSA, the prevailing view was that a non-circulating security interest would not be brought into existence over debtors or inventory without removing the debtor from physical control over the assets, mirroring the positon that existed in the United Kingdom and other common law jurisdictions.

WHAT ARE THE PRACTICAL CONSIDERATIONS FOR SECURED CREDITORS?

Date of categorisation of security interest type

Re Amerind confirms that time for determination of whether an asset is circulating or non-circulating is the time that a receiver is appointed and not when the security interested is granted.

Control

Even if the PPSA registrations disclose control over an account or inventory, there is a secondary requirement that the secured party retains actual control within the meaning of the PPSA.

Section 341 of the PPSA defines control in a number of ways, including that:

  • with respect to inventory, the secured party and the grantor have agreed that:
    • the grantor will appropriate specific inventory to the security interest;
    • the grantor will not remove the security interest without the consent of the secured party; and
    • the grantor's ordinary practice is to comply with that agreement;
  • with respect to an account that arises from the disposal of property, the granting of rights or the provision of services (in the ordinary course of business), the secured party has both an effective registration and control. This covers many forms of receivables financing.

Control in relation to an account is extensively defined by section 341 of the PPSA, which provides that control will arise in relation to an account when:

  • there is an agreement between the secured party and the person who is owed the money to deposit amounts into a specified ADI bank account;
  • the usual practice is that amounts are deposited into that ADI bank account; and
  • the secured party has control (a second control test!) of the relevant ADI bank account within the meaning of section 341A.

In order to pass the second control test with respect to an ADI bank account, regard must be had to section 341A of the PPSA, which provides that control exists over an ADI Bank account when:

  • the secured party is the ADI controlling the bank account; or
  • the secured party is able to direct the disposition of funds from the account without further consent by the grantor; or
  • the secured party becomes the ADI's customer.

However, with respect to control of the ADI bank account, a secured party can have control even if the grantor retains the right to direct the disposition of funds from the ADI bank account.

Actual control

In addition to formal requirements (including importantly making a control registration), the Court of Appeal in Re Amerind found that under the PPSA:

  • inventory, accounts, ADI accounts, the proceeds of inventory, currency and negotiable instruments are always circulating unless they fall within the exceptions outlined above; but
  • in every case it is necessary that the secured party has not "given the grant express or implied authority for any transfer of the personal property to be made, in the ordinary course of the grantors' business, free of any security interest" as at the date of the appointment.

Accordingly, there is now an increased element of focus on whether or not a grantor is allowed to transact with the personal property that will determine whether or not an asset is circulating.

What to do

Assuming that the underlying security agreements contain terms that either on default or ordinarily restrict the grantor's right to transfer personal property in the ordinary course of the business, then these provisions need to be enforced if assets are to be characterised as non-circulating. If this includes taking control over accounts, or requiring the debtor to take certain steps, then those steps should be taken if practical.

For example, if steps need to be taken to permit the secured creditor (through the issuance of a notice or similar) to be able to direct disposition of funds from a debtor's ADI account, this will ensure the funds in the account are characterised as non-circulating provided that the formal requirements have been met. These steps need to be taken in advance of the commencement of external administration in order to be effective.

While the decision in Re Amerind does not cover the field in relation to circulating and non-circulating security interests, it points in the direction that the Court will not be eager to find non-circulating security interests where the grantor in fact retains day to day control of the assets as at the date of appointment.

Where it is commercially feasible, consideration may be given to other methods of achieving priority over circulating assets, such as via the creation of account transfer or chattel paper purchase arrangements.

Some issues remain unresolved, like the operation of automatic chattel paper or account transfer arrangements that purport to operate prior to default. Under s. 340(4A) of the PPSA, these arrangements prima facie create a non-circulating security interest notwithstanding the operation of the balance of the provisions. Whether these provisions are upheld seems likely to be a future ground of contest. Any attempt to rely on an automatic chattel paper transfer purchase arrangement (such as the standard clause in the WALRUS Group GSA) will require careful consideration in the face of better alternatives.

OTHER CONSIDERATIONS

Proceeds will be traced in the ordinary way

Following their appointment, the receivers of Amerind caused the company to enter into a new debtor finance facility to expedite the realisation of the company's stock on hand (WIP). At the time of appointment, the WIP was characterised as a circulating asset. The Court held that regardless of post-appointment arrangement for financing and securing the WIP, the monies received from these activities retained their characterisation from the time of the appointment.

This restates the importance of secured creditors having appropriate arrangements for control of circulating assets in place well before an appointment, and ideally on settlement of a facility. Asset characterisation cannot be re-organised post-appointment via a re-financing transaction.

Ability for non-trust creditors to access trust assets

Re Amerind considers extensively, but does not ultimately decide, the vexed question: can trust assets be used to meet the claims of non-trust creditors?

In order to reach its primary opinion on the applicability of section 433, the Court confirmed that the liquidator's right of indemnity from a trustee does indeed amount to the property of the company. But the Court did not decide whether the property could only be applied to meet the claims of trust creditors, leaving open duelling authorities from the Victorian Court of Appeal (Re Enhill) and the Full Court of the Supreme Court of South Australia (Re Suco Gold).

The question ultimately turns to whether section 555 of the Corporations Act requires all debts and claims to rank equally and be paid proportionally unless otherwise provided by the Act. The answer derived from trust law principles in Re Suco Gold is that the language of section 555 is insufficient to overturn the great weight of precedent as to the nature of trust law. On the other hand, the approach in Re Enhill may achieve greater consistency with the apparent legislative intention of section 555.

Prior to Re Amerind, Re Enhill has been widely criticised, particularly in commentary on trust law. Jacob's Law of Trusts in Australia states the decision is "plainly wrong", and that the transfer of trust property to a liquidator does cause it to cease to be trust property. But Re Amerind defends Re Enhill, noting that it is "more internally consistent than some academic criticism may suggest" (at [264]). While not deciding the issue, Re Amerind provides a possible foundation to mount an argument that trust assets are indeed available for the benefit of creditors in general.

As it is increasingly common under finance and other agreements for various moneys to be held on trust, it is only a matter of time before the Courts will have to confront this clash between the common law of trusts and the Corporations Act. In the meantime, insolvency practitioners should consider seeking judicial directions if they are faced with competing claims of trust and non-trust creditors over trust assets.

For secured creditors and financiers, the solution remains to always ensure that the borrower is liable in their own right and in their capacity as trustee of any relevant trust.

SOME FINAL THOUGHTS

With the increasing proliferation of non-bank and alternative financiers, increased flexibility in terms and conditions and large amounts of cash chasing a limited pool of available deals, there is a potential for significant miscalculations in relation to the characterisation of assets as circulating or non-circulating.

Where a lender is relying on receivables, inventory or the proceeds of accounts to cover their position, they need to take care at every stage of the transaction to be conscious of where they sit in relation to circulating versus non-circulating assets.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Chambers Asia Pacific Awards 2016 Winner – Australia
Client Service Award
Employer of Choice for Gender Equality (WGEA)

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions