Bruce Whittaker’s Review of the Personal Property Securities Act (“PPSA Review”), tabled in the Australian Parliament in March 2015, recommends that the PPSA be amended to expand the “purchase money security interest” (PMSI) super priority of a seller of inventory by permitting the “cross collateralisation” of PMSIs in specified circumstances.  Nearly four years on, the Government has yet to implement this recommendation or any of the other 393 recommendations of the PPSA Review.  But an Exposure Draft Bill to amend the Act is expected to be released in 2019. This article considers the practical implications of the “PMSI cross collateralisation” recommendation in the PPSA Review (the “Review Recommendation”) for sellers and insolvency practitioners.  It concludes that it would be desirable for the Government to implement a broader provision for PMSI cross collateralisation than is set out in the Review Recommendation.  This would “level the playing field” for sellers which use retention of title terms but not unduly “skew the balance” in their favour.

Introduction

A seller which retains title to particular goods supplied by it to a buyer until the buyer pays for those particular goods has a PMSI over those goods for the purposes of the Personal Property Securities Act 2009 (Cth) (the PPSA).  A PMSI is like any other PPSA security interest in that it needs to satisfy the following conditions:

  • The seller’s security interest must have attached to those goods – that is: (a) the buyer must have rights to those goods (for example, permission from the seller to hold those goods for the purposes of on-sale to third parties); and (b) the seller must give value for its PMSI – for example by supplying those goods to the buyer, or where no value is provided by the seller the buyer does an act by which the security interest arises (like granting the security interest by deed).
  • A security agreement that provides for the seller’s security interest must cover those goods in accordance with section 20(2) of the PPSA.

The seller’s PMSI will in general have “super priority” over the rights of most other secured creditors who also have security over those goods (even if those other creditors perfected their security interests earlier) if the seller registers its PMSI as a PMSI on the PPS register:

  • before the buyer obtains possession of those goods, in the case of inventory (e.g. goods purchased by the buyer for on-sale); or
  • within 15 business days after the buyer obtains possession of those goods where the goods are not inventory (e.g. manufacturing equipment used in the buyer’s plant).

The security interests that are subordinated to a seller’s “super priority” PMSI might include, for example, a bank’s prior registered “all present and after acquired property” security interest over all of the personal property over which the buyer is capable of granting security, including the goods supplied by the seller.  

Today, if a seller with PMSI super priority supplies goods on retention of title terms in separate deliveries (A, B and C) and the buyer only pays for deliveries A and B before becoming insolvent, the seller will generally be entitled to repossess goods it is able to identify as being referable to delivery C, even if the buyer had also granted a prior security interest over those goods.  

The PPSA Review Recommendation is that a seller which retains title to inventory sold by it to a buyer and satisfies the conditions set out above will be able to claim PMSI super priority for its security over all items of inventory that the seller supplied, not just the items of inventory for which the seller has not been paid.  But this right of “PMSI cross collateralisation” will only be available where it is not possible to distinguish between items of inventory supplied by the seller for which payment has, and has not, been made.  As Bruce Whittaker notes in the PPSA Review:  

The [cross-collateralisation] rule should only apply where the inventory is in effect fungible, so that it is not possible to identify what inventory might have been supplied to the grantor at what time. Cross-collateralisation should not be available if the items of inventory are separately identifiable.

After this recommendation is implemented, if a seller supplies items of inventory in separate deliveries (A, B and C) and the buyer only pays for deliveries A and B, the seller will be able to repossess items of inventory from deliveries A and B to cover the purchase price owing for delivery C – so long as it is not possible to distinguish which items were actually delivered in each delivery.  

Retention of title (ROT) clauses in terms of trade will need to be reviewed

ROT clauses may provide for a seller’s title to particular items of inventory to be retained:

  • only for so long as those particular items have not been paid for (Invoice-Specific ROT); or
  • until those particular items, as well as all other items supplied by the seller to the buyer, have been paid for (in addition, title may be retained until other debts owed by the buyer to the seller – such as service and delivery charges – have been paid) (All Moneys ROT).

In my experience, retention of title clauses may sometimes be ambiguous as to whether they seek to provide for an Invoice-Specific ROT or All Moneys ROT.  If the Review Recommendation is implemented, a seller wishing to rely on PMSI cross collateralisation, should check its terms of trade to confirm that it has an All Moneys ROT, not just an Invoice-Specific ROT.  If the seller has an Invoice-Specific ROT only, it will not be able to have the benefit of PMSI cross collateralisation over inventory that has been paid for by the buyer. In other words, if:

  • a seller has supplied inventory to a buyer in three separate deliveries (A, B and C) in relation to which the PMSI super priority criteria are satisfied; and
  • the buyer has only paid for deliveries A and B,

on default by the buyer the seller will not be able to repossess inventory from deliveries A and B to cover the purchase price owing for delivery C.  

Correspondingly, if the Review Recommendation is implemented, insolvency practitioners should confirm that an ROT claimant with only an Invoice-Specific ROT is not overreaching by seeking to have the benefit of PMSI cross collateralisation over inventory supplied by the claimant that has been paid for by the buyer.

Other impacts of the Review Recommendation on PMSI cross collateralisation

As noted above, the Review Recommendation is that “PMSI cross collateralisation” should only be available where it is not possible to distinguish between items of inventory supplied by the seller that have, and have not, been paid for.  This will be a piquant and curious role reversal for insolvency practitioners and sellers’ credit managers: for decades, insolvency practitioners have routinely asked sellers to identify their goods on an invoice-by-invoice basis and credit managers are used to being asked to do so.  But if the Review Recommendation is implemented in its proposed form, a seller seeking to cross collateralise its PMSI will need to demonstrate that the inventory supplied by it that has been paid for cannot be distinguished from inventory supplied by it for which payment has not been made.

Let us take three examples:

  • Example 1 – A buyer purchases grain from a seller, for on-sale, subject to an All Moneys ROT which is appropriately documented and registered on the PPS register.  As an ABN is allocated to the buyer’s enterprise and the buyer holds the grain for on-sale, the grain is inventory in the hands of the buyer.  As a result, the cross collateralisation rule is potentially available.  The seller sells the grain under invoices A, B, and C and the grain the subject of the separate invoices is delivered to the buyer.  The buyer stores that grain in a hopper which does not contain any other grain. The grain delivered under invoices A, B and C is commingled in the hopper such that it is not possible to distinguish between the grain supplied under the three invoices.  If the buyer pays invoice A (but not invoices B and C), the effect of the Review Recommendation is that the seller will have PMSI super priority in relation to the grain in the hopper, to recover payment for invoices B and C.
  • Example 2 – A buyer enters into a credit agreement with a seller including standard terms and conditions to apply to all sales from time to time.  Under that agreement, the buyer purchases television sets from a seller, for on-sale, subject to an All Moneys ROT which is appropriately documented and registered on the PPS register.  As an ABN is allocated to the buyer’s enterprise and the buyer holds the television sets for on-sale, the television sets are inventory in the hands of the buyer.  As a result, the cross collateralisation rule is potentially available.  The seller sells television sets under invoices A, B, and C and the television sets the subject of the separate invoices are delivered to the buyer.  The buyer stores the television sets in its warehouse.  The television sets supplied under each invoice are identifiable as having been supplied under that invoice, on account of serial numbers or barcodes or RFID tags.  If the buyer pays invoice A (but not invoices B and C), the effect of the Review Recommendation is that the seller will not have PMSI super priority – as against a prior registered secured party – entitling the seller to repossess television sets delivered under invoice A to recover payment for television sets delivered under invoices B or C.  The same result will follow if television sets were supplied under invoice A and laptop computers were supplied under invoices B and C. This is because the inventory supplied under invoice A will be distinguishable from the inventory supplied under invoices B and C.
  • Example 3 – A buyer purchases a lathe from a seller, for installation in the buyers manufacturing plant, invoiced under invoice A, together with two deliveries of sheet metal invoiced under invoices B and C respectively.  The sale of the lathe (and the sheet metal) is subject to an All Moneys ROT which is appropriately documented and registered on the PPS register. If the buyer pays invoice A (but not invoices B and C), the effect of the Review Recommendation is that the seller will not be able to apply the cross collateralisation rule to claim PMSI super priority in relation to the lathe to recover payment for the sheet metal delivered under invoices B and C.  This is because the lathe is not inventory.

Example 1 demonstrates how the Review Recommendation would enable a seller to cross collateralise a PMSI.

Examples 2 and 3 serve to make six points.  

1. Seller’s All Moneys ROT gives it a non-PMSI security

In Example 2 and Example 3, the seller will have a perfected (non-PMSI) security interest in relation to the (already paid for) inventory supplied under invoice A as a result of its All Moneys ROT.  So in the unlikely event that there is no prior holder of a perfected security interest over the inventory supplied under invoice A, the seller will be able to repossess that inventory even though its security interest does not have PMSI super priority in relation to that inventory.  

2. Seller would have had PMSI super priority to repossess the goods supplied under invoices B and C if those goods were available for repossession

Under the present law and regardless of whether or not the Review Recommendation is implemented, in both Example 2 and Example 3 the seller will have PMSI super priority over the inventory supplied under invoice B to recover payment of invoice B and the inventory supplied under invoice C to recover payment of invoice C.  The issue for the seller is that, if for some reason the invoice B and C inventory is not available for repossession, the seller cannot assert a super priority PMSI over the inventory supplied under invoice A to recover payment for inventory supplied under invoice B or invoice C.

3. Allocation of payments

It follows from the discussion at (1) and (2) above that the order of allocation of the buyer’s payments towards invoices A, B and C is very important in Examples 2 and 3.  In each of these examples, the seller might not have lost out if payments from the buyer had been capable of being allocated towards payment of invoices B and C (and not invoice A).  

The PPSA permits the parties to agree on how the buyer’s payments are to be allocated and sets out default rules to apply if the parties do not agree on payment allocation.  As a result, a seller can improve its chances of claiming PMSI super priority by allocating the buyer’s payments towards the payment of non-PMSI obligations first.  But where the buyer and the seller are in a continuing relationship, with the seller supplying goods to the buyer on a short term credit basis, with the buyer paying the seller on a continuing basis – both to reduce or extinguish past liability and to ensure continuance of supply – the seller would usually operate a “running account”.  Amongst other things, the seller would do this to improve its position in case the buyer goes into liquidation and the seller is subjected to an unfair preference claim.  If the seller operates a running account, it appears unlikely to be able to re-allocate a buyer payment initially allocated by the seller on an “oldest invoices paid first” basis retrospectively so as to improve its chance to claim PMSI super priority based on the inventory that is actually available for repossession.  In Examples 2 and 3, this would seem to preclude the seller from claiming – after the fact – that payments it received from the buyer should be re-allocated to payment of invoices B and C (and not invoice A).  In my view, this constraint on a seller’s ability to allocate payments to maximise its PMSI super priority is relevant to the scope of the proposed cross collateralisation rule, as outlined in (4) below.

4. Scope of the seller’s right to cross collateralise its PMSI

As noted above, the Review Recommendation proposes to make PMSI cross collateralisation available in a very narrow circumstance, where the inventory is in effect fungible. Therefore, it will not be available in Example 2. This contrasts with the broader approach in Article 9 of the Uniform Commercial Code (UCC) in the United States.  The UCC was amended in 2001 to provide that:

a security interest in goods is a [PMSI] if the security interest is in inventory that is or was purchase-money collateral, also to the extent that the security interest secures a purchase-money obligation incurred with respect of other inventory in which the secured party holds or held a PMSI.

I have not reviewed any case law on this provision in the UCC but on its face it appears to permit the seller in Example 2 to have PMSI super priority – as against a prior registered secured party – entitling the seller to repossess television sets delivered under invoice A to recover payment for television sets delivered under invoices B or C.  

There is a proposal for a change to the Canadian Personal Property Security Acts that will broadly align with the UCC, except that the Canadian proposal additionally limits PMSI cross collateralisation to inventory that is supplied by a seller under “related” transactions.  A transaction is “related” to another transaction when the possibility of both transactions is provided for in the first transaction or an agreement between the parties entered into prior to the first transaction.  The Canadian proposal would appear to permit the seller in Example 2 to have PMSI super priority – as against a prior registered secured party – entitling the seller to repossess television sets delivered under invoice A to recover payment for television sets delivered under invoices B or C.  This is because all of the supplies were under the terms of trade agreed to by the parties prior to entry into the specific contract that led to the issuing of invoice A.

The pre-PPSA common law does not necessarily represent sound policy settings – given the vicissitudes of litigation and judges’ lack of control over what is brought before them – but it is worthwhile noting that All Moneys ROT was upheld. Further, there is no reason to believe that the ability of either the seller or the insolvency practitioner to identify goods on hand on an invoice-by-invoice basis would have detracted from the enforceability of the All Moneys ROT in the Australian cases. It is reasonable to suggest that – pre-PPSA- the All Moneys ROT device was used by sellers in Australia partly to obviate practical difficulties in identifying goods on an invoice-by-invoice basis and partly just to strengthen the seller’s position by giving it more “security”.

I suggest that the underlying policy ought to be that a seller’s PMSI may be cross collateralised to qualify the rights of a prior security holder (e.g. a bank with a prior registered “all present and after acquired property” security interest) if the seller and the buyer are in a continuing relationship, with the seller supplying goods to the buyer on a short term credit basis and the buyer paying the seller on a continuing basis – both to reduce or extinguish past liability and to ensure continuance of supply – under a running account.  This is because that seller is arguably providing “new money” to the buyer by the operation of the trading arrangement as a whole, not just the individual deliveries. In addition, it is in this scenario that the seller is precluded from allocating buyer payments in a way that would maximise its PMSI super priority so it appears to be appropriate to permit that seller to cross collateralise its PMSI super priority.      

In my view, the UCC and the Canadian approach may permit PMSI holders to cross collateralise their PMSI super priority in a range of scenarios beyond the paradigmatic trading terms example outlined in the  preceding paragraph, to the detriment of a prior secured party or receivables financier. In contrast, the approach to PMSI cross collateralisation adopted in the Review Recommendation has the considerable merit of using a clearer “bright line”. That is, if the inventory sought to be repossessed by the seller is identifiable on an invoice-by-invoice basis PMSI cross collateralisation is not available.  

Despite the merits of the Review Recommendation, in light of the policy setting I have outlined above, I suggest that in Australia a PMSI in inventory should also secure any obligation arising out of a “related transaction” that created a PMSI in inventory (the Canadian proposal) but only if the seller and the buyer are in a continuing relationship, with the seller supplying goods to the buyer on a short term credit basis and the buyer paying the seller on a continuing basis – both to reduce or extinguish past liability and to ensure continuance of supply – under a running account. This is narrower than the UCC and the Canadian proposal but broader than the Review Recommendation. This proposal would permit the seller in Example 2 to have PMSI super priority – as against a prior registered secured party- entitling the seller to repossess television sets delivered under invoice A to recover payment for television sets delivered under invoices B or C.  

5. Why should the PMSI cross collateralisation rule be limited to inventory?

The Review Recommendation is that its PMSI cross collateralisation rule be applied in relation to inventory only.  This is why the seller was not able to rely on the rule in Example 3, to claim PMSI super priority in relation to the (already paid for) lathe to recover payment for the sheet metal delivered under unpaid invoices B and C.  In this respect the Review Recommendation aligns with the PMSI cross collateralisation rule in the UCC in the United States and the cross collateralisation rule that has been proposed for Canada.  It is not immediately obvious why the rule should be limited to inventory so as to be unavailable to a seller which supplies goods that are not inventory to a buyer.  Perhaps this is a control mechanism to limit the ability of PMSI holders to cross collateralise their PMSI super priority beyond the paradigmatic trading terms example outlined above.  On balance, I favour the limitation of the PMSI cross collateralisation rule to inventory.  

6. Impact of PMSI cross collateralisation on proceeds of inventory

Examples 2 and 3 address the PMSI cross collateralisation rule in the context of priority contests involving physical goods.  It is important to note that cross collateralisation rights that apply to a physical item of inventory may also apply to the proceeds of that inventory in certain circumstances. This is relevant in the receivables financing context, including for securitisation programs involving trade receivables.      

David Kreltszheim, Special Counsel, Cornwall Stodart

d.kreltszheim@cornwalls.com.au

www.cornwalls.com.au

David is a banking and regulatory lawyer. He advises financiers, suppliers and insolvency practitioners on finance and PPSA issues.   The views expressed are the author’s and do not necessarily reflect those of Cornwall Stodart.