The Act prescribes a three stage test for the creation of an effective security interest together with a priority-time. All three steps must be completed to ensure priority but they need not be performed in order. The three steps are:
- Attachment Rule 1 – enforceability against the grantor;
- Attachment Rule 2 – enforceability against third parties; and
Attachment is the time when a security interest is created in personal property. The Act provides a uniform rule for the attachment of a security interest. However, the parties may specify a different time for attachment by agreement.
Enforceability against Grantors – Attachment Rule 1 - section 19
A security interest attaches to collateral when:
- the grantor has rights in the collateral; and
- the creditor has given value for the security interest.
In this context, value includes a past indebtedness. This means that a creditor may take a security interest supported by a pre-existing debt.
Importantly, a grantor’s rights in collateral are not limited to ownership or title. A mere possessory right is sufficient to support a security interest. A grantor has rights in goods:
- bailed; or
- sold to it under a conditional sale agreement or retention of title clause
when the grantor obtains possession of the goods (s 19(5))
It is therefore particularly important for lessors, bailors and commercial consignors to perfect their security interest before delivering possession to the lessee.
Upon completion of attachment rule 1, the security is enforceable against the grantor but not against third parties or in the event of insolvency.
Enforceability against third parties – Attachment Rule 2 - section 20
To be enforceable against third parties, the security interest must have attached to the collateral (Rule 1) and either:
- the secured party possesses the collateral; or
- the secured party has perfected the security interest by control; or
- a security agreement that provides for the security interest ‘covers’ the collateral.
In most cases, the parties will enter into a written security agreement which creates the security and regulates the respective rights and obligations of the parties.
Security Agreements – section 20(2) – (5)
A security agreement will ‘cover’ the collateral when:
- it is evidenced in writing;
- signed or adopted by the grantor; and
- it contains a description of the particular collateral.
Under the Act, the definition of ‘writing’ is broad. It includes any electronic recording that may be readily accessible for future reference.
A description of personal property (including collateral and proceeds) is defined to be:
- in the case of a particular item or personal property – a description that identifies the item, or that identifies a class to which the item belongs; or
- in the case of a class of personal property – a description that identifies the class, including a description that identifies the class by identifying a larger class of personal property that wholly includes the class.
A description of collateral in a security agreement as ‘consumer property’, ‘commercial property’ or ‘equipment’ will not be sufficient to ‘cover’ the collateral. Further particularity, such as the item or class of collateral, is required.
Further, particular care should be given when describing collateral as ‘inventory’ because the security will only be enforceable while the grantor holds collateral as inventory.
Alternatively, a security agreement may specify that the security interest is taken in ‘all of the grantor’s present and after-acquired property’. This category will replace the prevalent fixed and floating charge.
Proceeds – sections 20(6), 31, 32 and 33
Section 31 introduces the concept of ‘proceeds’ of collateral. Proceeds are the traceable or identifiable items of personal property that derive from a ‘dealing’ with collateral. An account arising from a sale of inventory would be ‘proceeds’.
A security interest will continue in the proceeds of collateral and is enforceable against a third party whether or not the security agreement contains a description of proceeds. Furthermore, a security interest will automatically attach to proceeds unless the security agreement provides otherwise.
A security interest in proceeds will be automatically perfected if the proceeds are:
- a cheque;
- an ADI account;
- a right under an insurance claim;
- any other payment as indemnity or compensation for loss or damage of collateral or proceeds.
In other cases, a security in proceeds will be perfected if the registered financing statement describes (as defined by the Act or regulations) the proceeds – generally ‘all present and after acquired property’.
If there is no description of proceeds in the financing statement and the proceeds are not within the description of the original collateral, or the description does not ‘cover’ the proceeds, the security interest in the proceeds will only be temporarily perfected for five days.
If possible, a description of the likely proceeds of collateral should therefore be included in any financing statement registering a security interest. This will ensure that the security interest in any proceeds will remain perfected and maintain its priority against competing security interests. The prescribed descriptions of proceeds in schedule 1, reg 2.4 of the Personal Property Securities Regulations 2010 are:
- All present and after acquired property;
- All present and after acquired property except;
- For a particular item of personal property – in a way that identifies the item, including identifying a class to which the item belongs;
- For a class of personal property – in a way that identifies the class, including identifying the class by identifying a larger class of personal property that wholly includes the class.