Security Agreements Generally
A security interest is a legal right granted by a debtor in which collateral is pledged to secure the obligations of a loan, or other form of agreement. Examples of security agreements include:
- A business loan, with a general security agreement over all present and after acquired personal property taken as collateral.
- A car loan, with a specific security interest in the motor vehicle being finance.
- A retention of title, or romalpha clause.
The key ideas associated with Security Agreements and Security Interests are as follows:
Security Agreement: An agreement in which a debtor grants a right in collateral to a creditor.
Collateral: An asset which a lender accepts as security for a loan. For example, a Motor Vehicle in the case of a car loan.
Secured Party: The creditor who is providing value (typically advancing money) in the transaction and taking an interest in collateral.
Value: Something of value being provided by the secured party, typically money (i.e. money advanced to buy a car).
Personal Property Securities Register (PPSR): A searchable register allowing people to search for registered security interests against a company. Typically used by finance companies when conducting due diligence for lending.
Financing Statement: A statement lodged on the PPSR by a secured party to register, or state their interest in collateral of the debtor.
Examples of Security Interests
As mentioned earlier security interest take many forms, however the most common examples include: Car loans, secured business loans and retention of title clauses.
Motor Vehicle Loan
Your typical motor vehicle loan is a secured loan with the motor vehicle being pledged as collateral. In this case:
- The debtor is the individual or entity taking out the loan.
- The secured creditor is the bank, or finance company advancing funds to the debtor to purchase the motor vehicle.
- The collateral will be the motor vehicle.
In the event that the debtor defaults on the loan, the finance company will have the right to repossess the motor vehicle, sell it, and apply the proceeds from the sale to the loan.
Secured Business Loan and General Security Agreements
In our experience business loans primarily take two forms, unsecured business loans, and secured business loans with a general security agreement in all present and after acquired personal property.
A general Security Agreement grants the creditor an interest in the debtors all present and after acquired personal property of the company, and among other entitlements the ability to appoint a receiver over the Company.
Generally speaking, a General Security Agreement means that in the event of default the secured will have the right to realise everything not subject to another prior ranking security interest ahead of the unsecured creditors.
There are exceptions to this rule, for example in an insolvency, debtors and inventory will satisfy preferential entitlements (notably employees’ unpaid wages and holiday pay, and Inland Revenue for unpaid GST and PAYE) despite the General Security Agreement.
The agreement is structured as follows:
- The debtor is the Company taking out the loan
- The secured creditor is the bank, finance company, or entity advancing funds
- The collateral is all present and after acquired personal property of the Company. (including equipment and motor vehicles)
- The security agreement is the business loan, and General Security Agreement.
A less conventional example of a General Security Agreement we have seen is the landlord of a Company obtaining a General Security Agreement over their tenant to secure rent obligations under a commercial lease.
Retention of Title Clause:
Colloquially known as a romalpa clauses, Retention of title clauses are typically found when suppliers supply goods to a customer, before the customer pays for them.
Simplified, a retention of title clause means that if the goods are not paid for the supplier will be able to uplift their supplied goods until they are paid for in full, despite being delivered to the customer.
For example, if a steel manufacturer supplies steel to a builder, and the builder goes into liquidation, the steel company will be entitled to take back their steel; and potentially have a claim to traceable proceeds from the sale of their steel in outstanding invoices of the Company.
In this specific case:
- The debtor is the customer ordering goods on credit
- The secured creditor is the supplier of the goods (i.e. the steel supplier)
- The collateral is the goods supplied, or proceeds from the sale (i.e. the steel, if it hasn’t been installed, or the traceable proceeds in outstanding invoices)
Ever heard the phrase ‘Romalpa clause’?
The most famous example of a retention of title clause is the Romalpa clause.
In 1976, a Dutch aluminium company supplied steel to Romalpa Aluminium on credit. Before delivering the aluminium, the Dutch company got Romalpa to sign an agreement stating that: The aluminium in question would remain property of the Dutch company until Romalpa had paid in full.
Unfortunately Romalpa was placed into receivership, and the aluminium company had not been paid in full.
The Receivers of Romalpa were in possession of:
- 50,000 pounds worth of aluminium; and
- 35,000 pounds being the proceeds of the sale of Romalpa’s aluminium.
After litigating the issue, It was ultimately determined that the Dutch company still owned the aluminium, and were entitled to the identifiable proceeds of the sale of aluminium being $35,000.00
Notably, it was ruled that this clause trumped the General Security Agreement.
It is common for businesses to have multiple secured creditors with a variety of security agreements, and pledged collateral.
In practice the common situations we encounter are: Businesses which have both a General Security Agreement, and a finance company with a specific security interest in a motor vehicle.
In the above example, both the General Security Agreement holder, and the finance company have a security interest in the same collateral (a motor vehicle). In cases like this, it is important to determine who can sell the motor vehicle, and receive the proceeds from sale.
This is where the two key ideas of Attachment, and Perfection of a security interest come into play:
Attachment of a Security Interest
Section 40 of the Personal Property Securities Act 1999 (PPSA) sets out what an attached security interest is. Simplified, attachment of a security interest has three key elements:
- A security Agreement (i.e. a car loan), as discussed earlier; and
- The Debtor must have rights over the assets (i.e. they own and are in control of the asset in question; and
- The creditor must provide some form of value to the debtor
Value from the creditor to the debtor can take many forms but usually consists of:
- Funds advanced, in the case of a business loan
- Goods supplied to the debtor
As mentioned earlier, we have also seen the provision of rent secured via a General Security Agreement
Perfection of a Security Interest
In summary, perfection of a security interest is when a secured creditor has an attached security interest (discussed above), and registers a financing statement on the PPSR.
Set out in section 41 of the PPSA, perfection of a security interest requires two elements to be satisfied:
- Attachment of the security interest,(discussed previously); and
- A financing statement being registered over the Company on the PPSR; or
- The secured party has taken possession of the collateral (except where possession is the result of seizure)
The Personal Properties Security Register (PPSR) is an online noticeboard where secured creditors register their security interest in personal property.
You can search Companies, individuals, or specific collateral (i.e. Motor vehicles provided you have the rego / Vin number) to determine whether other parties have a security interest in any assets.
The PPSR also allows you to lodge a financing statement against debtors, registering your interest in assets.
Priority Generally Speaking:
As mentioned earlier, in practice companies often have multiple secured creditors who have interests in the same collateral.
In cases like this, we must refer to section 66 of the PPSA to ensure that the security interests are appropriately ranked. In summary:
A perfected security interest defeats an unperfected security interest (i.e. the secured party had a security agreement, advanced goods on credit, but did not register a financing statement).
Where there are two perfected security interest, the party which first registers their financing statement on the PPSR or takes possession of the collateral (but not through seizure or repossession), will have priority.
I.e., two secured lenders have General Security Agreements; the lender which registered their financing statement first will have priority in the present property of the Company (provided they are not subject to other security interests, to be discussed earlier).
In the event of two unperfected security interests, the party whose security interest attaches first will have priority.
For example, two secured lenders have General Security Agreements, but have not registered a financing statement on the PPSR. The lender whose security agreement attached first (i.e they had a security agreement, and advanced funds) will prevail.