- 21.1 The Extinguishment Rules – Introduction
- 21.2 Table Summarising the Extinguishment Rules by Class of Collateral
- 21.3 The Extinguishment Rules - Commentary
- 21.4 Buyer or lessee of personal property subject to unperfected security interests – section 43
- 21.5 Sales or leases of serial-numbered property – motor vehicles, watercraft, aircraft/engines and intellectual property (patents, trade marks, designs and plant breeder’s rights) – section 44
- 21.6 Private sales or leases of motor vehicles – sections 45(1) - (2)
- 21.7 Buying motor vehicles from licensed dealers – sections 45(3) - (4)
- 21.8 Buying or leasing from a seller/lessor in the ordinary course of business – section 46
- 21.9 Low value (below $5,000) consumer property (except serial numbered property) – section 47
- 21.10 Currency – section 48
- 21.11 Prescribed financial markets – investment instruments and intermediated securities – section 49
- 21.12 Investment instruments – section 50
- 21.13 Intermediated securities – section 51
- 21.14 Temporarily perfected security interests – section 52
- 21.15 Returned goods following sale or lease
- 21.16 Subrogation by extinguished secured parties to rights in relation to collateral sold or leased
If someone buys or leases property from another, where the seller or lessor conducts a business of selling or leasing property of that kind and sells or leases in the ordinary course of that business, then the buyer or lessee takes free of security interests over the collateral granted by the seller or lessor, subject to the two exceptions discussed below1.
It is important to note that only security interests granted by the immediate seller or lessor are extinguished under section 46. Security interests granted by previous owners, which remain unextinguished over collateral, will not be extinguished under section 46 by sales or leases in the ordinary course of business. The low-value consumer goods (less than $5,000) extinguishment rule in section 47 (discussed next) will extinguish all security interests regardless of who granted them, but this will not be the case for higher value items (over $5,000).
For example, furniture wholesalers or retailers, and anyone else in the business of wholesale or retail trade and selling items worth more than $5,000 (outside the scope of the low-value consumer property extinguishment rule in section 47), who sell in the ordinary course of business, can only sell free of security interests that they themselves have granted, not which others (for example, previous owners) may have granted over the property.
This may be an issue for dealers in second-hand property who have inadvertently bought property for sale in their businesses that is subject to a security interest, without extinguishment of the security interest. Technically, they cannot sell and extinguish security interests over the property granted by others under section 46.
There are two exceptions. First, if the collateral in question is serial numbered property (motor vehicles, watercraft, aircraft and engines, and certain intellectual property rights (patents, trade marks, designs and plant breeders rights)) and the buyer or lessee holds the property once purchased or leased as inventory in their own business, they do not get the benefit of taking the property free of security interests under this extinguishment rule2 in section 46. The rationale here is that the buyer/lessee could easily search the PPS Register against the serial number for encumbrances over the serial numbered property before buying or leasing.
Second, if the buyer or lessee has actual knowledge (not constructive knowledge) that the sale or lease would breach the terms (restrictive covenants) of a security agreement granted by the seller/lessor which prohibits the sale or lease, then the buyer or lessee takes subject to security interests3. Buyers and lessees cannot request copies of security agreements, and security agreements are not available from the PPS Register, so this is likely to be rare.
This extinguishment rule may be problematic for sales of high-value items (over $5,000) such as furniture, clocks, machinery, or similar items, because there is a higher likelihood that a party other than the immediate seller has granted a security interest. As noted above, buyers cannot buy these items free of security interests granted by persons other than the immediate seller, even from sellers who sell in the ordinary course of their business such as retailers.
The question of whether an outright sale where title has already transferred to the buyer, or a mere agreement to sell where title has not yet passed, will engage section 46 and cut off security interests attached to the personal property sold, was considered in Warehouse Sales Pty Ltd (in liq) v LG Electronics Australia Pty Ltd [2014] VSC 644 (Warehouse Sales).
In Warehouse Sales Sifris J reviewed relevant Canadian authorities decided under the Canada provincial Personal Property Securities Acts, notably in Saskatchewan and in Ontario. Warehouse Sales followed the approach determined in the Saskatchewan Court of Appeal in Royal Bank of Canada v 216200 Alberta Ltd (1986) 33 DLR (4th) 80 (216200 Alberta). This line of authority requires title to pass (which for goods, will depend on the rules under the applicable sale of goods legislation) before there can be a sale which engages section 46 to extinguish any security interests attached to the personal property sold - see [57] to [73] of the judgment.
The alternative position was taken in the Ontario Court of Appeal decision in Spittlehouse v Northshore Marine Inc. (1994) 114 DLR (4th) 500 (Spittlehouse). In Spittlehouse the court held that an agreement to sell personal property was sufficient to engage the equivalent extinguishment rule to extinguish security interests attached to personal property the subject of an agreement for sale. Spittlehouse was considered by the Saskatchewan Court of Appeal in 216200 Alberta (see above) and not followed.
Separately, Warehouse Sales confirms that sales of personal property within corporate groups, say from one subsidiary to another, will engage section 46 to extinguish security interests attached to the personal property sold, provided that title has transferred from the selling to the buying entity - see [74] to [111] of the judgment. This naturally depended on whether the sale fell within the “ordinary course of business” of the selling entity, as required under section 46. In turn this depended on what business was conducted by the selling entity, and then looking at this business, what was its “ordinary course”. The court in Warehouse Sales followed the approach to this issue espoused in the New Zealand Court of Appeal case of Stockco Limited v Gibson [2012] NZCA 330 (Stockco).
To determine the “ordinary course of business” of a company, Stockco looked at a variety of factors, including the degree of formality of the sale, the quantity of property sold, the price, the nature and significance of the transaction, the reason for the transaction, the frequency of the transaction, whether the transaction was on arms’ length terms, whether the transaction resembles a liquidation of assets, and whether the transaction was intended to undermine security interests.
