The consequences of not perfecting a security interest under the PPSA are dire. That is why they are discussed upfront, even before explaining how to perfect security interests, to reinforce the importance to secured parties of always perfecting their security interests.

The consequences echo (but are not identical – see below) those following non-registration of a registrable company charge under the pre-PPSA company charges system in Chapter 2K of the Corporations Act 2001 (Cth). However, given the broad application of the PPSA to so many transactions as security interests, the consequences are, in fact, far greater.

To summarise the consequences of not perfecting a security interest:

1. 1. other perfected security interests granted over the same collateral may have priority;

   2. the security interest may be void upon the bankruptcy, administration or liquidation of the grantor, subject to the exceptions discussed below. The PPSA calls this “vesting in the grantor”;

   3. unperfected security interests are on serious risk of being extinguished upon sales or leases of the collateral; and

   4. unperfected security interests cannot be enforced following the commencement of administration, namely:

1. 1. 1. for security interests over the whole or substantially the whole of the grantor’s property, if unperfected they do not carry the remedy of enabling the secured party to appoint receivers over the top of administrators within the 13 business day decision period upon the grantor entering administration¹; and
      2. for other unperfected security interests, under which a secured party has commenced enforcement action by appointing a receiver or controller before the grantor enters administration or liquidation, unperfected security interests cannot continue to be enforced following the commencement of administration or liquidation, and presumably any receivers or controllers appointed would have to cease acting².

There are some exceptions, and these are discussed below.

Most deemed security interests do not vest in the grantor upon bankruptcy, administration or liquidation if they do not secure obligations

Most of the deemed security interests (certain PPS Leases, transfers of accounts (receivables) or chattel paper, and commercial consignments) do not vest in the grantor upon the grantor’s bankruptcy, administration or liquidation if they remain unperfected, provided they do not secure the payment or performance of obligations.

PPS Leases over serial numbered goods for a term that exceeds three months but is less than one year will
not vest in the grantor upon the grantor’s bankruptcy, administration or liquidation if not perfected³ and no obligations are secured. Other PPS Leases will vest in the grantor if unperfected upon bankruptcy, administration or liquidation.

Turnover trusts do not vest in the grantor upon bankruptcy, administration or liquidation

So-called turnover trusts, which typically appear in intercreditor agreements and priority agreements, do not vest in the grantor if they remain unperfected upon the grantor entering administration or liquidation⁴.

Briefly, turnover trusts are where junior creditors agree to pay-over to more senior-ranking creditors funds they may receive from a grantor/debtor before senior creditors are repaid in full. Pending turnover of the funds, junior creditors typically hold any funds they must turnover on trust for the benefit of senior creditors. The idea is to preserve the priority of the senior debt over the junior debt, or put another way, to preserve the subordination of the junior debt. Turnover trusts are one method of implementing or administering subordination agreements between senior and junior creditors, in particular to protect a senior creditor from the insolvency of a junior creditor.

This exception appears designed to preserve the operation of turnover trusts upon the insolvency of a junior creditor if turnover trusts remain unperfected. The grantor under a turnover trust is the junior creditor. Junior creditors include financial institutions or investors taking a junior debt position.

The exception from vesting in the grantor that applies to unperfected turnover trusts (section 268(2)) supports the view that turnover trusts, and (although the PPSA is silent on the point) trusts that secure obligations, are security interests under the PPSA.

Unperfected turnover trusts will not vest in the grantor and will survive the bankruptcy, administration or liquidation of the grantor (the grantor is the junior creditor who declares the turnover trust).

The question then becomes, would an unperfected turnover trust be vulnerable in any way as an unperfected security interest. The answer is yes. Turnover trusts are granted by junior creditors. If the turnover trust proceeds are transferred by the junior creditor, then any unperfected turnover trust security interest would be easily extinguished under the extinguishment rule in section 43. An unperfected turnover trust may also lose in priority disputes to other perfected security interests granted by the junior creditor (grantor).

Security interests granted in foreign countries and the perfection of which is not governed by Australian law do not vest in the grantor upon insolvency

Where the matter of perfection of a security interest is governed by the law of another country, the security interest will not vest in the grantor upon the grantor’s bankruptcy, administration or liquidation in Australia if it is not perfected under the PPSA⁵.

As discussed below commencing at paragraph 17.11.11, where certain intangible property rights or financial property (excluding intellectual property, ADI accounts and negotiable instruments) which is subject to a security interest granted in a foreign jurisdiction is relocated to Australia, the foreign security interest may not need to be perfected under the PPSA unless the PPSA provides that Australian law governs the perfection of the security interest – see Part 7.2 of the PPSA. If the law of the foreign jurisdiction where the security interest was granted governs the perfection of a foreign security interest over intangible property or financial property (excluding intellectual property, ADI accounts and negotiable instruments), and the security interest remains unperfected under the PPSA, it will not vest in the grantor upon the grantor’s bankruptcy, administration or liquidation.

From paragraph 17.2.6 above, PPS Leases that secure obligations generally vest in the grantor if unperfected upon the grantor's bankruptcy, administration or liquidation. However, PPS Leases over serial numbered goods for terms over three months but less than one year will not vest in the grantor upon the grantor’s bankruptcy, administration or liquidation if not perfected⁶ and no obligations are secured.

If a PPS Lease vests in the grantor upon bankruptcy, administration or liquidation because it is unperfected, then the secured party can prove an unsecured claim for damages thereby suffered against the grantor⁷.

The amount of damage recoverable, and so the amount that could be proved as a debt in the liquidation of the grantor, is the greater of the amount determined under a formula in the security agreement (if the parties have agreed a formula), or otherwise the value of the collateral (which is lost because the security interest is void) at the time the grantor enters into bankruptcy, administration or liquidation plus other resulting losses⁸.

Such a damages claim is likely to be particularly useful where a PPS Lease agreement is not clear about amounts owing if the collateral is lost, which may be the case in many small-ticket lease transactions. In such situations, the lessor may be able to fall back on the damages claim against the grantor’s insolvent estate.

Unperfected commercial consignments that vest in the grantor upon bankruptcy, administration or liquidation also carry a damages claim for extinguishment upon vesting in the grantor.