- 18.1 What is priority?
- 18.2 Priority rules under the PPSA
- 18.3 Priority waterfall - summary
- 18.4 First: payments to creditors - section 69
- 18.5 Second: general law liens and statutory liens and charges arising in the ordinary course of business - section 73
- 18.6 Third, takers of interests in negotiable instruments, chattel paper and negotiable documents of title – sections 70, 71 and 72
- 18.7 Fourth: control - section 57
- 18.8 Fifth – accounts – security interests over (future) accounts generated from sales of inventory, as original collateral and granted for new value – section 64
- 18.9 Sixth: “strong PMSIs” – section 63
- 18.10 Seventh: “normal” PMSIs – section 62
- 18.11 Eighth: perfected v’s perfected – earliest priority time wins – section 55(4)
- 18.12 Ninth: execution creditors may defeat unperfected security interests – section 74
- 18.13 Tenth: perfected v’s unperfected – perfected wins – section 55(3)
- 18.14 Eleventh: unperfected v’s unperfected – the first to attach wins outside of the grantor’s bankruptcy, administration or liquidation – section 55(2)
- 18.15 Priority waterfall diagram
- 18.16 Transfers of collateral
- 18.17 Security interests over ADI accounts
- 18.18 Tacking of further advances is permitted
- 18.19 Transitional security intersts – priority disputes
- 18.20 Knowledge and its diminished relevance to priority disputes
- 18.21 Accession, processing and commingling priority rules
- 18.22 Prioirity of security interests in agricultural interests
Below is a summary priority waterfall which shows the respective priorities of the various types of security
and other interests under the PPSA, and the various methods of perfection. The waterfall is extracted again from paragraph 18.4.2 with more detailed commentary on each of the priority buckets, and diagrams, to explain how priority contests may arise between various security interests and other interests in the same collateral, and how the priority contests are resolved.
The idea of the priority waterfall is to take the ride down until it becomes relevant to the transaction under consideration. Not all elements of the waterfall will be relevant to all transactions.
Not all priority matters are discussed in the priority waterfall. Less common priority matters are discussed in the sections following the waterfall, including:
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- where collateral is transferred without the extinguishment of security interests, the priority of security interests granted by the seller and any security interests granted by the buyer and which attach to transferred collateral;
- the priority of security interests over goods that are the subject of accession, processing or commingling into a product or mass;
- the priority of transitional security interests including transitional security interests that are so-called “common law PMSIs”; and
- security interests in agricultural interests.
In the event that multiple security interests arise and compete with each other, the idea of the waterfall is to show in a relatively simple fashion how the priority contests may be resolved.
The priority waterfall is not an exhaustive statement of the priority that will apply to all security interests and other interests in every situation. It is an indicative summary of the priority hierarchy for security interests and other interests in personal property under the PPSA. Specific and careful consideration needs to be given to each particular priority dispute.
The summary priority waterfall below is the same waterfall as appears from paragraph 13.2.1 of Chapter 13 (Priority) in Part 2: The PPS Framework of this book.
The summary priority waterfall is as follows:
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- First, creditors receiving payment of a debt- section 69
- Second, general law liens, statutory liens and charges - section 73(1)
- Third, acquisitions of interests in chattel paper, negotiable instruments and negotiable documents of title – sections 70, 71 and 72
- Fourth, control – section 57
- Fifth, accounts – section 64
- Sixth: “strong PMSIs”
- Seventh: “normal PMSIs”
- Eighth: perfected v’s perfected – earliest priority time wins - sections 55(4) and 55(5)
- Ninth: perfected v’s unperfected – perfected always wins - section 55(3)
- Tenth: execution creditors can defeat unperfected security interests - section 74
- Eleventh: unperfected v unperfected – priority is by order of attachment - section 55(2)
1 First, creditors receiving payment of a debt- section 69 Creditors who receive the payment
of a debt with funds subject to a PPSA security interest have priority over a security interest in the funds, if the payment is made by electronic funds transfer (EFT), debit or transfer order from an ADI account, or payment is made by negotiable instrument1.
The recipient (payee) must have no actual knowledge that the payment was made in breach of the terms of a security agreement that governs a PPSA security interest over the funds or instrument used to make the payment2.
Only debts paid will benefit from this priority rule, as opposed to the wider concept of “liability”. However, this should not be too significant a distinction. Although liabilities include contingent and unascertained amounts, once an amount is paid on account of a liability, the liability will usually have been ascertained or quantified, in which case the amount owing is likely to be a characterised as a debt at law.
This category is first in the priority waterfall, ahead of general law liens and statutory liens and charges arising to secure amounts owing from the provision of goods and services in the ordinary course of business (second priority, below). This is because, while the PPSA appears to be silent on the point, as a matter of general law, in many (but not all) cases the payment of a debt would likely extinguish or defeat a general law lien or statutory lien or charge over the funds used to pay the debt. Take for example a trustee’s lien over trust funds (including a trust bank account) to secure the trustee’s right of indemnification from trust assets (including the trust bank account) for the trustee’s remuneration, which is payment for services rendered in the ordinary course of business of the trustee. The trustee’s lien over the bank account is very likely to be extinguished or defeated by payments duly made from the trust bank account.
It is extremely difficult to make a general statement of priority because so much will depend on the nature of the lien or charge over the funds in question (legal or equitable), the nature of the interest that the creditor recipient of the funds acquires (legal or equitable – usually legal) and any knowledge that the creditor recipient has of the prior lien or charge over the funds.
General law liens arise at both common law (legal liens) and in equity (equitable liens). Common law liens are possessory liens because they rely on the continued possession of the property the subject of the lien for their existence. Equitable liens are recognised in favour of a person who incurs expenses or indebtedness to buy, build, repair or otherwise in relation to property, where it would be unfair to leave that person with a mere unsecured claim3. Equitable liens do not rely on the continued possession of the property subject to the lien for validity.
Exceptions aside, the priority position of creditors who receive payment of a debt from an ADI account with funds subject to general law liens or statutory liens or charges is likely to follow this general pattern:
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- a creditor receiving payment of a debt should in most cases acquire the legal interest in the funds paid;
- any common law liens over the funds should have extinguished because the lienee would have lost possession of the funds;
- equitable liens may or may not continue to attach to the funds in the hands of the creditor recipients (a difficult point), but should be defeated in the creditor receives the legal interest in the funds without knowledge of the equitable lien; and
- the legal nature and priority of statutory liens or charges should be checked under the legislation under which they arise, and (if applicable) the steps outlined above at (i) to (iii) above applied to determine priority.
Negotiable instruments, including bills of exchange, cheques and promissory notes, have their own particular priority rules, including under the Bills of Exchange Act 1909 (Cth) and the Cheques Act 1986 (Cth) - PPSA section 256.
Accordingly, creditors receiving the payment of debts by transfers from ADI accounts or by negotiable instrument should prevail in many circumstances over general law liens over the funds used to make payment, and that is why this priority rule appears at the top of the priority waterfall. The priority of statutory liens and charges must be checked under the relevant legislation under which they arise, in case priority is accorded over “any interest” (which may include the interest of a creditor receiving payment4) in the property subject to the lien or charge.
2. Second, general law liens, and statutory liens and charges – section 73(1). Both general law liens, and statutory liens or charges, arising after commencement of the PPSA and which secure amounts owing from the provision of goods or services in the ordinary course of business, defeat PPSA security interests unless the lien or charge holder has actual knowledge that the lien/ charge arising breaches the terms of a security agreement that governs a prior perfected security interest over the collateral5. This will be the case if, for example, a security agreement contains a restrictive covenant that prohibits liens or charges arising over the collateral and the lien or charge holder has actual knowledge of that restrictive covenant.
General law liens are introduced in the paragraph above in the waterfall. There are two types of general law lien – common law possessory liens and equitable (non-possessory) liens. Common law possessory liens can be general liens (which secure all moneys owing) or particular liens (which secure only amounts owing in relation to a particular item of property). Solicitors, bankers and stock brokers have general common law possessory liens over items in their possession to secure all amounts owing from clients. Particular liens most commonly arise where a person has repaired or improved property by performing services in relation to it. An example is a mechanic's lien over a car for unpaid repair costs.
Turning to equitable liens, the most common equitable liens are those that arise for the benefit of buyers and sellers of real estate, to secure payment of the balance of the purchase price (seller's lien), or for repayment of the purchase price if the sale is rescinded (buyer's lien). Equivalent equitable liens also apply to buyers and sellers of personal property6, and possibly goods to the extent not inconsistent with the Sale of Goods legislation in each Australian State7. Another example is that a trustee has an equitable lien over trust assets for amounts owing associated with the provision of trustee services or liabilities incurred on behalf of the trust.
There are also many examples of statutory liens and charges that arise under specific State and Commonwealth legislation to secure amounts owing from the provision of services in the ordinary course of business.
State and Commonwealth legislation can and does exclude certain statutory liens and charges which arise under State and Commonwealth legislation from the “super priority” accorded by the PPSA under section 73(1). Section 73(2) of the PPSA permits State and Commonwealth legislation to make this declaration in respect of any statutory lien or charge. In these cases, the statutory lien or charge will have the priority provided for under the legislation under which the lien or charge arises. Some legislation applies the general law to determine priority. Other legislation provides for a specific priority regime for liens or charges arising under the legislation itself. Similarly, general law liens can be excluded from the “super priority” accorded by section 73(1), by legislative instrument8.
The statutory liens and charges that have been excluded from section 73(1) “super priority” under the PPSA are listed and discussed at paragraph 18.5.8 below. There do not yet appear to be any legislative instruments that exclude general law liens from the priority accorded by section 73(1).
3. Third, acquisitions of interests in chattel paper, negotiable instruments and negotiable documents of title – sections 70, 71 and 72. The PPSA has special rules to facilitate the transfer (negotiation) of negotiable instruments, negotiable documents of title and chattel paper in priority to PPSA security interests that may attach to them.
This is provided (in broad terms) the buyers or investors (persons taking an interest) in them:
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- provide value;
- take possession or control over the instrument, document or chattel paper;
- in most cases, acquire the instrument, document or chattel paper in the ordinary course of a business of acquiring negotiable instruments, documents of title or chattel paper of that kind; and
- in many cases, acquire the instrument, document or chattel paper without actual or constructive knowledge of either the existence of a security interest, or that the terms of a security agreement would be breached by the acquisition9.
There is a more detailed discussion of these rules in paragraphs 18.6.1 to 18.6.20 below.
These priority rules appear ahead of security interests perfected by control in the priority waterfall, because sections 70, 71 and 72 are clear that holders or acquirers of negotiable instruments, negotiable documents of title or chattel paper in compliance with the conditions in those sections have priority to PPSA security interests, which by definition should include security interests perfected by control (although the PPSA is not explicit on this point).
Security interests cannot be perfected by control over negotiable instruments evidenced by certificate, negotiable documents of title or chattel paper as original collateral. However, if a negotiable instrument, negotiable document of title or chattel paper represents proceeds of other original collateral against which a security interest was perfected by control (for example, shares), and that security interest (perfected by control) attaches to the instrument, document or chattel paper as proceeds with “control priority”10, then the priority rules in sections 70, 71 and 72 should defeat even security interests perfected by control. However, if the interest acquired is itself a security interest perfected by control (for example, over negotiable instruments not evidenced by certificate), section 57(3) appears to operate to give that security interest priority.
These priority rules appear in the priority waterfall below general law liens and statutory liens/charges. While it is extremely difficult to provide a general statement of priority, it seems likely that liens or statutory charges over negotiable instruments, negotiable documents of title or chattel paper should have priority over ownership (or similar) interests in them, else the purpose of the lien or charge would be frustrated.
These priority rules are subject to the provisions of the Cheques Act 1986 (Cth) and the Bills of Exchange Act 1909 (Cth) - section 256.
4. Fourth, control – section 57. Security interests perfected by control are very powerful and defeat other PPSA security interests in relation to both original collateral and proceeds, regardless of time of attachment, time of perfection or knowledge of prior security interests11
Perfection by control is subject to perfected transitional security interests12. This is to preserve the priority of the existing pipeline of pre-PPSA transitional security interests, and ensure that they are not suddenly and unexpectedly subjected to the risk of being defeated by a new class of security interests introduced under the PPSA that can be perfected by control.
So far the priority waterfall has not dealt with the priority of PPSA security interests. The first three priority buckets in the waterfall relate to interests (not security interests) taken in collateral that is also subject to other PPSA security interests, and general law and statutory liens/charges (which are not PPSA security interests). Security interests perfected by control are the highest-ranking PPSA security interests in the priority waterfall, subject to the important exception in relation to transitional security interests.
Perfection by control is only possible for six (6) classes of collateral, mainly financial collateral, being:
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ADI accounts (bank accounts)
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intermediated securities (for example, ASX-listed shares)
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investment instruments (for example, unlisted shares, bonds, units in managed investment schemes, etc)
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letters of credit
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negotiable instruments not evidenced by a certificate; and
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satellites and space objects
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Perfection by control is subject to the priority buckets above it in the waterfall. This is because section 69 (creditors receiving payment of debts), section 73 (liens and statutory charges in the ordinary course of business) and sections 70, 71 and 72 (acquisitions of interests in negotiable instruments, chattel paper and negotiable documents of title) are clear on their terms that when they apply, PPSA security interests (which should include security interests perfected by control) are defeated.
5. Fifth, accounts – section 64. Security interests over accounts (including purchasers such as factors or invoice financiers) generated from sales of inventory, as original collateral and granted for new value, defeat PMSIs (but see section 59 discussed below) that may attach to the same accounts as proceeds of sales of the inventory to which the PMSIs attached as original collateral.
To defeat inventory PMSIs that attach to accounts as proceeds, the incoming secured party over the accounts (factor) must either:
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- register over the accounts (presumably as future property – see discussion below) before the PMSI is registered against the inventory which when sold will generate the accounts over which the factor will take security13; or
- if not registered before the PMSI, the factor must give 15 business days notice to the holder of the PMSI which describes the inventory that, when sold, will generate the accounts, before the factor’s security interest over the accounts attaches or is registered (whichever is earlier)14.
The author's interpretation is that both options (i) and (ii) above appear (the PPSA is unclear) to operate prospectively. Assuming this is correct, factors (secured parties over accounts generated from inventory) can only take advantage of the priority rule in section 64 to trump PMSIs that attach to accounts (as proceeds) generated from inventory sales, in respect of accounts to be generated in the future from inventory sales, not in respect of existing accounts.
Although this priority rule sits ahead of PMSIs in the priority waterfall, it clearly has a limited scope of operation and will not defeat all PMSIs - only inventory PMSIs in some circumstances.
This priority rule creates a space for factors to operate - to buy or take security interests over future accounts to be generated from inventory sales, free from defeat by PMSIs over the underlying inventory sold that would otherwise attach to the accounts as proceeds with PMSI super-priority.
This is one instance where “normal” security interests may defeat PMSIs.
If a grantor has granted a security interest that has attached to and been perfected against
its existing accounts such as an all-assets security interest (first security interest), then the priority of the first security interest could not be upset by a factor by operation of the priority rule in section 64 alone. However, the factor may be able to rely on section 59 of the PPSA, which attempts to resolve "circularity" in priority disputes. The factor has priority over the PMSI holder, the PMSI holder has priority over the first security interest, therefore (by operation of section 59) the factor may have priority over the first security interest.
This priority rule allows factors to defeat inventory PMSIs in limited circumstances to provide invoice financing options to businesses.
This priority rule in relation to (future) accounts generated from inventory sales appears behind security interests perfected by control in the waterfall. There may be little overlap in respect of original collateral, however, priority disputes may occur in relation to proceeds.
For example, if a security interest perfected by control (for instance, the security interest of a bank over an ADI account held with it) comes into competition with a security interest over an account (receivable) generated from inventory sales because the proceeds of the account (once collected) are deposited into the ADI account, then the security interest perfected by control wins15.
This priority rule is complex, and it is discussed further at paragraphs 18.8.1 to 18.8.22 below.
Security interests over accounts that are outright transfers (that is, an assignment) of accounts will not be circulating security interests, despite many accounts being deemed to be circulating assets unless the secured party takes control of them16. Accordingly, invoice financiers are best placed to take security interests over accounts by way of outright assignments, and to this extent title still matters under the PPSA. This is in contrast with pre-PPSA case law, which requires that a secured party have actual control over the proceeds of accounts (receivables) to enjoy a fixed (instead of a floating) charge over the accounts17.
6 Sixth: “strong PMSIs” – section 63. PMSIs of sellers, lessors and commercial consignors (strong PMSIs), provided they comply with the PMSI Rules (see below).
Strong PMSIs will defeat “normal PMSIs” (see below – seventh in the waterfall) granted by the same grantor in the same collateral.
To qualify for PMSI “super priority” all PMSIs (strong and normal PMSIs alike) must comply with what are termed the PMSI Rules in this book.
The PMSI Rules18 are that:
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- perfection must be by registration
- the registration must nominate that the security interest is a PMSI
- where the collateral is inventory the PMSI must be registered before the collateral is either supplied to the grantor (for inventory that is goods), or the security interest attaches (for other inventory)
- where the collateral is equipment (not inventory), the PMSI must be registered within 15 business days of the secured party supplying goods to the grantor, or 15 business days of the security interest attaching (for collateral other than goods)
PMSIs appear in the priority waterfall after the priority rules relating to security interests perfected by control and security interests over (future) accounts generated from sales of inventory. There is very limited scope for priority disputes in relation to original collateral because PMSIs cannot be taken over original collateral that is investment instruments, intermediated securities or negotiable instruments, which are the three major classes of collateral against which security interests can be perfected by control19.
However, if PMSI collateral is disposed of and the proceeds are used to acquire collateral which can be perfected against by control, and another secured party perfects a security interest by control over those proceeds, the PMSI would be defeated. For example, this would be the case where PMSI collateral is sold and the proceeds are deposited into an ADI account where the ADI account bank is owed money and holds a perfected security interest over the ADI account. Another example is where PMSI collateral is inventory
that when sold generates an account which has been taken security over under the priority rule in section 64 - inventory PMSIs will be defeated in relation to such accounts.
7. Seventh: “normal PMSIs” – section 62. All other PMSIs, again provided they comply with the PMSI Rules (see the paragraph immediately above).
8. Eighth: perfected v’s perfected – earliest priority time wins - sections 55(4) and 55(5). In competitions between two perfected security interests, the interest with the earliest priority time wins, subject to any secured party later perfecting by control or having a PMSI.
9. Ninth: perfected v’s unperfected – perfected always wins - section 55(3). In competitions between one perfected and one unperfected security interest, the perfected security interest wins.
10. Tenth: execution creditors can defeat unperfected security interests - section 74. Execution creditors who obtain garnishee or other court orders to enforce judgment debts over collateral, or take possession of collateral to enforce a judgment or court order, before security interests are perfected over the collateral, defeat unperfected security interests in the collateral; and
11. Eleventh: unperfected v unperfected – priority is by order of attachment - section 55(2). In competitions between two unperfected security interests, the first to attach wins20.
Notes:
1 PPSA section 69. The PPSA treats the matter of payments from an ADI account, and payments by negotiable instrument, as a priority contest with other security interests attached to the funds or instrument used to make payment. Thus, creditors receiving payments are subjected to a priority dispute, although such creditors will be well-positioned in most cases. Disputes should seldom arise. The matter is different if an extinguishment rule applies, for instance, section 48 in respect of currency.
2 PPSA section 69(2)
3 See Deane J in Hewitt v Court (1983) CLR 639
4 PPSA section 73(2) permits Commonwealth and State legislation to determine the priority of statutory liens and charges in relation to PPSA security interests.
5 PPSA section 73(1)
6 In relation to equitable liens in favour of sellers and buyers under contracts of sale, it is unclear whether the contract in question must be specifically enforceable for the equitable lien to arise. The better view is that there is no need for specific enforceability - this view is supported by Deane J in Hewitt v Court, and in JNJ Investment Australia Pty Ltd v Sunnyville Pty Ltd [2006] QSC 249. However, several first instance decisions hold that specific enforceability is required – see for example Electrical Enterprises Retail Pty Ltd v Rodgers (1988) 15 NSWLR 473; Re Mas Good Industries (Australia) Pty Ltd [2000] WASC 155.
7 Electrical Enterprises Retail Pty Ltd v Rodgers (NSWSC, Kearney J) (1988) 15 NSWLR 473.
8 PPSA section 73(7)
9 PPSA sections 70, 71 and 72
10 The author's interpretation of section 57(2A) is that security interests perfected by control over original collateral (say shares) retain “control super priority” if the original collateral is sold and the security interest attaches to proceeds. The exception is where another security interest is perfected against the proceeds as original collateral by control – section 57(2A)(b).
11 PPSA section 57(1), 57(2A) and 322A
12 PPSA section 322A
13 PPSA section 64(1)(a)
14 PPSA sections 64(1)(b) and 64(2)
15 PPSA section 64, note 1
16 PPSA section 340(4A)
17 Agnew v The Commissioner of Inland Revenue (PC) [2001] 2 AC 710 (Agnew); and National Westminster Bank plc v Spectrum Plus Limited (HoL) [2005] UKHL 41 (Spectrum).
18 PPSA section 62
19 PPSA section 14(2)
20 PPSA section 55(2)
