- 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
What is chattel paper?
First, what is chattel paper? Chattel paper is a new idea introduced to Australia by the PPSA. Perhaps the most common forms of chattel paper will be the original (security) agreements under leases of goods (broadly, chattels means goods) and conditional sales by retention of title in respect of specific goods.
In very broad terms, chattel paper means writing that evidences both a debt owing in respect of goods and a security interest in the same goods. There is an elaborate definition of chattel paper in section 10 of the PPSA, which extends even to things like intellectual property. Simple examples of chattel paper are the original documents for leases of goods and conditional sales by retention of title in respect of specific goods.
The idea behind chattel paper is to recognise a document by which chattels and debts owing on them can be transferred, so that existing secured parties can “monetise” the debts owing to them by selling them (and the interest in goods that secures repayment of the debts) to other investors.
The special status of chattel paper, negotiable instruments and negotiable documents of title
It is important to ensure that each of chattel paper, negotiable instruments and negotiable documents of title can be “negotiated”, that is, transferred for value to others.
The PPSA includes special rules in sections 70, 71 and 72 to facilitate the negotiation of these instruments, documents or chattel paper in priority to PPSA security interests which may be attached to them, provided (in broad terms) the buyers or investors in them:
- 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 instruments, documents 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 over the instrument, document or chattel paper, or that the terms of such security agreement would be breached by the acquisition1
The priority rules in sections 70, 71 and 72 appear ahead of security interests perfected by control in the priority waterfall. This is 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 all security interests, which by definition should include security interests perfected by control.
Security interests cannot be perfected by control over negotiable instruments evidenced by certificate, negotiable documents of title or chattel paper as original collateral - there should be few, if any, priority contests in relation to original collateral. However, if a negotiable instrument, negotiable document of title or chattel paper represents proceeds of other original collateral against which security interests were perfected by control and those security interests attach to the negotiable instrument, negotiable document of title or chattel paper as proceeds with “control priority”2 then the fact that the priority rules in sections 70, 71 and 72 defeat security interests perfected by control may become relevant.
The priority rules in sections 70, 71 and 72 in respect of negotiable instruments, chattel paper and negotiable documents of title are set out below.
Negotiable instruments – section 70
Negotiable instruments include cheques, promissory notes, letters of credit that must be presented to claim payment and bills of exchange under the Bills of Exchange Act 1909 (Cth).
The idea is that there is an instrument that evidences the obligation of a person to pay an amount at a certain date, which instrument can be sold to others (“negotiated”) for either face value, or slightly less than the face value, and so monetised.
A person who acquires a negotiable instrument (for example, buys it, knowing that s/he can later claim payment from the person(s) ultimately liable under the instrument) or an interest in a negotiable instrument takes priority to a perfected security interest over the negotiable instrument if all of the following conditions are satisfied3:
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- the person acquires the interest for value, and pursuant to a consensual transaction
- the person takes possession or control of the negotiable instrument; and
- either:
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- if the person acquires the interest in the ordinary course of his/her business of acquiring interests in negotiable instruments, without actual or constructive knowledge that the acquisition may breach the terms of any security agreement that governs a security interest over the instrument; or
- otherwise, the person acquires the interest without actual or constructive knowledge of the existence of any perfected security interest over the instrument.
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The idea of this priority rule is to preserve the negotiability of negotiable instruments, so they can be freely transferred in the Australian economy. However, unless persons who acquire interests acquire them in the ordinary course of their business of regularly acquiring interests in negotiable instruments, they take the risk of having constructive knowledge of the existence of a perfected security interest over the instrument (see paragraph above), in which case they will take subject to security interests.
Accordingly, it will be safest to acquire negotiable instruments in the ordinary course of a business of acquiring interests in negotiable instruments.
Chattel paper – section 71
From above, perhaps the most common forms of chattel paper are the original (security) documents for leases of goods, and conditional sales by retention of title in respect of specific goods.
A person who acquires chattel paper or an interest in chattel paper takes priority to a perfected security interest over the chattel paper if all of the following conditions are satisfied4:
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the person acquires the interest for new value, and pursuant to a consensual transaction
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the person acquires the interest in the ordinary course of the person’s business of acquiring interests in chattel paper; and
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the person takes possession of the chattel paper (the original documents) without actual or constructive knowledge of the existence of a perfected security interest over the chattel paper – any search of the PPS Register would be dangerous before acquiring chattel paper. There is no constructive knowledge of the contents of the PPS Register5
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There is a further limb to section 71. Even if a person acquires chattel paper or an interest in chattel paper without taking possession of the chattel paper, or with knowledge of the existence of a security interest over the chattel paper, the person will still have priority over a security interest that “has attached to proceeds of inventory as original collateral”. This appears (it is unclear) to ensure that even purchasers of accounts generated from sales of inventory where the inventory is subject to financing by chattel paper (for example, lease or retention of title sale) are defeated in relation to proceeds if the collateral is sold6.
Negotiable documents of title – section 72
One example of a negotiable document of title is a negotiable bill of lading. A bill of lading is a document that evidences the carriage of an underlying item (which is often transported by ship). A bill of lading may in certain circumstances be negotiable in the sense of being transferrable to others who have either purchased or financed the item, and permits the holder to collect the item (at port).
The key difference between negotiable instruments and negotiable documents of title is that negotiable instruments evidence the right to receive a payment, whereas negotiable documents of title evidence the right to receive an underlying item.
The priority rule for negotiable documents of title is similar but not identical to negotiable instruments.
The holder of a negotiable document of title takes priority to a perfected security interest over it if7:
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- the person gives value to acquire the document; and
- either:
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- if the person acquired the document in the ordinary course of a business of acquiring negotiable documents of title, without actual or constructive knowledge that the acquisition breaches the terms of a security agreement that governs a security interest over the document; or
- otherwise, the person acquires the document without actual or constructive knowledge of the existence of a perfected security interest over the document. Again, a search of the PPS Register before acquiring an interest in a negotiable document of title would be dangerous.
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Notes:
1 PPSA sections 70, 71 and 72.
2 Security interests perfected by control over original collateral (for example, shares) attach to proceeds of the original collateral with “control priority” – section 57(2A). An exception is where another security interest is perfected against the proceeds as original collateral (not proceeds) and is perfected by control – section 57(2A)(b).
3 PPSA section 70
