The priority rule
Security interests over accounts generated from sales of inventory as original collateral and granted for new value defeat inventory PMSIs that may attach to the same accounts as proceeds of sales of inventory, provided the secured party either:
registers over the accounts (presumably as future property – see below) before the PMSI is registered over the inventory which when sold will generate the accounts1; or
(b) otherwise, the secured party looking to take security over the accounts gives 15 business
days notice to the holder of the PMSI before the attachment of the security interest over the accounts or the registration to perfect the security interest over the accounts (whichever is earlier), nominating the inventory which when sold will generate accounts over which the incoming secured party over accounts will take priority2.
Where there are existing PMSIs over inventory, and the inventory when sold will generate accounts (that is, proceeds) to which the inventory PMSIs would otherwise attach, that is the main space where it appears that an incoming invoice financier can give existing PMSI secured parties over inventory a notice in the prescribed form informing them that they will be trumped over all (future) accounts generated from the sale of inventory described in the notice3.
This rule creates a space for invoice financiers to operate, to buy or take security interests over (future) accounts 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.
Prospective operation - secured parties over accounts generated from inventory can seemingly only trump PMSIs that attach to the accounts as proceeds, in respect of accounts generated in the future
The PPSA is unclear but both options (a) and (b) in paragraph 18.8.1 above seem to operate only prospectively. That is, an incoming invoice financier (secured party over accounts generated from inventory sales) must register before the priority time of an inventory PMSI over inventory (option (a) above), which would only be possible if the invoice financier registered against future accounts, well before the inventory PMSI collateral is sold. Alternatively, the invoice financier must give a description of inventory which when sold will generate accounts over which the invoice financier will take security (option (b) above). Again, it would seem that the invoice financier must enter the scene before the inventory is sold and the accounts are generated, otherwise it would seem difficult to give a notice which describes the inventory which when sold will generate accounts, after the inventory has been sold and the accounts already generated.
The PPSA is unclear on the matter but it appears that invoice financiers (secured parties over accounts generated from inventory) can only take advantage of this priority rule in section 64 to trump inventory PMSIs that attach to accounts (as proceeds) generated from inventory sales, in respect of accounts to be generated from future inventory sales, not in respect of existing accounts.
Security interests over (future) accounts generated from inventory sales granted for new value and in compliance with section 64 appear ahead of PMSIs in the priority waterfall. However, clearly these security interests over accounts can only defeat inventory PMSIs, and even then only in limited circumstances.
“Normal” security interests over existing accounts cannot be upset?
If a grantor has granted a security interest that has attached to and been perfected against its existing accounts as original collateral, assuming it is correct that the priority rule in section 64 operates only in respect of future accounts, then it appears that the priority of that security interest cannot be upset under the priority rule in section 64 (but see the discussion of section 59 at paragraph 18.8.20). Assuming this is correct, an existing security interest over existing accounts should take priority over a subsequent invoice financier's security interest just as a fixed charge over accounts would pre-PPSA. The difference under the PPSA is that if existing accounts have been generated from sales of collateral over which there were PMSIs, then the PMSIs can attach to the accounts as proceeds with PMSI “super priority” and defeat a “normal” security interest over the accounts.
There lies the need for the priority rule in section 64, which allows invoice financiers to defeat PMSIs in limited circumstances. The priority rule in section 64 appears to give no protection against non-PMSI security interests over inventory sold which generates accounts and which may attach to the accounts as proceeds of the inventory sold.
Priority rule subject to perfection by control
The priority rule in section 64 is subject to perfection by control4. Once accounts are collected and the proceeds deposited into an ADI account, if the account bank holds security over the ADI account (which would be perfected by control), the account bank would win.
Invoice financiers must, therefore, be careful about bank account arrangements. Invoice financiers will presumably require collection accounts to be held either with them if they are a bank or authorised deposit-taking institution buying or taking security over accounts, or at independent banks which have no other lending to the seller of the accounts.
The priority rule in section 64 applies to accounts generated from the sale of inventory. Accounts generated from performance of services are not subject to this rule and would not be available to invoice financiers under the priority rule in section 64 . This is probably a non-issue since PMSIs over service-inputs (assuming it is possible to have PMSIs over services - unlikely) will seldom, if at all, attach to accounts as proceeds generated from services provided.
“Compensation” to inventory PMSIs defeated over accounts
In the circumstance where PMSIs that attach (as proceeds) to accounts generated from sales of inventory are subordinated to security interests over those accounts as original collateral under the priority rule in section 64, the PMSI secured party is compensated by being taken to have a PMSI over the new value (the loan funds or purchase price paid for the accounts, and possibly property purchased with those funds) provided by the invoice financier over the accounts as original collateral5.
The inventory PMSI secured party need not take any further steps to perfect against the new value. Perfection occurs automatically by force of section 64(3) of the PPSA.
Diagram 4
1. $50 milion loan, 1 January 2010
2. $50 milion loan, 1 August 2010
3. Security interest over all present and after-acquired property (fixed and floating charge), granted 1 January 2010
4. Transfer of accounts
5. Payment for accounts
6. Security interest (consignment of car)
7. Consignment of car (extension of credit), for D to on-sell car
Diagram 4 is again based on the standard PPS priority diagram, but this time includes a sale of accounts to an Invoice Financier, which will be a security interest and must be registered. Transfers of accounts are deemed security interests, regardless of whether they secure obligations.
In addition, a car supplier (consignor) has consigned a car to D for on-sale. Assume the car is inventory in D’s hands. The consignor’s car consignment will be an inventory PMSI (commercial consignments are PMSIs), and assume that the consignor registers it before the car is supplied to D, which the consignor must do because the car is inventory which is goods.
The consignor’s PMSI over the car will attach to proceeds of the car if the car is sold. Assume D sells the car for an account payable – the consignor’s security interest will attach to the account generated with PMSI super-priority.
Before the car (inventory) is sold to generate an account (debt owing for payment of the purchase price for the car), the Invoice Financier could serve a notice on the Car Consignor under section 64 nominating the car as inventory which when sold may generate accounts. The Invoice Financier could then purchase or take security over the (future) account (pay D for it), and take priority over the Car Consignor in respect of the account once generated.
Note that Bank A holds a prior perfected security interest that will attach to all accounts owned by D. The operation of section 64 is limited to giving the Invoice Financier priority over PMSIs (the Car Consignor) by serving a notice under section 64, not "normal" security interests such as those held by Bank A. However, the Invoice Financier may be able to rely on section 59 of the PPSA, which attempts to resolve "circularity" in priority disputes.The invoice financier has priority over the Car Consignor (PMSI), the Car Consignor has priority over Bank A, therefore (by operation of section 59) the invoice financier may have priority over Bank A.
The Car Consignor, if defeated by the Invoice Financier over the account generated by the sale of the car, would have a deemed PMSI in any new value that the Invoice Financier provides to D, being the purchase price or loan funds provided to D for the account purchased. The Car Consignor will need to be able to identify that new value in either an ADI account or otherwise in D’s business.
The Invoice Financier’s security interest over the accounts will not be a circulating security interest provided it is structured as a transfer of accounts and not a mere security interest6. This is despite many accounts being deemed circulating assets unless the secured party takes control of them7.
Notes:
1 PPSA section 64(1)(a)
2 PPSA sections 64(1)(b) and 64(2)
3 PPSA section 64(2)
4 PPSA section 64, Note 1
5 PPSA section 64(3)
6 PPSA section 340(4A)
7 PPSA section 340(5)(a) and (b)