- 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
PMSIs in general
PMSIs have super priority over many other security interests in the same collateral even when the other security interests are perfected and have a priority time before the PMSI.
Strong PMSIs are the title-based PMSIs, being PMSIs of sellers, lessors and commercial consignors, provided they comply with the PMSI Rules (see paragraph 18.9.6 below). Strong PMSIs defeat “normal PMSIs” granted by the same grantor in the same collateral. See the priority example beginning at paragraph 18.9.32 for how a priority contest can arise between strong PMSIs and normal PMSIs.
There are exceptions to so-called PMSI super-priority, which are predominantly the interests and security interests listed ahead of PMSIs in the priority waterfall. To summarise some key examples:
(a) payments to creditors from an ADI account or by negotiable instrument: assume, for example, a duly registered PMSI exists over a car because it was acquired on finance, the car is sold and the purchase moneys are deposited into an ADI account, and the PMSI attaches to the proceeds in the ADI account.
The PMSI will attach to and be automatically perfected over the funds in the ADI account without any registration that covers the ADI account, because security interests automatically perfect against proceeds that are cash in ADI accounts (and currency, cheques and insurance proceeds for damage to collateral)1 provided the security interest over the original collateral was duly perfected by registration.
Creditors receiving payment of debts owing to them by transfers of funds from that ADI account by EFT or transfer/debit order will defeat the PMSI over those funds, unless the creditor has actual knowledge that the payment breached the terms of the PMSI security agreement - section 69;
(b) general law liens and statutory liens or charges arising to secure amounts owing for goods or services provided in the ordinary course of business (below, liens) defeat PMSIs, provided:
(i) the lien holder has no actual knowledge that the lien arising would breach the terms of the PMSI security agreement, and
(ii) the priority of the lien is not excluded from the “super priority” accorded under section 73(1), by virtue of section 73(2) or section 73(7).
Using the car example, if a car is subject to a registered PMSI and is put into servicing with a mechanic, and the mechanic is not paid, then the mechanic could exercise a common law (possessory) lien over the car and retain the car pending payment, and the mechanic's lien would defeat the PMSI over the car; and
(c) security interests perfected by control: continuing with the car example, assume a duly registered PMSI exists over a car, the car is sold, and the PMSI attaches to the proceeds of sale when they are deposited into the grantor’s ADI account held with Bank A. From above (paragraph 18.9.3(a)) the PMSI attaches to and is automatically perfected against the proceeds in the bank account.
Assume the grantor also owes Bank A money and has granted Bank A a security interest over the ADI account, which will be perfected by control given that Bank A is the account bank. Bank A defeats the PMSI that attaches to the proceeds of the car in the ADI account, because Bank A holds a security interest perfected by control.
That is why strong PMSIs appear sixth in the waterfall, and normal PMSIs seventh in the waterfall after them.
The PMSI Rules
All PMSIs, both strong and normal, must be perfected in accordance with what are termed the PMSI Rules in this book, in order to qualify for their limited super priority over existing perfected PPSA security interests.
The PMSI Rules are that:
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- PMSIs must be perfected by registration2;
- or PMSIs over collateral that is inventory in the hands of the grantor (assume the car in the above example is acquired on PMSI finance but for further on-sale in the grantor's ordinary course of business as a car dealer), the PMSI must be registered before the collateral is either supplied to the grantor (for inventory that is goods – the car is a good), or before the security interest attaches (for other inventory). Accordingly, a PMSI secured party must (in most cases) “pre-register” an inventory PMSI against a grantor before entering into the security agreement, and certainly before supplying goods. Pre-registration is permitted where the secured party has reasonable grounds to believe a security interest will be taken in the future3;
- for PMSIs over equipment (collateral other than inventory), the equipment PMSI must be registered within 15 business days of the PMSI secured party supplying goods to the grantor, or 15 business days of the security interest attaching for collateral other than goods4.
This effectively means that there is always a 15 business day (three week) “lag risk” that equipment PMSIs may exist out there but are not registered yet when a search is made of the PPS Register against the grantor, and may later appear within a few weeks and defeat normal security interests.
15 business day latent equipment PMSI “lag risk”
To illustrate the 15 business day latent equipment PMSI “lag risk” introduced above (18.9.3(c)), suppose a secured party wants to lend money and take security over a truck that a grantor already owns. The secured party is not aware of any security interests over the truck and the grantor says that there are no other security interests. The secured party searches the PPS Register against the grantor and the serial number of the truck and obtains a clear search. Does that mean the secured party is clear to lend and take security over the truck?
What if the grantor acquired the truck on PMSI finance two weeks prior to use in his/her business as equipment, but the equipment PMSI secured party, having 15 business days to register, has not registered yet? The only way to be safe is for the incoming secured party to search the PPS Register, register a security interest to lock in a priority time, then wait 16 business days for any equipment PMSIs to appear on the PPS Register, search the PPS Register again to ensure no equipment PMSIs have appeared in the meantime, and only then lend money.
PMSIs that breach the PMSI Rules – PMSIs not registered in time
What is the position where PMSIs are registered outside of the PMSI Rule timeframes, which are (A) for inventory PMSIs, before supply of goods to the grantor, or before attachment for inventory other than goods, and (B) for equipment PMSIs, within 15 business days of supply (for goods) or attachment (for equipment other than goods)? Are PMSIs still valid as security interests but without their PMSI super priority, with a priority time of the time of registration, or are they completely invalid?
The PPSA appears to provide no answer to this important point. The better view is that PMSI super-priority status is lost, but the security interest remains perfected with a priority time from the time of registration.
“Strong PMSIs”
Duly registered PMSIs of sellers, lessors or commercial consignors are strong PMSIs. They defeat other “normal” PMSIs and other perfected security interests in the same collateral, except (from above) security interests perfected by control5. PMSIs are also subject to the security interests and other interests that appear above them in the priority waterfall.
Strong PMSIs are the title-based PMSIs, those of sellers (for example, retention of title sales), lessors and commercial consignors. The policy here is presumably to protect suppliers against the insolvency of their buyer customers, and to promote the supply of goods and other stock to retailers and the like, to keep the economy ticking over and facilitate commerce.
Suppliers may be better served by supplying property on lease or conditional sale by retention of title (which will be strong PMSIs), rather than outright sales and taking security interests back (which will be normal PMSIs). Much will depend on the circumstances.
An example of a contest between a strong PMSI and a normal PMSI is discussed at paragraph 18.9.33 below.
“Normal PMSIs”
All other duly perfected PMSIs (not PMSIs held by sellers, lessors or commercial consignors) are “normal” PMSIs. Normal PMSIs have limited super priority over other perfected PPSA security interests (but not strong PMSIs, and not security interests perfected by control). This is regardless of priority time or knowledge of prior security interests, again provided they comply with the PMSI Rules outlined above.
PMSI priority examples by diagram
Working through some priority examples with the aide of a diagram is perhaps the best way to understand how PMSIs fit into the PPSA priority hierarchy.
Take diagram 5. The diagram is based (as always) on the standard PPS priority diagram. To recap, the debtor/
grantor D has borrowed money from Bank A, and granted a standard security package to Bank A on 1 January 2010 before the PPSA commenced. Bank A’s security interests are valid and enforceable under the PPSA as transitional security interests, and are temporarily perfected for 24 months until 2014. Bank A’s security interests which are registered at ASIC will be migrated across to the PPS Register. Bank A should check the migrations to ensure Car they are sufficient, and if not Bank A should conduct new Lessor registrations within 24 months.
Diagram 5
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. Lease of car, 5 month term
5. Security interest (lease) over car
Assume that Bank A, conscious of the fact that security interests automatically attach to proceeds under the PPSA, ensures that the registrations for its security interests cover all proceeds generated from original collateral.
Assume that D later acquires a car on a five month lease to use in its business, and enters into a lease of the car with a finance company (car lessor) after Bank A lends to D and takes security. Given that:
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the car lessor finances the acquisition of a new asset by D by leasing the car to D;
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the asset is a good, and serial numbered property being a car (motor vehicle); and
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the term of the lease has exceeded three months,
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the lease that D takes from the car lessor over the car will be a PPS Lease, and so a PMSI. All PPS
Leases are PMSIs6.
The car lessor's PMSI over the car will have priority to the security interest held by Bank A (the all-assets fixed and floating charge security interest would attach to D’s interest in the car) if the car lessor complies with the PMSI Rules. This result applies regardless of priority time (the priority time of the car lessor’s PMSI is after the priority time of Bank A’s fixed and floating charge (which, being a transitional security interest, is immediately before the registration commencement time)) or knowledge.
Assume that D does not acquire the car as inventory to sell or consume in its business, but rather as equipment to use in its business. To comply with the PMSI Rules and obtain PMSI super priority, the car lessor must register its equipment PMSI (a PPS Lease) against D within 15 business days of supplying the car on lease to D.
Ideally the car lessor would also register against the serial number of the car (likely to be the vehicle identification number or VIN) to prevent its PMSI being extinguished if D sells the car (see discussion of the application of relevant extinguishment rules in paragraphs 21.5.1 to 21.7.8 of Chapter 21 (The Extinguishment Rules)). The registration of the car lessor’s PPS Lease (PMSI) will not be defective if not registered against the serial number of the car. Only non-registration against serial numbers of collateral that is commercial aircraft and consumer serial numbered property (serial numbered property which must be registered by serial number) results in a defective registration.
PMSI status in proceeds
This is not shown on the priority diagram but assume that before D acquired the car on lease from the car lessor, D bought a truck from a dealer and financed the purchase by mortgage – the truck dealer sold the truck to D outright, agreed to accept deferred instalment payments from D of the purchase price, and took a mortgage over the truck from D to secure payment of those deferred instalment payments. The truck dealer’s PMSI appears to be a normal PMSI because it is a mortgage and not a lease, assuming the truck dealer perfects the PMSI mortgage complying with the PMSI Rules. Howevever, note that section 63 provides for a "seller" to hold a strong PMSI, and the truck dealer is a seller, albeit taking a mortgage back.
Assume next that D sells the truck, receives the purchase price into D’s ADI account held with Bank A, then uses those funds to pay the deposit under the car lease by which D leases the car from the car lessor, and D makes the deposit payment to the car lessor from the ADI account by EFT or transfer/debit order.
Assume also that the truck dealer’s truck mortgage PMSI was registered against the truck as original collateral and against all proceeds generated from the truck. Proceeds include all identifiable or traceable personal property in which the grantor has an interest and which are derived directly or indirectly from a dealing with collateral or a dealing with proceeds of the collateral7. Proceeds include “proceeds of proceeds”8.
The truck dealer’s PMSI mortgage will automatically attach to the purchase price money received by D for
the truck and deposited into D’s ADI account. The truck dealer’s PMSI mortgage will also be automatically perfected against the truck sale proceeds deposited into D’s ADI account, because perfection against proceeds that are funds in an ADI account is automatic if the security interest was registered against the original collateral9. The truck dealer will have the same priority time in respect of the truck sale proceeds held in D’s ADI account as he or she had against the truck, provided that the truck sale proceeds remain identifiable in D’s ADI account10. The truck dealer will also enjoy PMSI super priority in respect of identifiable truck sale proceeds in D’s ADI account.
In terms of identification of proceeds to which a security interest attaches, the ADI account bank, Bank A, has a strong advantage, because its security interest will attach to all funds in an ADI account. By contrast, the truck dealer in the example must be able to demonstrate that the sale proceeds of the truck remain identifiable or "traceable" in D’s ADI account. If there are various transactions on the ADI account, identification becomes very difficult in the absence of clear identification rules, which are absent in the PPSA. The PPSA has identification rules, but only for goods that are processed or comingled into a product or mass (see Chapter 26 (Accession, processing and commingling of goods)). Equitable tracing principles (see paragraph 20.2.10 of Chapter 20 (Following Collateral Value Upon Transfers) may apply but that is a question for the courts to determine.
The payment of the car lease deposit to the car lessor with funds from the ADI account over which both Bank A and the truck dealer have attached and perfected security interests will defeat both Bank A's ADI account security interest over the funds which is perfected by control, and the truck dealer’s truck mortgage PMSI that has attached to the funds in D’s ADI account with PMSI super-priority when the truck was sold. The car lease deposit payment to the car lessor goes to pay a debt, being the deposit money owing to the car lessor under the car lease contract. The car lessor can retain the deposit money in priority to Bank A and the truck dealer under section 69, which makes sense, provided the car dealer has no actual knowledge that the deposit payment made from the ADI account may have breached the terms of either Bank A’s or the truck dealer’s security agreements.
Do the security interests of Bank A and (provided the payment from the ADI account can be indentified or traced as the proceeds of sale of the truck) the truck dealer attach to the car which D acquires on lease from the car lessor partially with funds (the deposit money) that are subject to these security interests? The question arises because the PPSA treats the matter of payments of debts owing to creditors from ADI accounts as priority (not extinguishment) matters – see section 69.
The PPSA is unclear. Can the car be said to be proceeds of the deposit payment paid by D to the car lessor from D’s ADI account? Can the car be said to be “derived directly or indirectly from a dealing with” the funds in D’s ADI account?11 The PPSA is unclear but it is at least arguable that yes, the car is at least partially the proceeds of the funds in D’s ADI account used to make the car lease deposit payment. If so, then the security interests of Bank A and the truck dealer would attach to the car as proceeds. The car dealer’s strong PMSI should (hopefully) defeat the normal PMSI held by the truck dealer, however the control priority that Bank A enjoys may produce unexpected results, especially for the car lessor.
Strong PMSIs v’s normal PMSIs
The car lessor's PMSI is a strong PMSI because it is the acquisition of personal property by lease. Leases, conditional sales and commercial consignments, being the title-based PMSIs, can be strong PMSIs12. Strong PMSIs defeat other “normal” PMSIs in the same collateral.
An example of how a strong PMSI and a normal PMSI can relate to the same collateral and become subject to a priority dispute is where two financiers provide funds for the acquisition of a new asset. In the example above, if Bank A provides a further advance to D to enable D to pay the car lease deposit to the car dealer, then Bank A will have a (partial - see PPSA section 14(1)) PMSI over the car to the extent of that advance. The car lessor will have also (partially) funded the acquisition of the car by D. Bank A’s existing security interest will attach to the car, with normal PMSI priority to the extent of the new advance made to D to fund the car lease deposit. Bank A should consider the need (if any) to conduct a new registration over the car within the PMSI Rule timeframes, nominate PMSI on the financing statement, and register against the car’s serial number. The car lessor as the lessor of the car to D will hold a strong PMSI over the car, which would defeat Bank A’s normal PMSI.
This demonstrates the need for/benefit of strong PMSIs, to ensure that suppliers get priority over the property they supply on finance, free of other normal PMSIs attaching to those items. Suppliers may often be better off supplying personal property by lease or conditional sale by way of retention of title (which will be strong PMSIs), rather than selling and taking a mortgage or other security interest back of the property supplied (which may be a normal PMSI)13. It should be noted, however, that section 63 provides for "sellers" to hold strong PMSIs. It appears arguable that even a seller taking a mortgage back to secure an outstanding purchase price may have a strong PMSI.
Title-based security interests such as leases and conditional sales still have an advantage under the PPSA – they are strong PMSIs and defeat other normal PMSIs that also happen to attach to the collateral.
Notes
1 PPSA section 33(1)(c)
2 PPSA section 62(2)(b) for inventory PMSIs, and section 62(3)(b) for equipment PMSIs.
3 PPSA section 151(1)
4 PPSA section 62
5 PPSA section 63
6 PPSA section 14(1)(c)
7 PPSA sections 31(1) and 31(3)
8 PPSA section 31(1)(a)
9 PPSA section 33(1)(c). This is not temporary perfection. It is automatic (sometimes called deemed) perfection which applies in respect of proceeds which take the form of currency, cheques, funds in an ADI account and insurance indemnity payments for damage to collateral, provided a security interest is registered over the original collateral.
10 PPSA section 32(5)
11 PPSA sections 31(1) and 31(3)
12 PPSA section 63
13 PPSA section 63, which provides that PMSIs of sellers, lessors and consignors are strong PMSIs.
