Security interests are not merely about the “day 1” collateral, or even after-acquired property. From above, security interests also automatically attach to proceeds1.
Proceeds are identifiable or traceable personal property derived directly or indirectly from a dealing in collateral or proceeds of collateral in which the grantor has or retains an interest2.
Secured parties have two pools of assets from which to recoup the money or obligations owed to them if security interests are not extinguished upon transfers of collateral. These are the original collateral, and the proceeds generated upon disposal of the original collateral. From above (paragraph 20.1.7(d)), secured parties can enforce against both original collateral that is transferred if the security interest is not extinguished by the transfer, and proceeds that are generated from the transfer, limited to the value of the collateral when transferred.
Security interests must also be perfected against proceeds. See paragraph 17.8.2 of Chapter 17 (Perfection) for discussion on how to perfect against proceeds.
Secured parties have much stronger rights against proceeds than before commencement of the PPSA. Before commencement of the PPSA, secured parties looking to trace proceeds of disposed or transferred collateral had to bring themselves within the equitable principle of tracing.The better view is that tracing in equity requires the existence of a fiduciary duty (whether by the existence of a trust or otherwise), and a breach of fiduciary duty by, for example, the mis-appropriation of trust or other property. Secured parties do not face this difficulty under the PPSA because all security interests automatically attach to proceeds under the PPSA.
The difficulty that secured parties will face under the PPSA in respect of proceeds is identification. Secured parties must be able to identify proceeds to establish a claim to them. This may be difficult if there are insufficient records.
Where collateral is goods, and it is processed into another product or comingled with other similar goods, the PPSA provides solutions by providing for identification rules. Security interests over various goods mixed or processed together continue into the product or mass, and share in the product or mass rateably in proportion to the debt they secure, limited to the value of the goods when processed or mixed. See Chapter 26 (Accession, Processing and Comingling of Goods) for discussion.
If processed or mixed goods are then sold and proceeds are generated, the security interests that continued into the product or mass should, following the general principles of the PPSA, attach to the proceeds.
Where the original collateral is not goods, the PPSA does not provide for identification rules to deal with situations where collateral is mixed with other property such as proceeds being deposited into an ADI account, or processed into other property, except that security interests attach to proceeds which are “traceable”.
The general law equitable principles that apply to identify trust property mixed with other property into a so-called “mixed fund” to permit tracing would provide a close and convenient analogy. These identification rules can be summarised as follows:
(a) where amounts are deposited into a fund (for example, an ADI account), and then the funds are withdrawn in their entirety to pay creditors or discharge debts or liabilities, the right to trace those funds is extinguished3. The same result would follow if the funds are paid into an overdrawn account such as an overdraft. Aside from equitable tracing and identification rules, section 69 of the PPSA (discussed at paragraphs 18.4.2 to 18.4.14 of Chapter 18 (Priority)) would produce these results in many cases;
(b) where funds are deposited into a mixed fund (for example, an ADI account in which there are other funds), and the mixed fund comprises:
(i) money of innocent parties (often the beneficiaries under the trust whose funds were misappropriated and mixed into another fund); and
(ii) money of the wrongdoer (usually the trustee who has committed a breach of trust and fiduciary duty by misappropriating trust funds to his own account), then any withdrawals from the mixed fund are taken first to dissipate the wrongdoer's funds4. It is difficult to see how this identification rule might be applied to the PPSA given that there is no obvious “wrongdoer” in many PPSA priority disputes; and
(c) where the mixed fund comprises the funds of many innocent parties, withdrawals are deemed to reduce each party's share in the fund rateably. The primary rule in relation to a mixed fund is that gains and losses are borne by the contributors to the fund rateably5. The rule in Clayton’s Case6, which is that withdrawals from a mixed fund are deemed to dissipate funds in the mixed fund in the order in which funds were deposited into the fund – “first in, first out”- should also be considered, but is of questionable application in the modern context.
It remains to be seen whether, and how, these identification rules that developed mainly under trust law will be applied under the PPSA where original collateral or proceeds (other than goods) to which different security interests attached are mixed into the same fund such as an ADI account.
Notes:
1 PPSA section 32(2)
2 PPSA section 31. There are particular rules about proceeds of financial property, intangible property, intellectual property, investment instruments and intermediated securities in section 31.
3 See Snell’s Equity (31st Ed), para 28-43. (link)
4 See Snell’s Equity (31st Ed), para 28-37, citing Re Hallet’s Estate (1879) 13 Ch D 696.
5 Foskett v McKeown (HoL) [2000] 3 All ER 97, Lord Browne- Wilkinson at p 102, Lord Millet (Lord Hoffman concurring) at p 124.
6 Devaynes v Noble, Clayton's Case (1816) 1 Mer 529
