The PPSA provides for around ten (10) (depending on how you count them) extinguishment rules under which security interests can be extinguished when the grantor sells or leases collateral covered by a security interest. Some level of protection is required for buyers and lessees of personal property to facilitate commerce and the workings of Australia’s market economy in which people regularly buy, sell and lease personal property.

The extinguishment rules aim to strike a balance between protecting secured parties when collateral is transferred without their consent to others, and protecting those who buy or lease collateral from a grantor.

The extinguishment rules have many conditions to their operation. It is completely conceivable that in various instances buyers and lessees will not be protected, and that security interests will continue unextinguished in collateral when transferred or leased.

The Table in Section 21.2 lists the key features of each of the ten (10) extinguishment rules.

The background, policy and a few matters relating to the extinguishment rules are discussed before approaching the table. Hopefully this makes the Table in Section 21.2 easier to understand.

Following the Table in Section 21.2, each extinguishment rule is discussed separately in more detail.

What security interests do the extinguishment rules “extinguish”

This raises the question of the relationship between the extinguishment rules and the general law principle of nemo dat quod non habet (no one can give what he does not have). Do the extinguishment rules apply to extinguish a security interest for the benefit of a buyer or lessee where the seller or lessor is not the person who granted the security interest? Diagram 9 below illustrates this situation.

In the above diagram, the debtor/grantor D grants a security interest over all its assets including a motor
vehicle to Bank A in return for a loan. Bank A registers the security interest against the serial number of the car. Assume that Dodgie borrows the car from D. Assume next that Dodgie tries to sell the car to B, but B does not search the PPS Register against the serial number of the car (which would have revealed Bank A’s security interest). As discussed below, B buys the car subject to Bank A’s security interest (Bank A’s security interest is not extinguished).

From the language of the extinguishment rules, the extinguishment rules appear merely to extinguish security interests for the benefit of purchasers or lessees. They say nothing at all about whether title to the collateral being transferred is validly passed to buyers. This point is developed below.

What is nemo dat?

There are certain exceptions to the nemo dat principle, most of which relate to non-owners selling as agents of the true owner and authorised to bind the seller to the sale. There are other exceptions to nemo dat under the sale of goods legislation in Australia's various States.  For example, in some States such as Western Australia, bona fide purchasers of goods for value without notice in "market overt" (a recognised and regularly held market) can take good title to goods even if the seller does not have good title (because, for example, the goods are borrowed or stolen)¹. The market overt exception to the nemo dat principle has been abolished in England, and certain other Australian States such as New South Wales and Victoria.

Another exception to the nemo dat principle is that a seller of goods who remains in possession of the goods after the goods have been sold and title transferred to a buyer, can re-sell and give good title to another buyer who acts in good faith and has no notice of the previous sale². The justification for this exception to nemo dat is that the seller looks like the owner while the seller remains in possession of the goods. This is another manifestation of the apparent ownership problem – see Chapter 15 (Why the PPSA)) for discussion.

The PPSA extinguishment rules and the nemo dat principle

Assume for the moment that the "scheme" of the PPSA enables grantors without title to sell collateral and extinguish security interests — the PPSA extinguishment rules would then do much more than simply apply to the matter of whether buyers or lessees take free of existing security interests over the collateral in otherwise valid sales or leases. Rather, the extinguishment rules would then go further and deliver title to a buyer or lessee which

(i) a seller or lessor did not have themselves, or

(ii) where the sale or lease is not validly completed,

although see the discussion below (commencing at paragraph 21.1.18) about the application of the extinguishment rules to agreements to sell and lease.

The issue can perhaps be stated in the following question - is the passage of title and assignment of interests
(not security interests) a matter for the general law of assignment and nemo dat only, or matters also for secured transactions law? Clearly there is overlap where a grantor sells or leases collateral.

United States, Canadian and New Zealand case law on the extinguishment rules

The United States and Canadian case law is consistent that there must first be a valid sale for the extinguishment rules to apply. The extinguishment rules clearly apply where a grantor sells collateral. The most common issue is what “sale” means – is an agreement to sell enough, or must title pass?

Disputes seem to have been most common in the United States, Canada and New Zealand where goods are being manufactured (for instance, ships or motor vehicles), or remain unascertained (in bulk, for example, wheat in a silo), and the manufacturer or seller has granted an all-assets security interest that attaches to the seller's or manufacturer's interest in the unfinished or bulk goods³.

In sales of unascertained (unfinished) goods or bulk goods, depending on the applicable sale of goods legislation, title may not pass until the goods under manufacture are completed (ascertained) and allocated (appropriated) to the sale, or bulk goods are separated from the bulk and allocated (appropriated) to the sale. The problem arises where the seller or manufacturer enters into bankruptcy, administration or liquidation before the completion of goods under manufacture, or the separation of bulk goods. If a buyer has paid in full or in part for the goods, the buyer may end up in a dispute with a secured party holding a perfected (often all-assets) security interest. The secured party typically argues that the buyer takes no title and the unfinished or bulk goods remain the property of the grantor and subject to the security interest.

Perhaps the leading and strongest authority in favour of the view that title must first pass in a sale for relevant extinguishment rules under the PPSA to apply to the sale is the Saskatchewan Court of Appeal decision in Royal Bank of Canada v 216200 Alberta Ltd⁴ (Alberta).

Alberta involved a furniture retailer who had granted a perfected all-assets security interest to Royal Bank of Canada (RBC). Upon the appointment of receivers by RBC to the assets of the retailer, disputes arose with various classes of purchasers of furniture, many of whom had ordered furniture through the retailer and paid in full or part. The retailer had not itself taken delivery of the furniture from wholesalers, and accordingly, there was no appropriation of the furniture to any sales to buyers.

The court in Alberta confirmed that there must be a sale of goods for the purposes of the relevant sale of goods legislation before any question of the application of the extinguishment rules to the sale arises. The court held that a sale under the Saskatchewan Sale of Goods Act requires the passage of title to the buyer, which does not occur until the goods to be sold are appropriated to the sale⁵. Accordingly, the buyers of furniture were mere unsecured creditors of the furniture retailer, the retailer itself not having acquired the furniture and there being no appropriation of the furniture to customer purchases. There were no “sales” to which the extinguishment rules could apply to extinguish RBC’s security interest over the furniture. RBC prevailed over the furniture.

The court in Alberta referred to the competing lines of authority in the United States, and preferred the Wisconsin Supreme Court decision in Chrysler Corp v Adamatic Inc. (1973) 208 N.W. (2d) 97 (Chrysler). Chrysler held that an agreement to sell, and a sale, are different things. Accordingly, only an actual sale by which title to property passed would attract the extinguishment rules under Article 9 of the United States Uniform Commercial Code (the equivalent United States legislation to the Australian PPSA) as adopted in Wisconsin. The contrary line of authority in the United States, which holds that the extinguishment rules apply to mere agreements to sell, is the Illinois Appellate Court decision in Herman v First Farmers’ State Bank of Minier (1979) 392 N.E. 2d 344, and another Supreme Court of Wisconsin decision in Daniel v Bank of Hayward (1988) 425 N.W. 2d 416.

The British Columbia Supreme Court recently (in 2002) followed Alberta in Re Anderson’s Engineering
Ltd⁶ (Anderson). After referring to a contrary line of authority from the Ontario Court of Appeal in Spittlehouse v Northshore Marine Inc. (Spittlehouse), which is discussed below, the court in Anderson preferred the view that property in goods must have passed to a buyer in accordance with the applicable sale of goods legislation before there can be any application of a PPSA extinguishment rule to extinguish security interests over the goods sold for the benefit of a purchaser⁷.

Cases that hold or support the view that an agreement to sell (without passage of title) is sufficient for the application of the extinguishment rules

Transamerica appointed a receiver to Northshore Marine following a default, and naturally argued that its perfected security interest attached to the boat under construction, and that title to the boat had not passed to the buyer Spittlehouse. Transamerica’s argument continued that the extinguishment rules did not apply to extinguish Transamerica’s security interest in the boat.

The court in Spittlehouse held that the extinguishment rules under the Ontario PPSA apply even to agreements to sell, even where title has not yet passed from the seller to the buyer⁸. This meant that the interest of the buyer of the boat, Spittlehouse, defeated Transamerica’s security interest. The court emphasised that the spirit of the PPSA is to avoid technical rules about when title passes, and is to look to the substance of transactions. Spittlehouse does not, however, override the nemo dat principle, as discussed at paragraphs 21.1.34 and 21.1.35 below.

Closer to home, the High Court of New Zealand seems to have gone even further in Orix New Zealand Limited v Milne & Nicholls⁹ (Orix).

In Orix, Orix New Zealand lent money to Comquip to finance Comquip’s purchase of marini paving machines. Comquip granted a perfected security interest over the paving machines to Orix. In a group reorganisation, Comquip transferred title to one particular paving machine to a related company, Pavement. Pavement sold this paving machine to Nicholls, and a dispute developed between Nicholls and Orix. Nicholls argued that the “sale in the ordinary course of business” extinguishment rule applied to the sale of the paving machine by Pavement to Nicholls and extinguished Orix’s security interest in the paving machine.

Orix, holding a perfected security interest over the paving machine (albeit granted by the previous owner, Comquip, not the most recent seller, Pavement), argued that the “sale in the ordinary course of business” extinguishment rule applies only to extinguish security interests granted by the immediate seller (which is consistent also with the language of the equivalent provision under the Australian PPSA, section 46). Orix argued that a sale by Pavement could not extinguish a security interest granted by Comquip. Put another way, Orix argued that its security interest in the paving machines could not be extinguished by the sale by Pavement to Nicholls because the grantor of the security interest to Orix was the previous owner, Comquip.

The New Zealand High Court seems to have held that a non-owner can sell goods and pass title to a buyer. The court held that Comquip (a non-owner, having transferred the paving machine to Pavement) somehow managed to be the seller of the paving machine to Nicholls, despite the evidence showing that Pavement owned the paving machine, and sold it to Nicholls. The court was clearly striving to protect the buyer by fitting the situation within the applicable extinguishment rule, which only extinguishes security interests granted by the immediate seller.

Agreements to sell are not sales without title

There appears to be no suggestion in the United States or Canadian cases discussed above that the extinguishment rules deliver title where the seller does not have title, or has impaired title. The above United States and Canadian cases dealt with situations where the seller has good title, but the goods cannot be transferred to the buyer yet given they are unfinished (unascertained), or mixed with bulk.

Why do most extinguishment rules apply to extinguish any security interests if nemo dat still applies to the sale or lease transaction?

Nemo dat is partially overridden in relation to the priority of title-based security interests

The New Zealand case of Graham v Portacom New Zealand Ltd (High Court) [2004] 2 NZLR 528 confirms that where a lessor of goods has not registered its lease as a security interest, a receiver appointed under a registered fixed and floating charge (general security interest) can sell the leased goods even though the lessee company in receivership does not own the goods. This is because:

In Australia (but not in New Zealand) most unperfected leases that secure obligations would vest in the grantor upon the bankruptcy, administration or liquidation of the grantor, so the question of a priority contest involving an unperfected lease upon the insolvency of the grantor would seldom arise. The leased collateral would fall back to the grantor’s estate and could be swept up by registered all- assets security interests such as fixed and floating charges and their equivalents under the PPSA in general security interests.

To state the obvious, a new secured party will not get the benefit of the extinguishment rules to extinguish a prior security interest in favour of its new security interest in collateral, even if the secured party extends new value (a further loan) to the grantor¹¹. Only buyers or lessees can benefit from the extinguishment rules.

Lessees and the extinguishment rules/new security

A lease may be a security interest, but the lessee has not actually granted any interest in the collateral as such (other than by force of the PPSA). Under the (non-PPSA) general law it is the other way round - the owner or lessor of collateral has granted a leasehold interest to a lessee. The PPSA then regulates a lease as a security interest.

It is not clear but the weight of views appears to be that a lessee or other bailee of collateral does have sufficient interest in the collateral to grant a further security interest in the collateral. Naturally a grantor with a "possessory" interest (a lessee) could grant a further "possessory" security interest (a sublease). The question is whether the PPSA goes further and permits a "possessory" security interest holder (lessee) even to grant a mortgage or a charge? It is not clear but the weight of views appears to say yes. Again, this is said to arise from the "scheme" of the PPSA as opposed to any particular provision of the PPSA.

If a lessee or other person in due possession of a motor vehicle without ownership of it manages validly to sell or lease (by private sale or lease) the motor vehicle and pass good title or interest (because an exception to nemo dat applies), then the extinguishment rule in section 45(2) may apply to extinguish security interests over the motor vehicle. The extinguishment rule in section 45(2) is the only extinguishment rule that (on its express terms) applies where the owner has lost the right to possession, presumably because the motor vehicle is leased to another.

What does “extinguish” mean in relation to leases?

Leases are by definition for a limited period, and upon expiry the collateral reverts to the grantor free of the lease. For goods only, upon the expiry of leases, security interests that were extinguished by the lease re-attach to the collateral¹².

Perfection of the extinguished security interest(s) re- enlivens, and priority is determined as if the goods
were never leased and the security interest was never extinguished¹³, provided that a registration of the security interest that was extinguished remains effective when the lease expires and the goods return to the lessor/grantor.

Knowledge – knowledge of security interests, or that the sale or lease of collateral breaches the terms of the security agreement under which the security interest to be extinguished arose

This is a powerful reason always to include appropriate restrictive covenants in security agreements to prohibit the sale or lease of collateral without the prior consent of the secured party. Practically, the terms of security agreements will not appear on the PPS Register. A limited class of interested parties, such as other secured parties and auditors, can obtain copies of security agreements.

It seems unlikely that many cases will arise where an extinguishment rule does not operate because the buyer or lessee has knowledge that the sale or lease transaction breaches the terms of a security agreement to which the collateral is subject.

Further, the extent of knowledge varies. Sometimes the knowledge requirement is actual knowledge, sometimes actual or constructive knowledge.

More confusing still is that sometimes the knowledge requirement is knowledge that the terms of a security agreement are breached by the sale or lease (as described above), and other times it is mere knowledge of the existence of a security interest over the collateral. Clearly, a requirement of mere knowledge of the existence of a security interest is favourable to secured parties because buyers or lessees may know of the existence of security interests if they search the PPS Register (assuming perfection is by registration).