Unperfected security interests are extremely vulnerable upon the bankruptcy, administration or liquidation of a grantor for at least five reasons. All security interests identified should be perfected before any enforcement.

First, most unperfected security interests do not survive the bankruptcy, administration or liquidation of the grantor. Most unperfected security interests “vest in the grantor” upon the grantor’s liquidation or administration¹. This means that most unperfected security interests become invalid as soon as the grantor enters liquidation or administration. By contrast, the appointment of receivers will not cause an unperfected security interest to “vest in the grantor”. However, receivership is often accompanied by administration, either because the secured party appoints, or procures the appointment of, both receivers and administrators (to take the benefit of the administration moratorium – this is called a “donkey” appointment), or because the board of the grantor company places the company into administration. Alternatively, a receivership can be accompanied by liquidation.

Second, only perfected security interests benefit from the exceptions to the moratorium on enforcement of security interests under sections 441A and 441B of the Corporations Act 2001 (Cth) upon the administration of a grantor that is a company.

To explain, if a secured party holds a security interest over the whole or substantially the whole of the assets of a grantor, they have the right under section 441A to appoint receivers “over the top” of administrators already appointed by the board of a company or by another secured party, during the 13 business day “decision period” following the commencement of the administration.

Following the commencement of the PPSA, the right to appoint over the top under section 441A only exists if the security interest is perfected in relation to the whole or substantially the whole of the property of the grantor². For transitional security interests, property of a company for section 441A purposes excludes the grantor’s interests in “PPSA retention of title property” (for example, leased, retention of title and consigned property)³. For “general security interests” (all assets security interests) newly granted under the PPSA, the property of a company includes PPSA retention of title property because security interests under the PPSA can attach to property which the grantor merely leases or possesses (under a consignment or conditional sale) but does not own.

In a similar way, the right of secured parties under section 441B to continue enforcing a security interest despite a grantor’s administration if they commenced enforcement (for example, appointed receivers or controllers) before the administration commenced, only applies to perfected security interests⁴. Crucially, even if a secured party acts first and appoints receivers or controllers, a later administration would seemingly invalidate and remove the secured party’s ability to continue to enforce if the security interest is unperfected against the (or any?) assets the subject of enforcement. Receivers or controllers appointed would presumably have to retire if the security interest under which they were appointed is unperfected and the grantor later enters administration or liquidation.

Secured parties cannot side-step the fact that their security interests may be unperfected simply by acting first and appointing receivers or controllers before the grantor enters administration or liquidation. A subsequent administration or liquidation will cause an unperfected security interest to vest in the grantor, regardless of whether enforcement action has commenced under the unperfected security interest.

Accordingly, upon enforcement, a security interest simply must be properly perfected. Careful checking of the perfection of security interests must be conducted before any enforcement. This includes checking that security interests are properly perfected against proceeds if there have been any disposals of collateral.

Perfection against proceeds may become a very significant issue when determining whether a secured party who holds a security interest over the whole or substantially the whole of the property of a grantor is perfected over that property for the purposes of appointing receivers over the top of administrators under section 441A.

Put another way, if there have been significant transfers or disposals of collateral to generate proceeds, but the security interest in question is not perfected against the proceeds (because, for example, the registration is not wide enough, or does not cover proceeds), then this may be a ground for others to challenge appointments over the top. It may mean that the secured party does not hold a perfected security interest over the whole or substantially the whole of the grantor’s property for section 441A purposes if the secured party is not perfected against proceeds, where proceeds represent a significant proportion of the grantor’s assets. See the discussion at paragraphs 24.087 to 24.097 below for the meaning of the “whole or substantially the whole” of the property of a company.

Third, when companies are in the zone of distress but have not yet reached the stage of entering into administration or liquidation, they often sell assets to raise much needed working capital. Sales and leases of collateral for value will extinguish unperfected security interests, whether the buyers or lessees have knowledge of the unperfected security interest(s) or not⁵.

Fourth, there is the further general reason of ensuring that all security interests are perfected to ensure maximum strength in priority disputes with other secured parties upon enforcement.

Fifth, purchasers of assets from a receiver or controller appointed under an unperfected security interest who have actual or constructive knowledge of the administration or liquidation of the grantor, do not have the protection (under section 267(3)) when buying from a receiver or controller of being excluded from the operation of section 267. Section 267 is the provision under which unperfected security interests are void upon the administration or liquidation of the (corporate) grantor.

Well advised purchasers who detect that security interests are wholly or partially unperfected may create extreme difficulty for secured parties and the receivers or controllers they appoint. The receivers or controllers may not be able to sell and deliver good title to purchasers given that the security interest and collateral may have vested in the grantor. The result is that the receivers or controllers may encounter difficulty in performing their role of selling assets to repay the secured party.

Can secured parties perfect by control after the commencement of bankruptcy, administration or liquidation?

The threshold consideration here is that if security interests are not perfected at all upon the commencement of bankruptcy, administration or liquidation, then most will vest in the grantor – they are extinguished. Only secured parties holding security interests that are perfected by registration, possession or temporary perfection, but not control, over financial assets such as shares and bonds, survive to contemplate whether they can perfect by control after the commencement of bankruptcy, administration or liquidation.

The PPSA appears to be silent on this point. It seems theoretically possible for a secured party perfected
by registration before bankruptcy, administration or liquidation, to perfect by control after the commencement of the bankruptcy, administration or liquidation. However, this does not seem correct in principle, and would lead to a very uncertain situation for the administrator or liquidator, and other secured parties. The better view is that secured parties perfected by registration, possession or temporary perfection only should not be able to perfect by control over financial assets such as shares or bonds following the commencement of bankruptcy, administration or liquidation.

Perfection by control and transitional security interests

This gives transitional security interests, especially fixed and floating charges given their broad coverage, a very important advantage over new PPSA security interests. Transitional security interests that are “all moneys” securities and can secure future advances should not be released, but preserved to take full advantage of their privileged priority position. This is likely to mean that the pipeline of transitional security interests lingers much longer that is otherwise intended or desirable.

Perfection against proceeds

Security interests not only attach to proceeds but also must be perfected against proceeds. Secured parties need to check that their registrations are wide enough to cover proceeds if proceeds are generated from original collateral. Secured parties can, and should, register against all proceeds generated from the original collateral that they hold security over, even if the security interest is narrow and only relates to specific items or classes of original collateral such as a truck (item) or motor vehicles (class).

Security interests will continue in collateral when transferred if not extinguished and the transfer generates proceeds⁷, but sometimes original collateral is hard to find if transferred, or uneconomic to chase. The ability to pursue proceeds where original collateral is transferred or disposed of is sure to become a very important remedy for all secured parties in Australia, provided they perfect against proceeds and the proceeds remain identifiable or traceable.

Can a secured party perfect against proceeds following the commencement of bankruptcy, administration or liquidation? This is a similar question to that posed about perfection by control at paragraph 24.3.15. The PPSA is unclear but the answer appears to be no. If a secured party is not perfected against proceeds before the commencement of the bankruptcy, administration or liquidation of the grantor, then the security interest would presumably vest in the grantor in respect of those proceeds. The PPSA does not explicitly state this, but this should follow from the general principles under the PPSA.

Unperfected security interests are easily extinguished by transfers of collateral

Knowledge is irrelevant to this extinguishment rule (section 43). Even a buyer or lessee who knows about an unperfected security interest can give value and buy or take a lease of collateral subject to an unperfected security interest to extinguish the security interest.

This is another reason why secured parties should ensure that all security interests are perfected before entering into any period of restructuring, workout or enforcement with a grantor.

Registration against the serial numbers of serial numbered property

Second, there is serial numbered property that may be perfected against by registration against the serial number. This is essentially all commercial serial numbered property except commercial aircraft.

The distinction is important to determine the validity of perfection. If security interests over consumer serial numbered property and commercial aircraft, being serial numbered property that must be registered by serial number, are not registered against the correct serial number, then the registration and perfection is defective. Only defects that arise outside the secured party's control (for example, the manufacturer changes the serial number) are accorded temporary protection for up to 5 years but will become invalid if the secured party does not correct the defect within five (5) business days of acquiring actual or constructive knowledge of the defect⁹. The security interest would then become unperfected. From above (paragraphs 24.3.24 to 24.3.26), unperfected security interests are on serious risk of extinguishment if the collateral is transferred to a buyer or lessee for value – knowledge is irrelevant to this extinguishment rule in section 43.

Further, for all serial numbered property, even if security interests are otherwise validly registered, non-registration against the serial number puts a secured party on risk of having its security interest extinguished under the extinguishment rules if the collateral is transferred or disposed of by the grantor. Other than motor vehicles in the circumstances outlined in section 45, under section 44, buyers or lessees of serial numbered property take free of security interests provided they search the PPS Register against the serial number immediately before buying or leasing the collateral and the register is clear, and provided they do not hold the collateral purchased or leased as inventory in their business. Knowledge is irrelevant for section 44.

When grantors are distressed they often sell assets to raise cash. The risk of a security interest over serial numbered property that is not registered against the serial number being extinguished upon disposal by the grantor is very real where a grantor encounters distress.