- 28.1 Circulating security interests and the floating charge
- 28.2 Background to floating charges and their specific legal issues
- 28.3 Circulating security interests give the secured party a proprietary interest
- 28.4 Circulating security interests continue to be subordinated like floating charges
- 28.5 How to characterise a circulating security interest – the trading power, control and circulating assets
- 28.6 When are accounts (receivables) circulating assets?
Another feature of floating charge law is that unless a chargee (secured party) has a sufficient level of control over charged assets, the charge will be characterised as a floating (not a fixed) charge over those assets.
The issue of control, and what level of control is required to support a fixed charge as opposed to a floating charge, is particularly difficult for book debts or receivables (accounts under the PPSA). Case law seems to have eventually established that actual control in the sense of having control over withdrawals from a locked bank account into which the proceeds of receivables or book debts are deposited is required to support a fixed charge over book debts or receivables. This is because an account (receivable) and its proceeds are best seen as indistinguishable (an account is valueless without the proceeds to be collected from it)1.
The position in England, and the better view in Australia, is that a floating chargee must take control over proceeds once generated to take control over charged book debts/ receivables (accounts under the PPSA). A secured party can take control over proceeds of receivables by, for example, restricting withdrawals from an ADI account into which the proceeds are deposited2. Control short of actual control, even if covenants in security agreements restrict a floating chargor’s use of proceeds of receivables without the chargee’s consent, is likely to be insufficient to support a fixed charge under general (non-PPSA) law.
The control issue remains for circulating security interests under the PPSA. The PPSA has rules for when a security interest/secured party enjoys control over circulating assets, in which case the security interest will not be a circulating security interest. This is discussed below.
Circulating assets and the trading power
First, the PPSA establishes an idea of circulating assets. Circulating assets are the collateral subject to circulating security interests. The matter of the characterisation of a charge as fixed or floating shifts under the PPSA to be determined by whether a security interest relates to circulating assets.
To identify a circulating security interest, one must determine whether the collateral is comprised of circulating assets.
From above, a trading power is definitive of a floating charge – if the chargor has the ability to deal with charged assets and dispose of them without the consent of the chargee (secured party), then the charge is a floating charge in respect of those assets3.
The position is very similar under the PPSA. The general rule is that if the grantor has a trading power to dispose of collateral in the ordinary course of its business then the collateral is circulating assets, and in turn, the security interest is a circulating security interest4.
The PPSA prescribes the default scope of the trading power to be the ordinary course of business of the grantor5. It is not clear whether the grantor and the secured party could contract for a wider trading power than this by the secured party authorising wider disposals of collateral.
Circulating assets – “deemed” circulating assets, and control
From above, the PPSA defines circulating assets as any collateral that the secured party has expressly or impliedly authorised the grantor to dispose of in the ordinary course of its business6. This is the equivalent of the floating charge trading power.
In addition, the PPSA deems certain classes of collateral to be circulating assets unless the secured party has control over them. These classes of deemed circulating assets are7:
(a) accounts that arise in the ordinary course of business, except where the security interest is an outright transfer of accounts8;
(b) accounts that arise from the sale or other disposal of inventory, again except where the security interest is an outright transfer of accounts9;
(c) inventory itself;
(d) ADI accounts (cash deposited in current accounts, not term deposits or “blocked” accounts), but not where the bank (ADI) holds a registered security interest over an ADI account held with it, and the registration nominates that the ADI has control over the ADI account, even if the ADI account is a current account10. Accordingly, such banks holding security over ADI accounts held with them would not be subordinated in respect of circulating assets as may other secured parties;
(e) currency; and
(f) negotiable instruments.
However, the above classes of collateral will not be circulating assets (and so a security interest over them will not be a circulating security interest) if:
(a) a registration that perfects the security interest discloses that the secured party has control over the collateral; and
(b) the secured party does, in fact, have control over the collateral11.
Also, for goods only, if the secured party has perfected its security interest by taking possession of them, then the secured party has control over the goods and they are not circulating assets12.
Further, to determine whether a secured party has control over accounts and inventory, the two most common classes of circulating assets, the PPSA has special rules.
Rules about control over inventory
For inventory only, the secured party will have control over inventory if13:
(a) the secured party and the grantor have agreed in writing (typically in the security agreement) that the grantor will specifically appropriate the inventory to the security interest, and will not dispose of it without the consent of the secured party; and
(b) this is consistent with the grantor’s usual practice.
This does little more than codify in the PPSA the (floating charge) law relating to control over fixed charge assets. To summarise, the PPSA provides on the one hand that security interests attach to after-acquired inventory without specific appropriation, but without specific appropriation the PPSA treats a security interest as a circulating security interest.
Rules about control over accounts
For accounts only, a secured party will have control if14:
(a) the secured party and the grantor have agreed in writing (typically in the security agreement) that the grantor will deposit the proceeds of the accounts into a specified ADI account that the secured party controls; and
(b) this is the usual practice of the grantor.
Again, this does little more than codify in the PPSA the floating charge law relating to control over receivables (accounts). From above (paragraphs 28.5.2 and 28.5.3), particularly English floating charge case law emphasises that an account and its proceeds are indistinguishable (an account is valueless without the proceeds collected under it). The PPSA effectively codifies this position. To take control over an account under the PPSA to prevent a security interest over the account being a circulating security interest, a secured party must take control over the proceeds of the account by, for example, requiring the proceeds to be collected into a designated ADI account, and by restricting withdrawals from that ADI account.
Again (see paragraph 28.5.16 regarding inventory), security interests attach to after-acquired accounts under the PPSA without specific appropriation, but without specific appropriation of an account and its proceeds to a security interest, the PPSA treats a security interest over accounts as a circulating security interest.
Can an individual grant a circulating security interest?
Under non-PPSA law the better view is that an individual cannot grant a floating charge. Floating charges attach to all after-acquired (future) property, which is not desirable for individuals for reasons of public policy.
The PPSA does not appear to restrict circulating assets, and accordingly circulating security interests, to grantors that are companies. If this is correct, it may be possible for an individual who conducts a business to grant a circulating security, perhaps over all his or her after-acquired (business?) property. Where the Australian Consumer Law applies, an individual probably cannot grant security over all after-acquired property. However, the PPSA alone does not appear to prevent this.
Conclusion on circulating security interests
Each key element of the floating charge is re-created under the PPSA under the guise of a circulating security interest. Modern economies cannot function without some form of floating or circulating security.
The rights of secured parties under circulating security interests are strengthened by the PPSA recognising immediate attachment to circulating assets without appropriation. This should assist secured parties in priority disputes where collateral has been disposed of by a grantor in an unauthorised manner, usually outside of the ordinary course of business.
Notes:
1 National Westminster Bank Plc v Spectrum Plus Limited [2005] UKHL 41 (House of Lords), at paragraph 110. See also Arthur D Little (in administration) v Ableco Finance LLC, 27 March 2002, High Court Chancery Division, at p13, holding that shares and dividends or distributions paid under them are for practical purposes the same property the subject of a charge.
