Taking priority over a PMSI – a guide to section 64 of the PPS Act

The Personal Property Securities Act 2009 (Cth) establishes a set of rules to determine the priority between competing security interests. These rules generally provide that a purchase money security interest (PMSI) over collateral that is perfected by registration will have priority over a non PMSI security interest that is granted by the same grantor in the same collateral. However, section 64 of the Act reverses this position and allows a non-PMSI to take priority over a PMSI for an interest in an account as proceeds of inventory. This article explores the application of section 64, and what to do if you have received notice pursuant to the section.

Section 64

The section provides, relevantly, that a security interest granted for new value and perfected by registration has priority over a PMSI that is granted by the same grantor in an account if certain conditions are met. These conditions are that either:

1. the registration of the non-PMSI is before the PMSI is perfected or registered (first condition); or
2. if the registration of the non-PMSI is after the PMSI, notice is given to the secured party (in the appropriate form) at least 15 business days before the earlier of registration or attachment (second condition).

This article focuses on the application of the second condition.

The use of the section is best illustrated by an example:

Business A is supplied widgets on retention of title terms from Business B. Business B registers a PMSI in the products it supplies to Business A at the time of supply. Business B’s PMSI extends to the proceeds of sale of the products.

Business A then sells the widgets to customers on credit terms before paying Business B for them.

Further, Business A enters into an agreement to sell its accounts receivable relating to the widgets (through, for example, a factoring agreement), which accounts receivable are secured by Business B’s PMSI as proceeds.

Section 64 allows the receivables financier, in certain circumstances, to elevate the priority of its security interest to defeat Business B’s PMSI in the proceeds.

Applying section 64

Section 64 allows a financier’s non-PMSI over an account (such as that arising under a factoring agreement) to take priority against a PMSI. This can be done so long as either of the conditions (above) are met.

The first condition will rarely be relevant as it effectively requires the supplier trade creditor to have forgotten or otherwise failed to have registered its security interest at the time of supply.

The second condition requires a receivables financier to take the following steps in order to take advantage of section 64:

1. They must conduct a PPSR search in respect of the prospective client.
2. They must locate the highest priority PMSI in respect of the collateral. As a matter of practice, if it is difficult to ascertain the highest priority PMSI, a cautious approach is to include all PMSIs.
3. Notice must be given to the PMSI security interest holder(s) in the appropriate form (via their address for service) 15 business days before the day of registration or the day the security interest attaches to the account. Generally, this will be the date the Accounts Receivable were purchased. The form of notice must be given in accordance with section 64(2) of the Act.
4. The financier can then perfect its security interest after the notice period (i.e. through registration).

The role of section 59

As section 64 only provides an invoice financier with a mechanism of obtaining priority over a PMSI, invoice financiers must rely on another section to obtain priority over non-PMSI security holders.

Section 59 of the Act provides that a security interest (the first security interest) will take priority over another security interest (the last security interest) if:

a) the first security interest has priority over security interests of a particular kind (the intermediate security interests); and

b) the intermediate security interests have priority over the last security interest.

Applying section 59 to our earlier example, the receivables financier’s security interest would be the first security interest. Business B’s PMSI would the intermediate security interest. Any other security interest in respect of the collateral would be the last security interest.

As Business B’s PMSI would usually prevail over all other registered security interests, section 59 operates so that the receivables financier’s security interest now prevails over all other security interests.

Financiers should bear in mind that section 64, and hence 59, would not operate this way if the secured party lodged only a non-PMSI in respect of the collateral. In these circumstances, section 64 and 59 will not give the financier’s security interest priority, and the earlier registered non-PMSI will prevail.

Receiving a section 64 notice

The recipient of a section 64 notice should seek advice as to whether the notice is defective. Section 64 provides a number of timing and form requirements that must be strictly adhered to by the financier.

If the notice is not defective, the recipient of the notice may want to negotiate with their customer to ensure that their trading terms adequately protect them from risk. This might involve additional security arrangements, depending on the commercial position of the parties.

The recipient of a section 64 notice should also note that it should still have priority over the amount that the receivables financier has paid to their customer. In practical terms, this will often mean that the recipient will be unsecured for the difference between the debt funded by the receivables financier and the total original value of the account.

Conclusion

Section 64 of the Act provides a powerful instrument for financiers looking to elevate the priority of their security interests.

If you are a business that has received a notice pursuant to section 64 of the Act, or a financier looking to take advantage of the section, we encourage you to seek prompt advice as time frames are critical.