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Brief Counsel

Construction contract creates a security interest

14 May 2013

​A High Court decision arising out of the Mainzeal receivership confirms that a construction contract can create a security interest in goods.

But where the contractor has granted other security interests, for example to its bank, the rights of the principal and the bank will rank in priority according to the rules in the Personal Property Securities Act (PPSA).

For a copy of the case click here.1

The context

Mainzeal had contracted to work on an apartment building known as Hobson Gardens and, for that purpose, had placed two large hoists on site.  Following Mainzeal’s receivership, Hobson Gardens had the right under the contract to use Mainzeal’s hoists to finish the work and then to sell them to recover any outstanding amount owed to it by Mainzeal. 

But the receivers insisted that BNZ, as holder of a general security agreement that had been registered on the Personal Property Securities Register (PPSR), had the better right to the hoists. 

Justice Collins’ decision contains a text book approach to a priority dispute.  He identifies the nature of each party’s interests in the collateral (the hoists), then analyses whether the bank’s interest was extinguished by any of the circumstances around the agreement between Mainzeal and Hobson Gardens.  Finding that it was not, he goes on to apply the well-understood priority rules.

The case is notable for three main findings.

The construction contract was a security agreement

The principal’s remedies against Mainzeal’s equipment were “clearly intended” to create “a form of security”. 

Both the right to continue to use the materials and equipment, and the right to sell the materials and equipment were for the purpose of securing “payment or performance of [Mainzeal’s] obligation”.  Those rights therefore gave rise to a security interest in the materials and equipment. 

To resolve the contest between Hobson Gardens and the bank, it was therefore necessary to apply the PPSA.

The General Security Agreement (GSA) holder did not authorise the transfer

The transfer to the principal of materials and equipment, provided for under the default clauses, had not been authorised by the bank.  Hobson Gardens failed to persuade the Court that the bank had given consent by any of:

  • the usual permission, given in a GSA, for disposal of inventory in the ordinary course of business, or
  • the obligation, in the GSA, on Mainzeal to notify the bank of the location of the hoists, or
  • the fact that the bank was in the business of lending money to construction companies, and that these clauses are (allegedly) common in construction contracts.

It is not clear whether compelling evidence was produced as the basis for Hobson Gardens’ argument that such clauses are common.  The current version of NZS 3910 contains a clause allowing for the principal to retain possession of equipment and materials, in order for it to finish the works.  It does not contain any right to sell such goods.

Not a sale in the ordinary course of business

The transfer under the default clause was not a sale in the ordinary course of business. 

Hobson Gardens argued that, because the default clause triggered a transfer, and because it was contained in a construction contract and Mainzeal was a construction company, this was a sale by Mainzeal in the ordinary course of its business.  The Court was right, in our view, to disagree.

Had this been a sale in the ordinary course of Mainzeal’s business then, under the PPSA, Hobson Gardens would have taken title to the hoists, free of the bank’s security interest. 

Plainly, this was not a sale.  Not all transfers of title come about as a result of sales.  A sale is a particular type of transaction involving a seller and a buyer agreeing to an exchange for consideration.  The transfer in this case came about as a consequence of a default, and on the basis that the transferee would account to the “seller” (Mainzeal), by applying the proceeds of the equipment and materials to any debt between them.

In any event, this was not, according to the Court, a transaction in the ordinary course of business. 

Be aware when you are creating security interests

In summary, while it may seem helpful to include in construction (and other) contracts rights to seize goods upon default, such rights will compete with other rights in those assets.  Contracts with clauses of that nature create security interests, which will rank behind prior-registered security interests granted to parties such as banks. 

For further information, please contact the lawyers featured.

Footnote

1   McCloy & Bridgman v Manukau Institute of Technology [2013] NZHC 936

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