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Brief Counsel

Lessons from the Crafar receivership: Part Two

13 May 2011

Big receiverships often test legal boundaries, and the Crafar group receivership is no exception.  Gibson & Stiassny v StockCo & Ors1  is the longest decision to date on the Personal Property Securities Act 1999 (PPSA). 

Although the facts are complex, the practical take-outs are fairly simple:

  • check the PPSA Register before making large purchases

  • update your PPSA registration immediately you have any reason to believe that your secured property might not be in the debtor’s possession, and

  • clearly identify any property to be bought, sold or charged.

This is the second of three Brief Counsels on the case and looks at the Judge’s treatment of section 88 of the PPSA, which provides a set of rules to resolve priority disputes between secured parties when property is transferred from one debtor to the other.  The first Brief Counsel is available here.

Background

Nugen Farms Limited (Nugen), a company related to the Crafar group, had leased around 5,600 cows from rural financier StockCo Limited (StockCo) under a long-term lease and was grazing the livestock on land owned by other Crafar companies.  Those companies had granted an 'all assets' security to the banks (the banks) which funded the Crafar group business, and which ultimately appointed the receivers.

The relationship matrix

Section 88 of the PPSA

Section 88 seeks to strike a balance between allowing the free flow of goods and giving secured parties reasonable peace of mind that they will retain priority to the assets on which they have calculated their security position.

It allows a registered security interest to survive the transfer of the collateral by the debtor to a third party, even where that third party has granted security which extends to the transferred collateral. 

But to maintain full priority, the security holder must register a financing change statement on the Personal Property Securities Register (PPSR) disclosing the transferee as an additional debtor.  Unless this is done within 15 days of receiving knowledge of the transfer, it will lose priority to the extent the secured party of the transferee provides further advances.

Issues before the Court 

In the Crafar case, the two debtors were Nugen and the other Crafar companies.  The secured parties were StockCo and the banks.  The transferred property was the leased cows.

The PPSA treats long-term commercial lessors (StockCo) as secured creditors rather than owners.  Long-term is for “more than one year” and includes leases for an indefinite term, leases that renew automatically or at the option of one party, and leases intended to be shorter but which roll-over past a year.

The general security held by the banks extended to all of the property in which the Crafar companies had rights, including the cows being grazed on the land.

The basic question before the Court was whether, under section 88, StockCo’s interest in the livestock trumped the banks’ interest, given that the banks had provided significant further advances in the period after the transfer, but before StockCo updated its registration some months later.  The answer to this centred on:

  • whether the grazing arrangement between Nugen and the other Crafar companies was a ‘transfer’
  • at what point StockCo had ‘knowledge’ of the arrangement, such that the 15 day period started to run
  • whether the ‘further advances’ that are able to benefit from the rule in section 88 are assessed on a gross basis (every subsequent dollar benefits) or on a net basis (repayments during the period are taken into account so that only the increase in borrowings benefits), and
  • whether the banks’ conduct was in good faith in terms of section 25 of the PPSA.

The arrangement between Nugen and the other Crafar companies

StockCo argued that no interest was transferred: the cows simply happened to be grazing on the other Crafar companies’ land.  However the Court held that the grazing deal was a transfer of an interest because:

  • it created a sufficient interest in the livestock such that the banks’ security interest attached to it, and
  • it was a lease for a term of more than one year and so came within the definition of a ‘transfer’ in section 87 of the PPSA.  (Section 87 defines a transfer to include a sale or the creation of a security interest, which includes such a lease.)

It would have been useful if the Court had offered a view as to whether a non-PPSA interest counts as a transfer of an interest.  Had the grazing arrangement been for less than a year, for example, who would take priority? 

As it stands, the judgment could be taken to imply that transfers that do not create a PPSA security interest do not trigger section 88.  This would leave two-debtor scenarios in short-term lease contracts to be resolved through the application of either non-PPSA law or PPSA section 66 rules, neither of which would be particularly satisfactory.

Non-PPSA law.  This would have given StockCo priority over the banks as StockCo would remain the owner of the livestock.  Application of non-PPSA law would, in our view, represent an unwelcome introduction into the PPSA framework of concepts that favour form over substance, concepts that the PPSA was intended to reform.

PPSA section 66 rules.  The ordinary priority rules are not designed to deal with competing claims between debtors, they give priority to the first party to register.  This could create unfair results where collateral is transferred without the knowledge of a secured party and would, in this case, have given the banks priority the moment the transfer took place without giving StockCo an opportunity to update its registration.  

In our view, the application of section 88 is also triggered by transfers that do not necessarily create security interests. 

The knowledge required to start the clock

The 15 day grace period starts once the secured party of the original debtor has knowledge of the facts required to update its registration to include details of the ‘new’ debtor in possession of its collateral.

The PPSA defines knowledge to include both formal notice, and

“when the fact is communicated to the organisation in such a way that it would have been brought to the attention of the person with responsibility for matters to which the transaction relates if the organisation had exercised reasonable care”. 

StockCo’s key witness admitted StockCo had been informed in writing of the grazing arrangement, but said that he had no personal recollection of seeing the letter. 

Perhaps unsurprisingly, the Judge held that there could be no real dispute that the information would have come to the attention of the relevant person had StockCo exercised reasonable care.  It will be a rare case in which a company can disclaim knowledge even though it has received a communication informing it of a transfer, or even circumstances that ultimately amount to a "transfer" of collateral for the purposes of section 88.  Accordingly, care needs to be take by secured parties to understand the potential PPSA-related impact of what they may be told by a debtor.

Whether ‘advances’ are net or gross under the PPSA

An interesting argument raised by StockCo was that, while the banks made further advances after the 15 day period had expired, there were also repayments, and that at best the banks would have priority only to the net increase in the liability owed to them by the other Crafar companies. 

The Court did not ultimately pronounce on this question as StockCo did not present evidence showing that the net position would not have extinguished StockCo’s interest in any event. 

We think the better view is that ‘advances’ means any further advance made by the transferee’s secured party, regardless of whether repayments occurred in the same period.  The definition of advance in the PPSA does not provide any support for a net interpretation2, and repayments should be for the benefit of the party that advanced the funds.

Whether the banks acted in good faith

Section 25 of the PPSA requires that all parties must exercise their security related rights in good faith and in accordance with reasonable standards of commercial practice.  StockCo said, in essence, that the banks had failed this standard by seeking to take advantage of Nugen’s entry into the grazing arrangement, which was in breach of StockCo’s security agreement with Nugen. 

The Judge held, following Canadian authority, that bad faith or breach of reasonable standards – the two matters were treated as one – requires some form of positive action such as a representation by one security holder that it will not seek to advance its priority while in settlement discussions with another affected party.  The banks had made no such representation or communication to StockCo, so there was no breach of section 25.

We think this is a sensible interpretation of the PPSA’s good faith requirement.  Section 25 provides a useful back-stop in exceptional cases, but should not be allowed to disrupt normal business practice that is not obviously at odds with the protections the PPSA is intended to provide.

Chapman Tripp’s views in summary

StockCo’s loss of priority is a reminder to secured lenders of the importance of keeping PPSR data up to date. 

In relation to the Court’s rulings, we would observe that:

  • the Court’s view that bad faith under section 25 requires a positive act is useful and true to the objectives of the PPSA
  • the issue of whether ‘advances’ are net or gross under the PPSA was not ruled upon in this dispute but we consider that the law should be read as favouring a gross approach, and
  • section 88 should not be restricted to transfers which create a security interest; we hope future courts will decline to draw any inference to the contrary from this case. 
Our thanks to Richard May, Solicitor, for writing this Brief Counsel.​
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Footnotes
  1. Gibson & Stiassny v StockCo & Ors (unreported) 17 December 2010, Auckland High Court CIV-2009-404-7120.
  2. PPSA s16: “advance — (a) Means the payment of money, the provision of credit, or the giving of value; and (b) Includes any liability of the debtor to pay interest, credit costs, and other charges or costs payable by the debtor in connection with an advance or the enforcement of a security interest securing an advance”.

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