New Zealand companies registering a security interest in Australia need to be aware that the Australian Personal Property Securities Act (the Australian Act) offers a third route to perfection, not available in New Zealand.
The Australian Act, which has now been in force for around six months, is very similar to the New Zealand Act. But there are some important differences, many of which we have already discussed.
This Brief Counsel looks at another key difference – the concept of perfecting security interests by “control”.
Perfection by control and “Super Priority”
Australia offers perfection by “control” in relation to certain financial assets, including bank accounts, intermediated securities and investment securities (as well as satellites and other space objects).
Importantly, any security interests perfected in this way have “super priority” over any other form of perfected security interest, including purchase money security interests.
If two interests are perfected by control, priority is determined by the order of perfection.
Control over bank accounts
A lender can have control of an account only if it is the “authorised deposit taking institution” (ADI) at which the account is held. The practical effect of this may be that a bank lender will be more likely to insist that borrowers have their transactional accounts with it so as to ensure repaid receivables are captured by the bank’s security.
If a borrower does not have its bank accounts with its lender, perhaps because the lender is not an ADI, the lender may consider entering into priority arrangements with the borrower’s bank to gain priority for any bank account security interests it holds.
An “intermediated security” is defined in the Australian Act as the rights of a person in a securities account maintained by an intermediary, such as a stockbroker, on that person’s behalf.
In simple terms, a secured party has control of a security provider’s intermediated security if there is an agreement in place that allows the secured party to instruct the intermediary directly or prevents the intermediary from acting without the secured party’s consent.
Alternatively, a securities account can be “controlled” if it is in the secured party’s name. There may be practical considerations that make this second option less attractive than entering into an agreement, including potential tax issues.
Amendments made to the Australian Act in May 2011 clarified what constitutes intermediated securities and introduced an additional test for control that:
"a secured party has control of an intermediated security if there is an agreement in force under which the secured party ... is able to initiate or control the sending of some or all electronic messages or other electronic communications by which the intermediated security could be transferred or otherwise dealt with."
This is intended to overcome difficulties in taking security over clearing house securities held in custodial accounts, such as those held with stockbrokers.
For Clearing House Electronic Subregister System or “CHESS” securities the difficulties arose when applying the original control requirements because the intermediary was technically the ASX Settlement and Transfer Corporation Pty Limited. It would not be practical for ASX to be receiving and dealing with copious notices from financiers seeking to control securities accounts.
The amendments should allow perfection by control of CHESS security interests to be achieved by entering into tripartite CHESS sponsorship agreements between a secured party, the debtor and its broker or other intermediary. These agreements will contain clauses to the effect that CHESS securities may not be dealt with without consent from the secured party. The form of sponsorship agreements is governed in part by the ASX Settlement Operating Rules.
The term “investment instruments” includes shares, debentures, derivatives, foreign exchange contracts, assignable options and other financial products – but does not include intermediated securities.
Control of investment instruments is possible by being the registered owner, holding the certificates of title (if there are certificates) or being in a position to sell the collateral without further action by the security provider. A person may gain control of an investment instrument not evidenced by certificates if there is an agreement in place under which that person is able to initiate or control the instructions by which the instrument can be transferred.
In some cases, the steps to perfect a security interest by control will be the same as the steps for perfection by possession in New Zealand, such as obtaining the share certificates. There is no super-priority under the New Zealand Act for perfection of a security interest by way of control though. Section 97 of the New Zealand Act gives priority to a purchaser for value who takes possession of the investment security without knowledge of the perfected security interest, but this will not assist financiers who do not take possession.
It appears the Australian rules were drafted with CHESS-type securities in mind, which are now considered intermediated securities under the Australian Act. Where investment instruments exist only as book entries, which is still common in both countries, it seems that perfection by control will need to be effected by a secured party actually becoming the registered owner of the security.
Parties taking security in Australia should be alert to the risk that a third party could gain priority by taking control of financial assets.
If financial assets are a significant part of the security, lenders should consider taking control of the assets to protect their position.
We are seeing new Australian security documents drafted very widely to take account of this so borrowers and lenders will need to ensure these arrangements work for them both.
Our thanks to Mace Gorringe and Cathryn Barber for writing this Brief Counsel. For further information, please contact the lawyers featured.