Lending & Borrowing Money with Personal Property Securities.
Just follow these eight easy steps:
1. Get the appropriate Security Interest
If you are a factor or other lender, then getting adequate security for the money you have advanced is paramount. Many factors and other lenders still rely on obsolete legal documents and they are unaware, for example, that a director’s guarantee is only a part of the solution.
A director’s guarantee should include provisions which not only allow you to mortgage the director’s present and after acquired land, but also provisions which immediately mortgage the director’s present and after acquired personal property – commonly called an “allpap” security, which is provided for by the Personal Properties Securities Act.
This allows for the appointment of a receiver on breach of the loan agreement and means that the factor or other lender does not have to wait until they get judgment against the guarantor before taking recovery action. The uncertainty and cost of litigation is avoided.
2. Use Segregated Accounts
Many factors (as well as other lenders) are also unaware of the benefits of ensuring that their security extends to segregated accounts. If the documents are properly drawn up, the upshot is that the factor/lender does not have to compete with the debtor’s banker for the money in the account, because the debtor’s clients pay what is owed to the debtor into a separate account which the factor or lender controls. The separate account is managed by a bank which has no relationship with the debtor’s bank.
‘Control’ in these circumstances means that the entitlement of the factor or the lender to the funds in the account is not “white-anted” by the claims of employees of the debtor. In company law, the debtor’s employee’s claims prevail against security interests over the debtor’s circulating assets – see s 561C of the Corporations Act. A bank account is a circulating asset, but where the grantee of a security interest has control of the bank account (see s 341 of the Personal Property Securities Act), the money in the account is no longer a circulating asset.
Factors can also gain special priority under s 64 of the Personal Property Securities Act. This arises from their security interest in the debt itself (i.e. in the right to be paid), as opposed to the money in an account after it has been paid.
3. Document the Loan
Even to this day many business partners and company directors neglect or refuse to document loans between each other, or between themselves and other business entities. They consider that formalising the loan is unnecessary because they trust each other.
Of course, the purpose of documenting the loan has nothing to do with trust, but everything to do with communication. What are the terms of the agreement? Only a properly crafted legal document will set it out with clarity.
That’s not all: where a loan is advanced on the basis that it is to be repaid at call – very common between close business acquaintances – then the loan becomes statute barred after six years. So not documenting your loan to your business associate or co-director could end up destroying your business relationship down the track, to say nothing of causing you to lose your money without even trying.
4. Get proper security over listed shares
Under the Personal Property Securities Act, a lender who is offered security by way of listed shares held in the borrower’s name, can perfect their security interest in those shares by entering into a CHESS security deed with the borrower. This will minimise the risk of the borrower transferring the shares without the lender’s consent, because the agreement provides (amongst other things) that the borrower holds the shares subject to any direction of the lender.
Do this sound lame? We think it does. What is there to stop the borrower transferring the shares without the lender’s consent? Nothing. The transfer is a breach of the agreement. How does that help the lender? The security is already gone. However s 27(5) of the Personal Property Securities Act provides for this type of arrangement!
It is far better to rely on s 27(2) – by which the lender becomes the registered owner of the shares. But that raises capital gain tax problems. Hardly a good start to the business relationship.
In our view, the best way to get security over listed shares is to ensure that the shares are “broker sponsored” and then for the lender to enter into an agreement with the broker and the borrower under s 27(4)(b) of the Personal Property Securities Act. In this scenario, the broker agrees to only act on the instructions of the lender and not to act on the instructions of the borrower. Properly worded, breach of the agreement by the broker would trigger the lender’s entitlement to recover not only against the broker but also against his business – as well as preserving any recovery rights the lender has against the borrower of course.
5. Get proper security over unlisted shares
This is a lot easier. The lender should just make sure the documentation for the loan provides that (a) the lender gets possession of the share certificate, and (b) the lender has power on default to transfer the share certificate to third parties and otherwise deal with it and the shares to which it relates.
6. Think about the Personal Property Securities Register and Seriously Misleading Defects
The Personal Property Securities Register is your friend – don’t make it your enemy! If you are entering the details of your transaction yourself, then be aware that the following errors have caused registrations to be void resulting in a total loss of security (and money):
(a) Failure to enter the ACN of a company borrower.
(b) Entering the borrower’s correct names, but in the wrong order.
(c) Misspelling the borrower’s name by just one letter!
(d) Writing the borrower’s double barrel name as one word, rather than as two words.
(e) Failing to correctly enter the VIN for a motor vehicle.
(f) Recording in the box requiring the collateral description, simply a reference to the date of the general security agreement.
(g) Failing to indicate that collateral covers inventory.
The Personal Property Securities Register was meant to be user friendly. It isn’t. If you do not know what you are doing, brief us to do it for you.
7. Lending, leasing and hiring equipment
From 1 October 2015 short term leases (ie leases between 90 days and one year) of serially numbered goods are no longer deemed to be security interests under the Personal Property Securities Act.
The idea behind the change is to try and keep some consistency in the concept of the threshold term (one year) beyond which leases of equipment are taken to be security interests requiring registration.
But the changes did not deal with leases for an indefinite term. These are still deemed security interests.
Consider how this affected Harry. Harry’s company leased bull-dozers to builders on building sites. One bull-dozer lease was for 8 months. Just before the lease expired, the builder said “Can I have it for a couple of weeks longer, Harry?” Harry replied, “Yeah, sure, don’t worry – have it as long as you like.”
What Harry did not realise at the time was that this caused the bull-dozer lease to become a lease for an indefinite term, and thereby his company’s interest under the lease was a deemed security interest which required registration on the Personal Property Securities Register failing which it was void in the event that the builder went bust – which is what happened.
So the moral is: even if your loan, lease or hire of equipment is for less than one year, consider carefully before you decide to NOT register on the Personal Property Securities Register.
8. Stop your security driving out the front door!
You lend money to BrownCo, a building company. You register your “allpap” security interest on the Personal Property Securities Register.
BrownCo is in the business of leasing bull-dozers to others. It leases some of its bull-dozers to ColourCo but BrownCo forgets to register its security interest on the Personal Property Securities Register.
ColourCo then borrows money from Can-doBank which registers its own security interest against ColourCo on the Personal Property Securities Register.
While the lease is in place, ColourCo enjoys the bull-dozers it leased from BrownCo free of your security interest (s 46 Personal Property Securities Act).
But ColourCo then goes into liquidation before the end of the lease. BrownCo’s unperfected security interest vests in ColourCo and you have no recourse against ColourCo, only against BrownCo.
But BrownCo does not have enough dozers to keep trading and goes bust. Can-doBank (which can sell BrownCo’s dozers and keep the proceeds) sends you a Christmas card wishing you happy holidays. You are furious.
Another fine mess. Remember to ensure your lending documents state that the person you are lending to (a) must inform you of all relevant transactions and (b) must perfect their own security interests to the extent possible under the Personal Property Securities Act.
If you are thinking of lending or borrowing money with personal property securities, speak to our resident Personal Property Securities Lawyer in our North Sydney office.
02 9964 0022