Credit traps for the unwary

Standard procedures may no longer work for those giving credit, writes GARETH HOOLE*.

Recently, on two separate occasions, I consulted parties who had been financially affected by the collapse of businesses they dealt with.

Fortunately, in both circumstances, the clients were protected by a form of security over the debt owed to them.

In one case, the client had advanced money to a business belonging to a friend a few years earlier and had the foresight to secure the loan by registering a debenture over the company.

The business turned sour and was placed into liquidation, but the client had a preferential right to repayment of the loan from the liquidation proceeds, because the debenture ranked its claim ahead of those made by unsecured creditors.

In the other case, the client was owed money by a customer in respect of goods supplied on trade credit.

At the time that the client supplied the goods it was unaware of the financial difficulties that were being faced by its customer.

These problems resulted in the appointment of a receiver two weeks after the goods were delivered.

But on the back of the invoice raised by the client it was stated quite clearly that the title to the goods was retained by the supplier until full payment was made.

This is typical business practice and is known as a Retention of Title clause, or more commonly a Romalpa clause.

The client was able to prove to the receiver that it had not been paid for the goods and was also able to identify the goods, which were still in its customer's warehouse.

The receiver permitted it to re-possess the goods and thus avoid the probable financial loss it would have suffered it it had been an unsecured creditor.

These are two happy endings that could well have been unhappy had the new Personal Property Securities Act (PPSA) been in effect.

Although the act became law in October 1999, its practical implementation was delayed until the start of this month.

The act now applies and this will change significantly the way many people do business.

Anyone who gives or receives credit will be affected.

What, then, is this new legislation?

It is a law that follows North American precedents and aims to simplify and clarify the law relating to personal property security interests.

Our present legal framework allows for security to be registered over personal property for advances of cash and the provision of credit.

However, such law has been spread over several different statutes and common law principles and the registration of security interests has been catered for in several places.

The PPSA seeks to unify those legal principles into a single statute and to create a single register of interests.

Its objective is also to provide certainty regarding the priority of security interests and a centralised register of security interests that is easily accessible at a low cost.

From the start of this month, anyone wishing to take security for credit provided by them will need to do so in accordance with the provisions of the PPSA.

It is a complex piece of legislation that introduces many definitions and new concepts, which it would be impractical to detail here.

But anyone who gives or receives credit should be aware of the requirements and far-reaching implications of the PPSA.

A centralised register, the PPSR, which will be accessible only electronically via the internet, has been established.

All security interests that have been registered will be recorded on this register, allowing a potential provider of credit to determine what other security has been registered over the debtor's property.

There are exclusions, to which the PPSA does not apply, the most significant of which is an interest in land. This means that mortgages are not registered on the PPSR.

Another important point is that the PPSR is not a register of title. Rather, it is a register of security.

This means that although a security interest may have been registered over personal property it does not necessarily mean that the debtor has clear title to it.

The PPSA does not change the common law principles of retention of ownership, that is ownership not passing until payment has been effected for the goods supplied, but it does have an effect on the strength of that form of security.

To enjoy a priority claim in the event of a liquidation, or receivership, creditors must have registered their security interest and cannot simply rely on the common law principles, as has been the case in the past.

The client I consulted in this context might not have been able to retrieve its goods as it did had there been another creditor with a higher- ranking priority under the PPSA.

Another interesting innovation is the concept of a super priority security interest known as a PMSI (Purchase Money Security Interest), which can have the effect of eroding the security enjoyed by a debenture-holder.

Therefore, in the future, lending money to a company under security of a debenture might not necessarily protect the loan creditor in the event of a liquidation.

That security could be superseded by a subsequently registered PMSI.

This all might appear very confusing to the uninitiated, but it is of critical importance that a full understanding of this new legislation is gained by all who deal in credit.

It affects individuals as well as businesses and failure to come to terms with the concepts could be a costly oversight.

If you have not already done so, I recommend that you seek advice on the PPSA at your earliest convenience.

* Gareth Hoole is a senior manager in the Client Advisory Services division of Staples Rodway. The views expressed in this article are his own and not necessarily those of Staples Rodway.

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