How financiers can reduce their risk

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Written by Special Counsel Leigh Adams 

 

The problem

 

If you are a financier, then considering new ways to reduce your risk is always a good idea.

 

The most common forms of security are the following:

 

  • Registered first mortgage over real property. We have no issue with this one. The only problem is – what happens if this option is not available? If that is the case, then read on.
  • Caveatable interests in real property in conjunction with unregistered second mortgages. Recovery rights in such circumstances are dependent on the first mortgagee taking action. On your own, you cannot deal with the property at all. In any event, second mortgage rights are always risky particularly if you lend when interest rates are low and the property market later becomes overheated  with rising rates.
  • Guarantees. These are still very popular, but they frequently mean potentially long and costly delays through the courts before recovery can take place.
  • Security interests granted by companies. This can also be frustrating where the assets are illusory. Goodwill, for example, can disappear overnight in the event of scandal. Or the company can simply go broke for a myriad of other reasons.
  • Security interests given by individuals over their own personal and future property. We have found that this is far preferable to insisting on guarantees. Individuals can dispose of assets during the guarantee litigation and the resulting judgment can be a pyrrhic victory.
    Nevertheless, where an individual grants a security interest over their present and after acquired property, this security interest can run aground if the PPS registration details (like names and dates of birth) have been forged or are simply incorrectly transposed onto the PPS Register.
  • Invoice financing. Invoices can remain irrecoverable.
  • Floor plan financing – this type of security can become worthless in the event of a catastrophic event like fire.
  • Registering security interests in leased or financed goods – where an error in the registration details can cause the security interest to be void as against third parties.

 

The list goes on and on and for many financiers, it comprises a lamentable catalogue of missing the mark.

 

Access this rarely used PPSA security device

 

There are currently no cases in Australia relating to section 26 of the Personal Property Securities Act 2009 – the granting of a security interest in collateral which is an intermediated security, perfected by control.

 

The legal definition

 

What is an intermediated security? At the risk of oversimplification it includes the rights a person has in a security account.

 

In turn, a security account is the account into which and from which interests in financial products (eg listed shares) may be credited or debited. A security account also includes the rights a person has in respect to the record of holdings of those shares and transfers of interests in those shares as kept by the Australian Securities Exchange Settlement Transfer Corporation Pty Ltd  and its sub-registries – including CHESS.

 

The plain English definition

 

An intermediated security is the debtor’s rights to deal with their own publicly listed shares (and other financial products) as listed on the ASX and its sub-registers. 

 

How can you get an effective security interest over share dealings on the ASX?

 

That is, how can you “perfect” your security interest in a debtor’s intermediated securities?

 

Register on the PPSR – you are kidding!

 

You can register a security interest in that collateral on the Personal Property Securities Register. The problem with this is that  in reality, you cannot actually prevent the grantor from selling the shares and whilst technically the shares would (usually) be sold to the third party purchaser subject to the security interest,  in a practical sense the identity of the purchaser is most likely impossible to determine.

 

Control of the intermediated security

 

The only practical solution is to control the intermediated security. This is done by following the procedure outlined in section 26 of the Personal Property Securities Act 2009.

 

The best way we have found is to put an agreement in place between the lender, the borrower and the intermediary who maintains the securities account.

 

The agreement should provide that the intermediary must not comply with instructions given by the grantor without having the secured party’s consent and that the intermediary must comply with instructions given by the secured party without having the consent of the grantor.

 

Who is the intermediary?

 

The 2011 amendments to the Personal Property Securities Act 2009 make it clear that the section applies to security interests over CHESS intermediated securities with the parties being the grantor, the grantee and the applicable sub-broker (eg. Commsec)  or share issuer (if there is no sub-broker).

 

Other forms of security?

 

Other forms of collateral which financiers ought to consider are investment instruments, uncertificated negotiable instruments and rights under a letter of credit.

 

Take home message

 

There are a number of alternatives to consider when financing business transactions. The best way forward is usually to use a number of them, rather than just relying on one. Call Leigh Adams for details on 02 9570 7844.

 

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