Unfair preferences and unperfected security interests

Take the scenario where your company has supplied a customer with goods on credit.  The standard terms and conditions of supply grant your company security over the goods supplied until they are paid for.  In order for that security to be perfected, the interest granted needed to be registered on the Personal Property Security Register (PPSR).  If for example, the interest was not registered or if it was, it was invalid for technical reasons then your company may be at risk.

The customer then makes some payments but is subsequently placed into liquidation and upon appointment, any security interest held by your company vests in the customer that is now in liquidation.  To make matters worse, you receive a letter from the liquidator demanding ‘under threat of legal action’ that your company pay the payments you received from the debtor company during the six months prior to their appointment on the basis the payments were made in respect of unsecured debts and thus were “unfair preferences”.

None of the usual defences to an unfair preference claim such as good faith or running account are available.  That said, the case of Trenfield & Ors v HAG Import Corporation (Australia) Pty Ltd [2018] QDC 107 (Trentfield) suggests all may not be lost.

Unperfected by still secured?

In Trenfield it was held there was no formal agreement providing for ongoing supplies of goods on credit.  This was because while HAG’s credit application included terms and conditions granting a security interest in any goods supplied by way of a charge and a retention of title, the documents did not constitute a contract as such for ongoing supply.   Thus every supply of goods by HAG was a standalone contract subject to the terms and conditions of supply.

While a security interest arose in respect of any goods supplied, it was not perfected because the purported registration in reliance upon an agreement for ongoing supply on the PPSR was invalid.  Unsurprisingly, the liquidators claimed payments received by HAG during the six months prior to the liquidators’ appointment were for an unsecured debt, were thus preferential and should be disgorged.

Significantly, the Court was of the view that the Personal Property Securities Act 2009 (Cth) did not make an unregistered security void.  Registration prevents the security from vesting in a liquidator if a winding up order is made but an unperfected security vests in the company being wound up (the grantor) immediately before a winding up order is made.  Subject to that however, an unperfected security is still effective as between the parties to the security agreement.

Section 588FA of the Corporations Act 2001 (Cth) dealing with unfair preferences, depends on the debt being unsecured at the time a particular payment is made.  In the case at hand, each particular contract of supply contained a security for the purposes of section 588FA and although unperfected, were valid as between HAG and the debtor company.

Thus when the payments were received during the six months prior to the appointment of the liquidator, the debts were at first glance secured at the time of payment.  However, section 588FA(2) states that a secured debt is taken to be unsecured to the extent of so much of it (if any) as is not reflected in the value of the security.  The value of the security (i.e. the stock in the possession of the debtor company supplied on credit by HAG) had to be valued at the date of each payment made.

Unfortunately for HAG, if the total debt exceeds the value of the security, then any payment received is applied first towards reduction in the unsecured component of the total debt.   In other words, if the debt owed was $700,000 and the value of the stock held was $400,000, then a payment of $200,000 was to be applied first in reduction of the unsecured debt of $300,000.

Because of this, many of the payments received by HAG were in fact unfair preferences and had to be disgorged to the liquidators.

Takeaways

The case highlights the importance of having the correct contractual documentation in place when entering into commercial arrangements.  The failure to perfect the security interests did not mean they could not be relied upon, but their effectiveness was greatly reduced as the size of the debt when compared to the value of the security meant many of the payments received were in respect of an unsecured debt and thus unfair preferences.

Links and further references

Cases

Trenfield & Ors v HAG Import Corporation (Australia) Pty Ltd [2018] QDC 107 

Legislation

Personal Property Securities Act 2009 (Cth)

Corporations Act 2001 (Cth)

Related insights

The ‘good faith’ defence to an unfair preference claim

Unfair preference payments and third party payments

Purchase Money Security Interests (PMSIs) and super priority

Vesting of unperfected security interests on liquidation – register or perish!

Priority issues and the Personal Property Securities Register

Further information about unfair preferences and unperfected security interests

If you need assistance in relation to preferential payment claims or perfection of security interests, contact Dundas Lawyers Gold Coast for a confidential and obligation-free discussion:

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.