Bank and non-bank lenders alike have for some time understood the need to create and register personal property security interests as part of loan security portfolios. However, for many lenders, this is merely a 'must to' step without a good understanding of why or how such personal property security can be used to enhance your security position.
In this article we will address the fundamental reasons for adding personal property security to a loan, as well as how personal property security can be used to add real value.
The basics - why every loan should include a General Security Agreement
A general security interest, which is a security interest over all present and after acquired personal property of the borrower (or AllPAP), is usually created via the use of a General Security Agreement (GSA) and is a must for any loan product.
Since the advent of the Personal Property Securities Act 2009 (Cth) (PPSA), nearly all property that is not land, including chattels, vehicles, plant and equipment and intellectual property rights, can only be mortgaged via a security interest under the PPSA.
Even when the primary loan security is land, there is a good chance that there will be personal property situated upon or associated with the land, this could include whitegoods and furniture packages in newly constructed buildings, and development approvals, plans and designs that might attach to an unfinished project. It is essential therefore for the lender to take a security over personal property of the borrower to ensure that the lender has the capacity to deal in these assets together with the land, should the time come.
Whilst taking security over such assets could be done under a specific security agreement, the use of a general security interest or AllPAP, ensures you don't miss any personal property of the borrower that could be required and, in the context of a developer using a development specific company at least, doesn't usually place the borrower in any worse off position.
A general security interest needs to be perfected by registration on the personal property securities register (PPSR) in order to be enforceable. Since the registration must be made no later than 20 business days after the interest attaches (after the advance) and since it is possible to register in advance, the recommendation is to register once the GSA has been signed and before you advance. This also ensures that you register with the correct priority as there is no form of caveat or priority notice system for the PPSR.
The slightly more complex - understanding PPS priorities and take free rules
Priorities on the PPSR are very important and lenders should not simply assume that when they register their general security they will immediately have a security over the borrower's property associated with the development they are financing. You must conduct a PPSR search of the borrower and see who has already registered security interests ahead of you.
As between general security interests, the time of registration determines the priority. This means that where the same borrower has obtained facilities from multiple lenders, including for different projects, the first registered general security interest holder has priority to all of the borrower's assets, including those you are currently financing with your general security. To this end, it is recommended to obtain a partial discharge from any prior registered general security holder in connection with the property or project you intend to take security of.
An alternative is to document an advance for specific property and record a specific security interest over that property as a purchase money security interest (PMSI), which will have priority over any general security. Most lenders have come to understand PMSIs as the recording of retention of title interests by suppliers of the borrower, but that is only one type of security interest that can be registered with a PMSI priority. A PMSI can be recorded in respect of any goods paid for with the lender's money, hence purchase money. Direct payment of the supplier by the lender as evidence is recommended.
PMSIs can also arise in respect of other security interests. Debt factoring arrangements by borrowers can result in the recording of a PMSI priority over the book debts of the borrower by the debt factoring lender which, once notified to other registered security interest holders, will take priority over all interests on the register including other PMSI interests.
Another important concept to understand about the PPSR is that there is no rule against tacking. Recording a general security interest will not automatically stop or cap what is recoverable under an earlier general security interest or any other security interest. You must enter into a deed of priority with another secured party if you wish to change, limit or in any other way define, their priority.
The vanguard - using PPS security interests to secure special assets and improve security
The advent of the PPSA has made it possible to safely mortgage interesting classes of assets that may not previously have been thought of as a viable form of security.
Whilst a general security interest will of course attach to all personal property assets of the borrower, a lender who identifies a particular asset or who is unable to take a general security, may wish to mortgage that particular asset individually. This includes artwork, shares, book debts, intellectual property rights, cryptocurrency or non-fungible tokens (NFT), and carbon credits.
Obviously, the lender must give consideration to the strength of the security, not only in terms of value but also in terms of how the asset can be dealt with if the security was to be exercised. Shares in private companies are usually the subject of transfer restrictions under shareholders agreements, and due diligence needs to be performed in this regard. Listed shares, crypto assets and other intangible assets also require consideration of steps required in obtaining possession and dealing with the asset. However, this can be used to the lender's advantage.
Intangible assets such as crypto assets are likely to be held in either a hot wallet (online account) or cold wallet (physical hard drive). Security over intangible assets might therefore take the form of perfection by possession (keeping the hard drive as security) and or control (administration of the login and password).
Physical possession or control of an asset is just an alternative form of perfection under the PPSA, which can be made by either registration, possession or control. This means that questions of priority remain relevant. However, physical possession or control of an asset will in many cases take priority over registration if done correctly, making these somewhat outdated methods of security a resurging alternative for securitising passive investment assets of the borrower that could increase the level of security and make a deal that was previously unviable, now viable. Food for thought!
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
