Tacking in lending: Understanding the key concepts

The Principle of Tacking

As an overview, the principle of tacking allows the expected priority of interests to be altered under certain circumstances.¹

This principle enables a secured lender to add further advances that are secured by the existing security while maintaining priority over other subsequent lenders, for example:

• "Lender A" advances funds and registers a first registered mortgage over the security property.
• "Lender B" advances funds and registers a second registered mortgage over the same security property.
• "Lender A" subsequently makes further advances, which are secured against the same property. These further advances can be "tacked" onto the existing first registered mortgage and, therefore, take priority over "Lender B's" second mortgage.

The above scenario is a common example of the principle of tacking and when applied properly, it can be highly beneficial for lenders who make further advances.

The Rule Against Tacking

As with all principles, there can be exceptions. For tacking, a Lender's right to tack is rendered void by actual (not constructive) knowledge or notice of a subsequent lender's advance.² This is known as the 'Rule against Tacking'.

The Rule against Tacking was reinforced in Hopkinson v Rolt (1861) where it was held that a first lender cannot tack additional advances if they have actual notice of a subsequent lender's advance.³ For example:

• "Lender A" advances funds and registers a first mortgage over the security property.
• "Lender B" advances funds and registers a second mortgage over the same security property.
• "Lender B" issues a notice to "Lender A" notifying them of their advance.
• "Lender A" subsequently makes a further advance, secured against the same property. However, as Lender A now has knowledge of Lender B's advance, Lender A's subsequent advance will rank lower in priority to Lender B's advance.

The rule against tacking promotes fairness among competing mortgagees as it is considered unfair for an earlier lender to encroach on the security given to the later lender after notice or knowledge of a later security. However, as set out below, this principle does not apply to all types of security, and lenders should take certain precautions to protect their interests.

PPSA: Priority of Further Advances

The Personal Properties Security Act 2009 (Cth) (PPSA), which repealed Chapter 2K of the Corporations Act 2001 (Cth), largely allows for tacking.

Under section 18 of the PPSA, lenders are permitted to protect the priority of future advances, provided that the underlying security agreement contemplates both the future advance and captures the repayment of those advances as an obligation.

The rule against tacking will not apply to any PPSA security interest.

The following circumstances are examples that would give rise to a change in priority for a PPSA security interest and, ultimately, the principles of tacking:

1. Purchase Money Security Interests (PMSI), which hold super priority. Advances by a subsequent lender for acquisition funding ensure priority regarding the specified asset⁴; and
2. A priority deed that has been entered into between the two secured parties in respect of competing security interests and
3. Priority disputes between two competing transitional security interests under s 323 of the PPSA.⁵

Real Property

For real property mortgages, the rule against tacking primarily applies, subject to a few exceptions, which were highlighted in Matzner v Clyde Securities Ltd [1975] (Matzner v Clyde)⁶.

In Matzner v Clyde, it was held by the Supreme Court that the rule against tacking as set out in Hopkinson v Rolt applies to competing mortgage priorities even where the first lender is obligated to make a further advance and the mortgagor is obliged to accept the further advance. His Honour in Matzner v Clyde, however, observed that the rule against tacking should not apply concerning further advances by the first lender if they are used to improve the property.⁷ This is because the further advances by the first lender to improve the property had the additional effect of increasing the property's value and, therefore, were not prejudicial to the subsequent lenders, even if they did not consent to the improvements.

Safeguarding the Lender's Priority

To avoid uncertainty or a priority dispute between secured parties, a lender should always ensure that key assets and security have been identified and protected during the advance. Lenders commonly deal with including a 'negative pledge' clause in facility and security agreements that restricts a borrower from creating or permitting a security interest over the secured property without the lender's consent. If a subsequent security interest arises, the finance documents should also require the borrower to procure entry into a priority agreement between the secured parties.

Key Takeaways

• Tacking is where a secured creditor has already advanced funds and then advances further funds to the borrower while maintaining its priority ranking over other secured parties.
• The 'rule against tacking' is where a Lender's right to tack is rendered void by actual (not constructive) knowledge or notice of a subsequent lender's advance. In this scenario, the first lender's subsequent advance will rank lower in priority than any other secured parties.
• The PPSA permits tacking despite providing notice (with certain exceptions).
• The rule against tacking applies to real property unless it can be deemed that such advances were used to improve the property and increase its value.
• Lenders should include a negative pledge in the finance documents to protect their priority. As a second lender, it is imperative to make thorough inquiries to ascertain the ranking of priority, priority limits and available equity.

Footnotes
¹ Mercantile Credits Ltd v Australia and New Zealand Banking Group Ltd (1988) 48 SASR 407.
² Central Mortgage Registry of Australia v Donemore Pty Ltd [1984] 2 NSWLR 128.
³ Hopkinson v Rolt (1861) 11 ER 829.
⁴ Personal Property Securities Act 2009 (Cth) s 14(1)(a).
⁵ Personal Property Securities Act 2009 (Cth) s 323.
⁶ Matzner v Clyde Securities Ltd [1975] 2 NSWLR 293.
⁷ Bradford Banking Co. Ltd. v Henry Briggs, Son & Co. Ltd. (1886) 12 App. Cas. 29; Deeley v Lloyds Bank Ltd [1912] A.C. 756.

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.