How to avoid a catastrophe for $7.40 – practical advice about one ramification of the PPSA

Articles, Loan + Securities

A stitch in time…

A $7.40 outlay, and ten minutes filling in a online form, can save your clients ten of thousands of dollars. See below to learn why.

 

Things you already know

As is widely known, the Personal Property Securities Act 2009 (Cth.), came into force earlier this year. It is widely known as “the PPSA” and pretty much everyone in our field now knows at least roughly how it works: if you have a “security interest”, and you do not register it, you can lose it.

Having become comfortable with the general principle, the next logical step is to consider how it affects certain specific situations. This email deals with one of them – just one, but common enough that it merits attention.

 

The structure

A common business structure, employed for both tax and asset protection reasons, involves two related companies – one owning all of the business assets, and a separate company licensing those assets in order to carry on the business.

These companies are typically referred to as the holding company and the trading (or contracting or operations) company. The holding company does nothing but own the assets and licence them to the trading company, while the trading company does all the trading – entering into customer and supplier contracts, renting premises, employing employees and so on.

 

The situation

For the purposes of this bulletin, let us assume we are dealing with two hypothetical companies in the manufacturing industry, XYZ Holdings Pty Limited (Holdings) and XYZ Contracting Pty Limited (Contracting). Let us further assume: –

  • Holdings owns about $2.5M of plant and equipment.
  • Contracting licences the equipment from Holdings and uses it to carry on a manufacturing business.

 

The consequence of the structure in insolvency

Unfortunately, things do not go well for Contracting. It loses money on a few jobs and, eventually, it becomes hopelessly insolvent and suffers the appointment of a liquidator.

The liquidator sees the $2.5M of unencumbered equipment that the company has been using and gets very excited. However, this excitement quickly turns to disappointment when he learns that the equipment actually belongs to Holdings, not Contracting.

Despondent, the liquidator reports to creditors that there will be no distribution. Meanwhile, the owners of Holdings cause another company to be incorporated – XYZ Contracting (NSW) Pty Limited. Holdings re-licences all of its equipment to the new company, which promptly establishes a successful manufacturing business bearing remarkable similarity to that conducted by Contracting prior to its demise.

 

The new regime

As a result of the enactment of the PPSA, the above situation may evolve dramatically differently.

Under sections 12 and 13 of the PPSA, a “lease of bailment of goods” for “an indefinite term” is deemed to be a “security interest” for the purposes of the PPSA.

This means that, on a PPSA analysis, Holdings merely has a “security interest” in the equipment being used by Contracting – the fact that it is the legal owner of that equipment is wholly irrelevant.

Under section 267 of the PPSA, an unregistered security interest in goods is lost if the company in possession of the goods is placed into liquidation or administration.

This would mean that, under the PPSA, Holdings would irretrievably lose (and the liquidator would gain) any equipment that happened to be in Contracting’s possession at the time the liquidator was appointed.

Note: It is not actually quite as straightforward as is set out above (for instance there is a difference between “unperfected” and “unregistered”), but the foregoing is a correct analysis of the law as it relates to this particular case study.

 

What can be done to prevent this?

In order to prevent its equipment being lost upon the appointment of a liquidator to Contracting, all Holdings needed to do was register its interest on the PPSR (Personal Property Securities Register).

If it had done that, then its interest in the equipment would be “perfected” and, consequently, would not be wiped out upon the appointment of a liquidator to Contracting.

What does it take to register a security interest? About ten minutes online and a $7.40 fee.

 

Summary

The PPSA applies to relationships between related parties like Holdings and Contracting with no less force than it does to relationships between arms-length parties.

Accountants and business advisors should remember, when commending the above  business structure to their clients, to emphasise the need for the holding company to register its interest in any goods that are likely to find their way into the possession of the trading/operations/contracting company.

Failure to do so may result in the complete failure of the structure in the event the trading company becomes insolvent – and a claim against the advisors for professional negligence.

These are easy risks to guard against – but only if the risks are actually adverted to. We hope that this bulletin has been useful in this regard.

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