Thinking | 11 August 2016
How can a landlord prevent “landlord’s property” being sold by a receiver or liquidator if its tenant becomes insolvent?
Imagine if you owned expensive machinery – let’s say large mining equipment, leased it to a company that became insolvent, and after you retrieve the equipment you are ordered to return it to the Receiver so it can be sold and the proceeds paid to the company’s secured creditors, with nothing left for you!
That’s what happened to Queensland Excavation Services Pty Ltd (QES) in 2012. The NSW Supreme Court found that because QES had not registered a security interest under the Personal Property Securities Act (PPSA), the secured creditors were entitled to the proceeds from the sale of its equipment, leaving nothing for QES!
Now imagine that you own a building with valuable property in it, which is included in the lease you have granted to the tenant – often referred to in leases as Landlord’s Property. It could be goods that you have paid for by way of a fitout contribution (such as systems furniture and other unfixed goods) or in the case of industrial premises, valuable overhead cranes or heavy duty racking or shelving. If that tenant becomes insolvent and you have not registered a security interest over the Landlord’s Property, you could suffer the same fate as QES – in effect lose your property!
But wait, you own those goods. What gives someone else the right to sell them and keep the proceeds? The PPSA does.
The PPSA was established primarily to allow parties to protect (usually by registration) ‘security interests’ over personal property, being pretty much every kind of property other than real estate and water rights. A security interest is an interest that secures the payment of money or the performance of obligations.
What’s that got to do with a situation where a landlord includes goods with premises it leases to the tenant? Well the PPSA is also designed to address what is known as the ‘apparent ownership’ – where a third party assumes the person with possession and use of goods owns them, when in fact that is not the case. The third party, in most cases, has no way of knowing this. So the idea is that the PPS Register can be used by the owner of the goods to register its interest as owner so that anyone dealing with the tenant can simply search the Register to check whether any goods in the tenant’s possession belong to someone else, or are subject to any other third party claims.
This kind of interest is not a ‘security interest’ in the normal sense (because it is not securing any payment or other obligation). Rather, it is deemed to give rise to a security interest and is given a special name in the PPSA – a ‘PPS Lease’.
A crucial principle of the PPSA is that if you have an interest that can be registered under the Act, and you don’t register that interest, then other parties should be able to proceed as if that interest does not exist. It’s akin to a version of the ‘use it or lose it’ principle. There are two aspects to this in the Act:
- the first is referred to as the ‘taking fee’ rule. A purchaser of goods for valuable consideration is said to take the goods ‘free’ of any security interest that is not registered. In a leasing scenario this means that a tenant could ‘sell’ a landlord’s goods to an innocent third party who would obtain good title.
- the second aspect is referred to as the ‘vesting’ rule. This is the rule that deprived QES of its own excavation equipment. The effect of the rule, in a leasing scenario, is that if a person who has possession of goods belonging to another under a PPS Lease becomes insolvent, unless the owner of the goods has registered its interest arising under the PPS Lease, the goods are taken to ‘vest’ in the tenant meaning that they can be sold as the property of the tenant and the proceeds paid to secured creditors. In effect the true owner of the goods becomes an unsecured creditor for an amount equivalent to the value of its goods. In an insolvency situation this will often mean there is nothing left for the owner.
Here’s how it would work in a practical scenario. A company who occupies leased premises is in financial difficulty. A secured creditor has a charge over all of the company’s property and appoints a Receiver. The Receiver will search the PPS Register to see if any PPS Leases have been registered, which would indicate that certain goods in the possession of the company belong to someone else. If no PPS Lease is registered, then the Receiver will be entitled to treat all the property in the premises as the property of the company and sell that property to repay the secured creditor.
There are some technical rules around what types of arrangement constitute a PPS Lease. The most important of these is that the lease must be for a period of 12 months or more, including renewal rights, or of an indefinite term. It also applies where the lease is for less than 12 months but the tenant retains continuous possession of the goods for more than 12 months (for example if the lease is extended by agreement or continues under a holding over situation).
There is one other very important thing to be aware of, and that relates to the timing of registration. If a PPS Lease is registered within 15 business days of the lease commencing, it takes priority over any existing registration. For example, if the tenant has previously granted an all assets charge in favour of another party (for example a bank), registering a PPS Lease within the 15 day period will ensure your goods are protected even though the tenant’s bank has a prior ranking security interest. If you register after that period has expired, the registration is still valid, but it no longer has priority over a pre-existing security interest.
The moral of the story?
If you own valuable goods which are included in a lease of real estate, make sure you protect your interest in those goods by registering a PPS Lease within 15 business days of lease commencement.
Please note that the summary above is intended to explain the principles in a simple way and highlight the risks to landowners. The PPSA is very complex legislation and needs to be considered and applied carefully on the facts of each particular situation.
Hall & Wilcox can assist with advice on how and when a PPS Lease should be protected and we can effect registration for clients if required.
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