The recent Federal Court decision in Diversa Pty Ltd v Taiping Trustees Limited has highlighted some important risks faced by secured parties who don’t pay attention to the details when perfecting, and maintaining perfection of, their security. Those risks include:
The case concerned two disputes between Diversa and Taiping regarding their claims to funds realised by the receivers of SC Australia Holdings 1 Pty Ltd (Receivers and Managers appointed) (in Liquidation) (SCAH), the receivers having been appointed by Diversa as a secured creditor of SCAH. SCAH was a wholly owned subsidiary of Sargon Capital Pty Ltd (in Liquidation) (Sargon Capital).
The disputes related to whether Diversa or Taiping had priority under their respective security interests to the proceeds of the sale of shares in Sequoia Financial Group Ltd (SEQ shares) and Madison Financial Group Pty Ltd and certain other entities (Madison shares). The court found that Diversa had priority over the SEQ shares and their proceeds and Taiping had priority to the proceeds of the Madison shares. While the conclusion reached in respect of the SEQ shares is undoubtedly correct, the finding in favour of Taiping in relation to the Madison shares is controversial.
The relevant facts concerning the SEQ shares were as follows:
The main issue in dispute was whether Taiping’s security interest covering the SEQ shares, which was initially perfected by registration against Sargon Capital before Diversa’s security interest was perfected against SCAH, had priority over Diversa’s security interest in the SEQ shares as a consequence of Taiping’s security interest being re-perfected by registration against SCAH.
The court determined that Diversa had priority over the SEQ shares and their proceeds for the following reasons:
Accordingly, following the sale of the SEQ shares by the SCAH receivers and the receipt by Diversa of the net proceeds of sale, there was no “transferred collateral” as that term is used in s68 of the PPSA and it was not possible under s68 for Taiping to re-perfect its security interest in the SEQ shares or any proceeds of those shares.
The court found s68(1)(d) of the PPSA required Taiping to re-perfect its security interest in the SEQ shares before the time of the third party sale. However, Taiping only attempted to re-perfect its security and comply with s68(1)(d) by making registrations on the PPSR after the sale date. Those registrations were made against SCAH as grantor but the registrations were incapable of perfecting any security interest held by Taiping. Any entitlement SCAH may have had under s140 to the surplus of the proceeds of sale did not constitute “transferred collateral” as that term is used in s68 of the PPSA. Again, it is arguable, based on the reasoning of earlier Canadian and New Zealand PPSA cases, that s68(1)(d) required Taiping to re-perfect its security in the SEQ shares before the appointment of the receivers to SCAH rather than the later time of the sale of those shares by the receivers and that this factor alone should have been sufficient to enable Diversa to succeed.
As Taiping was not able to avail itself of priority via s68 of the PPSA, the court considered the priority between Taiping’s security and that of Diversa should be determined in accordance with s55 of the PPSA as at the date of the sale and as at that date, Diversa’s perfected security interest had priority over the unperfected security interest of Taiping. Even if the date for determining priority was the date of the appointment of receivers to SCAH rather than the date of the sale by the receivers, the result would not have been any different in this case.
The court’s decision in respect of the SEQ shares highlights the importance of secured parties monitoring and promptly reacting to information regarding unauthorised dealings with collateral by the grantor of a security interest. In particular, prompt re-perfection of security when collateral is transferred without authorisation, and in circumstances where the ‘take free’ rules do not apply, is essential.
The dispute concerning the Madison shares involved different factual considerations to the SEQ shares. The central issue was whether Taiping had an effective security interest in the nature of a pledge over the Madison shares which had been granted by SCAH in favour of Taiping to secure the obligations of Sargon Capital (not SCAH) to Taiping.
The relevant facts concerning the Madison shares were as follows:
The court found that Taiping held a consensual security interest in the Madison shares to which s12 of the PPSA applied and that this security interest was perfected by control at all relevant times, including both prior to and following the sale of the Madison shares by the SCAH receivers.
Because Taiping’s security interest was perfected by control, it had priority pursuant to s57 of the PPSA over the Diversa GSD which was perfected only by registration.
Although the court acknowledged some inadequacies in the documentation of Taiping’s security interest in the Madison shares, it did not consider any of those inadequacies to be fatal. The court rightly accepted that the grantor of a security interest need not be the debtor, but it glossed over the issue as to whether a security agreement should identify the obligations secured by the interest in personal property for it to constitute a security interest. Nowhere in the judgment is there any indication that the obligations intended to be secured by the pledge of the Madison shares were expressly identified. At best, they were implied, and the court appears to have concluded that this was sufficient.
Despite the court finding that Taiping’s security interest in the Madison shares was a security interest to which s12 of the PPSA applied and that, being perfected by control, Taiping had priority, the court went on to consider the outcome if Taiping’s security interest was in fact an interest arising by operation of the general law (i.e. common law and equity). The PPSA (other than s73) does not apply to such interests by virtue of s8(1)(c) of the PPSA. Section 8(2) of the PPSA provides that liens, charges and other interests in personal property that arise by operation of the general law can still be subject to s73. Section 73 regulates priority between security interests to which the PPSA applies and certain (but not all) non-consensual security interests to which the PPSA does not otherwise apply due to ss8(1)(b) and (c).
The court concluded that if the interest of Taiping was one arising by operation of the general law then, pursuant to s73 of the PPSA, Taiping would still have priority in relation to its interest. Furthermore, the court found that if Taiping’s interest was one arising by operation of the general law but s73 did not apply, then Taiping’s earlier equitable interest would, applying general law priority principles, prevail over Diversa’s legal interest under the Diversa GSD because Diversa had constructive notice of Taiping’s earlier equitable security interest at the time the Diversa GSD was granted.
The court’s observations regarding ss 8(1)(c) and 73 and the finding that Diversa had constructive notice of Taiping’s equitable interest at the time the Diversa GSD was granted are controversial.
First, the court does not clearly explain why Taiping would have had a security interest arising by operation of the general law as distinct from the consensual terms agreed between the parties. A key authority referred to by the court expressly held that although there is a presumption at law that an equitable mortgage will arise from the deposit of title documents to secure the payment of a debt (including a debt owed by a person other than the person making the deposit), such a mortgage is contractual in nature rather than arising by operation of law.
Secondly, some parts of the judgment seem to suggest an interest in property can be both a consensual security interest under s12(1) and also an interest to which the PPSA does not apply because of s8(1)(c). However, while a person could have a consensual security interest and a non-consensual security interest in the same property, these would be different interests, with different rights and a different legal foundation.
Thirdly, the court’s finding that if s73 did not apply, Taiping’s earlier equitable interest would prevail over Diversa’s legal interest under the Diversa GSD was based on Taiping having discharged the onus of proving Diversa had notice of Taiping’s earlier equitable interest. The court said this was due to the Diversa GSD expressly contemplating the deposit of share certificates and transfers for the Madison shares at the time of execution of the Diversa GSD but Diversa never obtaining them or receiving a satisfactory explanation for them not being provided. These factors by themselves seem to set quite a low threshold for proving Diversa had constructive notice, particularly when the Diversa GSD included a representation and warranty by SCAH that “no person other than the Secured Party has possession or control of the Collateral or an Encumbrance in the Collateral which is perfected by control”. Would the court’s conclusion have been different in relation to this issue if the Diversa GSD had merely contemplated the deposit of title documents (including share certificates) if SCAH had been requested by Diversa, at any time, to do so?
Given the obvious deficiencies in its security documentation, especially the failure to describe the secured obligations, Taiping may have been fortunate to succeed in its claim relating to the Madison shares. The case is a timely reminder that secured parties should, at a minimum, ensure their security agreement properly describes the grantor, the collateral, the intention to create a security interest and the obligations secured by that security interest.
Also, if a secured party wishes to have the best possible security over shares it should perfect by control; take the share certificates (if the shares are certificated) or have an appropriate control agreement in place and take signed blank transfers from the grantor. This will not only give the secured party the super priority that comes from perfecting by control, it will also make it much more difficult for third parties to take free of the security interest. Taiping failed to do these things in relation to the SEQ shares and Diversa failed to do so in relation to the Madison shares.
  FCA 316.
 In relation to the SEQ shares, Beach J held (at ) that “Taiping’s ambitious attempt to perfect the imperfectable fails.”
 Section 34 enables a security interest in transferred collateral to be temporarily perfected as against the transferee (SCAH) in circumstances where the transferee does not ‘take free’ of the security interest.
 Section 49 provides that a buyer of ‘investment instruments’ or ‘intermediated securities’ in the ordinary course of trading on a prescribed financial market takes free of a security interest.
 Section 68 deals with the priority of security interests in transferred collateral where there has been a break in the perfection of the security interest granted by the transferor.
 Section 140 provides for the distribution of proceeds received by a secured party.
 See, for example, Sperry Corp v CIBC 17 DLR (4th) 236; John Deere Credit Inc v Standard Oilfield Services Inc 16 CBR (4th) 227; Re 1231640 Ontario Inc 2007 ONCA 810; Gibbston Downs Wines Ltd v Perpetual Trust Ltd  NZCA 506 and Strategic Finance Limited (in receivership and in liquidation) v Bridgman  NZCA 357.
 It is not clear from the judgment precisely when the temporary perfection afforded by s34 ended.
 Section 140(2)(f) contemplates that the grantor will receive any surplus remaining after the payment of enforcement costs and secured creditors.
 Refer to the cases in note 7.
 Section 55 sets out the default priority rules that apply to security interests in the same collateral if the PPSA provides no other way of determining priority.
 Refer to the cases in note 7.
 Section 12(1) of the PPSA states that a security interest is an interest in property provided for by a transaction that secures payment or performance of an obligation. It is arguable that unless the obligations to be secured are ascertainable, there can be no security interest under s12(1).
 This may have been influenced by the fact Taiping had control of the Madison shares so, strictly speaking, it may not have been necessary to have a written “security agreement that provides for the security interest”, see s20(1)(b), PPSA. However, this is not clear from the judgment.
 In re Wallis & Simmonds (Builders) Ltd (1974) 1 WLR 391 at 404.
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