Ambitious attempts to perfect the imperfectable

Articles Written by Craig Wappett (Partner)

The recent Federal Court decision in Diversa Pty Ltd v Taiping Trustees Limited[1] 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:

  • not taking possession of the share certificates (for certificated shares) or not having a suitable control agreement (for uncertificated shares) and not taking signed blank transfers when taking security over shares;
  • security interests perfected by control rather than registration not being disclosed by searches and having the benefit of statutory priority;
  • failing to promptly re-perfect security against a transferee of collateral on becoming aware of an unauthorised transfer of that collateral by the original grantor of the security interest.

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.[2]  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. 

SEQ shares

The relevant facts concerning the SEQ shares were as follows:

  • Taiping held a general security deed over all present and after acquired property of Sargon Capital dated 27 April 2018 (Taiping GSD).  The SEQ shares became subject to the Taiping GSD when they were bought by Sargon Capital in July 2018.
  • Diversa held a general security deed over all present and after acquired property of SCAH from 28 June 2019 (Diversa GSD).
  • A financing statement in respect of the Taiping GSD was registered on the Personal Property Securities Register (PPSR) against Sargon Capital and Diversa registered a financing statement in respect of the Diversa GSD against SCAH.
  • The SEQ shares were transferred from Sargon Capital to SCAH on or about 6 December 2019 and Diversa’s security interest attached to the SEQ shares at that time.
  • At the time of the transfer of the SEQ shares, Taiping had the benefit of temporary perfection of its security under the Taiping GSD pursuant to s34 of the Personal Property Securities Act 2009 (Cth) (PPSA) in respect of those shares.[3]  However, Taiping lost that temporary perfection upon becoming aware of the transfer and failing to promptly re-perfect its security interest by registering against the transferee, SCAH.
  • Taiping appointed receivers to Sargon Capital under the Taiping GSD on 29 January 2020.
  • The receivers appointed to SCAH by Diversa on 4 February 2020 sold the SEQ shares on the ASX to a third party buyer on 19 February 2020.  The SEQ shares were obtained by the purchaser free of any security interests held by Taiping or Diversa as a consequence of the take free rule in s49 of the PPSA.[4]
  • The money realised upon the sale of the SEQ shares by SCAH’s receivers was received by Diversa on or around 25 February 2020.
  • On 26 May 2020 Taiping registered a financing statement against SCAH on the PPSR.  This was an attempt by Taiping to re-perfect its security interest in the SEQ shares and proceeds in reliance on s68(1) of the PPSA.[5]

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:

  • Once collateral was realised as a result of enforcement, and the proceeds were received by the secured party (Diversa) rather than the SCAH receivers, chapter 4 (Enforcement of security interests) of the PPSA operated and s140(2) of the PPSA prescribed how that money was to be distributed by Diversa as the secured party.[6]  Section 116 of the PPSA provides that chapter 4 of the PPSA does not apply in relation to property while a person is a receiver or receiver and manager of that property.  However, the court held this is not relevant once the collateral has been realised and proceeds are received by the secured party.
  • The time to determine priority between security interests over the same collateral is the time the underlying property is realised.  In particular, the court found that the priority contest between Diversa and Taiping was to be assessed at the time the SEQ shares were sold to a third party and that anything Taiping attempted to do after 25 February 2020 (including re-perfecting by registering on the PPSR against SCAH) was of no consequence.  This finding is a departure from the reasoning of earlier Canadian and New Zealand PPSA cases that suggest that priority between competing security interests is to be determined when the security interests first come into conflict, which is typically upon the appointment of a receiver or the initiation of other steps in the enforcement process.[7]  Interestingly, the judgment in Diversa does not refer to those earlier cases.  The court’s decision to determine priority when the SEQ shares were sold by the receivers, rather than when Diversa appointed the receivers to SCAH, did not alter the outcome because Taiping’s security was already unperfected as against the SEQ shares due to the temporary perfection afforded by s34 having ended before the receivers were appointed to SCAH.[8]  However, in another fact scenario, the choice of the later time to determine priority could be critical. 
  • Once the SEQ shares had been transferred to the third party purchaser free of any security interest by the SCAH receivers, and once the associated net sale proceeds had been received by Diversa, SCAH had no interest in either the SEQ shares or the proceeds other than a right to participate in any surplus distribution in accordance with s140(2)(f) of the PPSA.[9]
  • The monies received by Diversa from the receivers were not “proceeds” within the meaning of s32(1) of the PPSA because on and from 25 February 2020, they were governed by s140 of the PPSA.  Section 140(1) specifically provides that “proceeds” (as used in s140) has the ordinary meaning of that term and not the meaning in s31 of the PPSA.

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.[10]

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.[11]  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.[12] 

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 Madison shares

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 Madison shares were, at all relevant times, owned by SCAH, not Sargon Capital.
  • On 14 April 2018, a director of SCAH sent an email to Taiping which stated the Madison shares had been pledged to Taiping and that the original share certificates for those shares were being delivered to Taiping.  The email did not expressly identify the obligations to be secured by the pledge.  In addition, the email did not expressly identify that the director sent the email in his capacity as a director of SCAH or on behalf of SCAH, however, the court did not consider this to be significant in the overall context of the dealings and correspondence between the parties. 
  • Share certificates as well as blank transfers for the Madison shares signed by SCAH were delivered by SCAH to Taiping shortly after 14 April 2018.
  • Taiping was granted the Taiping GSD (by Sargon Capital, not SCAH) on 27 April 2018.
  • Diversa was granted the Diversa GSD (by SCAH) on 28 June 2019. 
  • In May 2020, Taiping made PPSR registrations against SCAH relating to the Madison shares.
  • On 2 June 2020, the receivers appointed to SCAH by Diversa purported to sell the Madison shares to Clime Investment Management Limited (Clime).
  • On or about 24 June 2020, Taiping provided its written consent to enable the Madison shares to be sold to Clime on the condition that the sale proceeds be held in a controlled money account with priority to the proceeds to be determined based on the same priority Taiping and Diversa had to the Madison shares.  Taiping provided the original share certificates to enable the sale to Clime to be completed.

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.[13]  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.[14]

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.[15]

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.

[1]  [2022] FCA 316. 

[2]  In relation to the SEQ shares, Beach J held (at [6]) that “Taiping’s ambitious attempt to perfect the imperfectable fails.

[3]  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. 

[4]   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.

[5]   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. 

[6]   Section 140 provides for the distribution of proceeds received by a secured party.

[7]   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 [2013] NZCA 506 and Strategic Finance Limited (in receivership and in liquidation) v Bridgman [2013] NZCA 357.

[8]   It is not clear from the judgment precisely when the temporary perfection afforded by s34 ended.

[9] Section 140(2)(f) contemplates that the grantor will receive any surplus remaining after the payment of enforcement costs and secured creditors.

[10]   Refer to the cases in note 7.

[11]   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.

[12]   Refer to the cases in note 7.

[13]   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).

[14]   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.

[15]   In re Wallis & Simmonds (Builders) Ltd (1974) 1 WLR 391 at 404.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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