PPSA in practice: When are goods sold free of security interests in the ordinary course of business? Middletons banking partner Richard Winter and lawyer Anthony Peterson write.
The Personal Property Securities Act (PPSA) allows for registered security interests to be extinguished in some instances. In the case of general business activity, where the grantor sells or leases the goods subject to a security interest, that interest will be extinguished if such sale or lease is done in the ordinary course of the grantor's business.
The Australian courts have not yet addressed the question of how to determine what is the ordinary course of business in relation to the PPSA. Therefore, practitioners must seek guidance from international Personal Property Securities law and the existing Australian case law.
Extinguishment rules are the rules that determine when personal property is purchased free from a security interest in that property. Section 46 of the PPSA contains an extinguishment rule that applies when personal property, secured by a security interest, is sold or leased in the ordinary course of business. The most common example is a supplier selling goods to a retailer on account, and the retailer then selling the goods to a customer. If the supplier takes a security interest in those goods, the security interest will continue in the goods unless the sale to the customer was in the ordinary course of the retailer's business.
Given the lack of Australian authority, it is instinctive to explore the approach taken by the Canadian and New Zealand courts under their respective Personal Property Securities Acts for guidance and the existing case law in Australia governing the ordinary course of business in relation to fixed and floating charges.
The Canadian PPSA Law has existed since 1979 and there is a developed body of case law relating to that law. It is likely that an Australian court would consider Canadian authority as the Canadian Law, along with the New Zealand Law and the United States Law were used as the basis for creating the PPSA.
A leading Canadian authority on the ordinary course of business in a personal property securities context is Fairline Boats Ltd v Leger et al. (Fairline). In Fairline, Linden J found that deciding if a transaction is in the ordinary course of business is a question of fact that requires consideration of all the circumstances of the transaction. His honour found that usual transactions of similar businesses were relevant to making this decision and that uncommon transactions, if ordinarily entered into by similar businesses, could come within this definition. The objective element of the test set out in Fairline was not, however, further continued.
In Wandering Creek Farms Ltd v Sphenical Capital Inc. (Sphenical) the Queen's Bench of Alberta (Canada) listed a number of subjective elements that are relevant for determining whether a transaction occurs in the ordinary course of a business. These included: the transaction type; the place of the sale (or lease); the parties to the transaction; the quantity of goods sold; the price charged; whether there was any advertising; and the percentage of overall volume of sales that the transaction represents. The list developed in Sphenical was also used as a guide in the commentary to the Personal Property Securities Bill.
The subjective approach developed in the Canadian case law was used in New Zealand in Gibson v Stockco Ltd (Stockco). In Stockco the New Zealand High Court found that a two-step test is required. First, determine the business of the seller; and second, enquire whether the sale was made in the ordinary course of that business. When determining what is in the ordinary course of the sellers' business "the focus should be on the trading activities of the seller at the time of the sale and whether the sale was “a straightforward deal in the mainstream” of the seller’s business…".
In Tubbs v Ruby 2005 Ltd the court agreed with the comments of Linden J in Fairline, and this was also quoted with approval in Nichibo v Lucich. The weight of the Canadian and New Zealand law supports a subjective test based on the business in question. This is consistent with section 46 of the PPSA, which states that a purchaser will take collateral free of a security interest if it “was sold or leased in the ordinary course of the seller's or lessor's business of selling or leasing personal property of that kind” (emphasis added). An objective consideration of what is normal for other people engaged in the same type of business as the seller, or business is general, appears not to be relevant to the interpretation of s46 of the PPSA.
In addition to the foreign authority there is an existing body of Australian case law relating to floating charges and the power of a company to pass title to its assets free of a floating charge. In Reynolds Bros (Motors) Pty Ltd and Ors v Esanda Ltd (Reynolds) Mahoney J adopted an objective test in determining what is in the 'ordinary course of business' and held that "[t]ransactions will be within this principle even though they are, in relation to the company, exceptional or unprecedented".
Similarly, in Taylor v White (Taylor) Dixon CJ said that "The time-honoured phrase “in the ordinary course of business” is meant to refer to transactions regularly taking place in a sustained course of activity or some usual process naturally passing without examination."
While the existing body of case law has the benefit of a settled interpretation, it applies to a regime and legislative framework that is different to the PPSA and there is no guarantee that a court would follow this precedent. Reynolds is a case concerning fixed and floating charges, while Taylor is concerned with preference payments in a liquidation, and they refer to business in a more general sense than the PPSA. Practitioners should be wary in relying on this authority as it appears from the drafting of the PPSA that 'ordinary' is to be confined to what is ordinarily done in the course of the particular business in question.
Given the extent of the changes to the law of personal property securities introduced by the PPSA, it is likely that the relevance of the existing case law relating to charges is greatly reduced. The commentary to the PPSA made clear reference to the list in Sphenical concerning when a transaction will be in the ordinary course of business.
Accordingly, the better view would be that the Canadian and New Zealand authorities provide a logical basis for determining what is in the ordinary course of business under the PPSA by applying a subjective, or at least, given the Australian authorities, a hybrid subjective/objective test.
The PPSA adopts a subjective formulation when referring to ordinary course of business in the extinguishment rules. Under the PPSA what is in the ordinary course of business should be determined by what is normal or ordinary for the specific business in question.
However given the prior Australian case law on point which adopted objective criteria, it is possible going forward that Australia courts will apply a hybrid subjective and objective test. Practitioners need to be aware of these issues in order to form an opinion as to which transactions will result in property being passed free of security interests and if so, potentially consider taking other collateral security to ensure the assumed security position is not diminished.