There’s an elephant lurking around construction sites who we affectionately call “Percy” (the Personal Property Securities Act 2009 (Cth) (PPSA)). “Percy” only arrived in Australia fairly recently (30 January 2012), after charging through Canada, New Zealand andthe United States. He is a prodigious, enigmatic creature. Although occasionally known to trample on people’s toes, the business communities in those countries have become well-acquaintedwith and even grown fond of him. However, reactions to “Percy’s” triumphant arrival in Australia have been mixed. Many people in the construction industry would prefer to pretend that he doesn’t exist and carry on with business as usual. But “Percy’s” here to stay, so we’d like to introduce him!
A recent decision of the New Zealand High Court has highlighted the importance of registering step-in rights under construction contracts on the Personal Property Securities Register (PPSR).
The case of McCloy v Manukau Institute of Technology  NZHC 936 involved a dispute between receivers appointed by the Bank of New Zealand (BNZ) who claimed to be entitled to take possession of two hoists that were owned by Mainzeal Property and Construction Ltd (Mainzeal) prior to it being placed in receivership, which were located on property owned by Hobson Gardens (a customer of Mainzeal).
Mainzeal was a construction company and had granted a number of security interests to BNZ, including a general security interest and a specific security interest over the hoists the subject of the dispute, which BNZ had registered.
In June 2011, Mainzeal entered into a contract with Hobson Gardens, which incorporated the terms of the standard New Zealand Institute of Architect’s contract, to carry out certain remedial works on an apartment building. The contract provided that in the event Mainzeal entered into receivership and the receivers failed to take over the construction works:
- Mainzeal’s interest in, relevantly, the construction machinery on the site would be transferred to Hobson Gardens;
- Hobson Gardens would be entitled to complete the construction works (at Mainzeal’s cost) using the construction machinery; and
- Hobson Gardens would be entitled to sell the construction machinery and deduct the net proceeds from Mainzeal’s liability to Hobson Gardens. (the Step-in Rights)
In February 2013, the receivers gave notice to Hobson Gardens that they would not be completing the construction works and Hobson Gardens (validly) terminated the construction contract. Hobson Garden then asserted that it was lawfully in possession of the hoists.
The receivers argued that BNZ’s registered security interest in the hoists had priority over any security interest that Hobson Gardens may have had in them.
Hobson Gardens advanced a number of grounds which argued, in effect, that BNZ did not have an enforceable security interest in the hoists or, if it did, that it was defeated by Hobson Gardens interest.
The issues for the court to decide were, relevantly, whether Hobson Gardens had a security interest in the hoists and, if so, which of BNZ’s and Hobson Gardens’ security interests had priority.
Collins J, in substance, made the following findings:
- The text and purpose of the relevant clause of the construction contract was clearly intended to secure performance by Mainzeal of its obligations, thereby giving Hobson Gardens a security interest in the hoists.
- Hobson Gardens failed to perfect its security interest by registration and seizing the goods is excluded by the Personal Property Securities Act 1999 (NZ) as a means of perfection by possession. Therefore, Hobson Gardens unperfected security interest was defeated by BNZ’s registered security interest and the receivers were entitled to take possession of the hoists.
Lessons for Australian Principals
The key message to take away from the McCloy case is that it is highly probable that, when the time comes for Australian courts to consider this issue, they will follow suit and find that step-in rights in construction contracts (and analogous rights) constitute a security interest within the meaning of the PPSA.
Importantly, two commonly used Australian Standard construction contracts (the AS 2124-1992 and the AS 4000-1997) both contain stepin provisions, although the wording is slightly different to the provisions of the New Zealand contract considered in McCloy. The provisions in the Australian contracts allow a principal to, in effect:
- Take possession of the contractor’s equipment and materials, without compensation, in order to complete the construction works; and
- Following completion of the works, if there is any debt owing by the contractor to the principal and the contractor fails to pay the debt after reasonable notice, sell the contractor’s equipment and materials to satisfy the debt.
Accordingly, to ensure that these provisions can be relied upon in the event of a default or the insolvency of the contractor, principals should proceed on the basis that step-in rights constitute a security interest in the contractor’s property and should take action at the earliest opportunity to perfect their security interest.
Perfection should be effected by registration on the PPSR; although it is possible to perfect a security interest by taking possession of the relevant property, exercising step-in rights would likely amount to seizure and, as is the position under the New Zealand legislation, seizure is not a valid means of taking possession under the PPSA (see section 21(2)(b)).
Furthermore, if principals delay perfecting their security interests until they become entitled to exercise their step-in rights, they risk allowing the contractor to grant a security interest in the same property to a third party in the interim which, if perfected, would take priority over the principal’s unperfected security interest in a priority dispute (as was the outcome in McCloy). On a related note, if there are existing security interests registered against the contractor’s property at the time of entering into the construction contract (e.g. a senior lender), it would be prudent for the principal to negotiate a priority (tripartite) agreement, to ensure that its security interest is given priority over the relevant goods to ensure that its step-in rights will be effective.
As a general rule, principals should ensure that their security interest is registered no later than 20 days after signing the construction contract. Otherwise, in the event that the contractor becomes insolvent within six months of the registration date, the security interest will be ineffective (s 588FL Corporations Act 2001 (Cth)). Importantly, principals needn’t wait until the construction contract is signed to register their security interest; under the PPSA, it is permissible to register as soon there are ‘reasonable grounds’ to believe that the construction contract will be entered into.