1. Secured Lends and insolvency risk – the ‘whole of the property’ test
In almost any secured lend by a financier (the Lender), its credit team will inevitably ask the question: “will we have security over the whole or substantially the whole of the property of our client”?
Behind this question sits a complex web of insolvency, corporate and finance laws and principles, but in short, what the credit team is really asking is:
if an administrator is appointed to our client, will we still be able to enforce our security interests, appoint a receiver, sell off the property of the security provider, and hopefully get all of our money back, in a timely and relatively straightforward fashion?
The reason this is such a significant issue for a Lender is due to section 440B of the Corporations Act 2001 (Cth) (the Corporations Act), which provides that during the administration of a company, the holder of a ‘security interest’ over that company is unable to enforce that security interest without either:
- the leave of the court; or
- the consent of the administrator,
both of which are outside of the control of the Lender.
While an administrator cannot unilaterally declare a Lender’s security interest to be void, or act inconsistent with the terms of any security interests granted by a security provider, the impact of section 440B on a Lender is that the Lender is exposed to administration risk and will be forced to wait out the administration moratorium period – an indeterminate period which can be, and often is, in excess of six to twelve months – before the Lender can enforce its security interest.
However, a Lender that can show that it has a security interest, or combination of security interests, over ‘the whole, or substantially the whole’ of the property of a security provider under administration can potentially avoid the above administration risk if it enforces its security interest or interests before or during the ‘decision period’, which is a period of 13 business days from the date of appointment of the administrator.
This exception to section 440B of the Corporations Act is found in section 441A of the Corporations Act, and is the reason why the Lender’s credit team asked the threshold question of whether or not the Lender will have security interests over the whole, or substantially the whole, of the property of the security provider.
2. No impact on administration risk issues from the introduction of the PPSA
While the introduction of the Personal Property Securities Act 2009 (Cth) (the PPSA) has had a significant impact upon the way parties consider a security interest (not least being that the concept of a ‘floating’ charge has now been replaced with the concept of a ‘security interest over circulating assets’), none of the changes made to the law of security interests by the PPSA has impacted upon the issue of administration risk for a Lender (except, perhaps, to make it clearer that a security interest over circulating assets attaches immediately to the assets the subject of that security interest, rather than when the security interest crystallises and becomes ‘fixed’ – an issue that had been the subject of considerable academic debate in the pre-PPSA universe).
This was made clear in the explanatory memorandum to a recent amending bill to the PPSA (the Personal Property Securities (Corporations and Other Amendments) Bill 2011), which clarified that the administrator risk issue, and the exceptions to it, remain unchanged under the PPSA regime.
Therefore, administrator risk still remains an issue, and ‘the whole, or substantially the whole’ question remains one of the most important considerations for a secured Lender.
3. Determining what is ‘the whole or substantially the whole’ of the property of asecurity provider
So what is ‘the whole or substantially the whole’ of the property of a security provider?
For a general corporate company, this is a relatively straightforward test. A security interest that secures ‘all of the rights, property, undertakings and other goods of the company’ will be, in the absence of some defect in the security interest itself, all that is required for a Lender to have a security interest over ‘the whole or substantially the whole’ of the property of that company.
Further guidance as to what constitutes ‘substantially’ the whole of the property of a security provider was given in a decision of the Victorian Supreme Court in Re Australian Property Custodian Holdings Ltd (admins apptd) (recs & mgers apptd) (2010) 80 ACSR 114;  VSC 492, where a single judge decision held that ‘substantial’ was something more than just a ‘significant part’ of that company’s property. The secured lender was found to have a security interest covering approximately 68% (by value) of the security provider’s property, but this was not sufficient for the lender to rely on the section 441A exception.
But what about asset-specific Lenders, or those security providers who, due to their existing financial arrangements or project documents, cannot grant all-assets security interests in favour of the Lender (or not without needing to go to the cost and delay of contacting each third party and seeking a consent or waiver)? What can a Lender do to avoid administrator risk and rely on the Section 441A exception in these circumstances?
4. The ‘featherweight’ floating charge as a device for Lenders to avoid administrationrisk
In funding scenarios where a Lender is unable, for whatever reason, to take a traditional ‘all assets’ security interest over a security provider, it is relatively standard for the parties to agree to a two-tiered security structure that consists of:
- a standard security interest over specific property of the security provider, or all of the property of the security provider with certain exceptions which are expressly referred to in the security interest; and
- a ‘featherweight’ security interest over that property of the security provider not covered by the substantive security interest above.
For example, a Lender might take a general security agreement over a borrower’s rights under project documents if funding that borrower’s development project, but not over any other property of the borrower, and a second featherweight security interest over the balance of the borrower’s property.
The featherweight security interest is very different to the typical general security agreement, and will have the following key features:
- it will only secure that property not secured under the general security agreement;
- it will not prevent the security provider from granting other security interests in any way;
- it will permit the security provider to freely deal with the secured property (and hence is a security interest over circulating assets for PPSA purposes);
- it will become enforceable only in one particular scenario, being when an administrator is appointed to the security provider;
- it will rank behind any other security interests granted by the security provider over the secured property; and
- it has traditionally contained an enforcement limit, such that there is some nominal cap on the amount the Lender can recover upon enforcing the featherweight security interest (for example, $16,000).
The main purpose of the featherweight floating charge is not to reduce the credit risk of the Lender in a direct sense (particularly when the featherweight charge contains a nominal enforcement limit), but rather to provide a device for the Lender to manage the administration risk issue.
The Lender gets the benefit of a combination of security interests that, when taken together, allow it to show that it has security interests over the ‘whole or substantially the whole’ of the property of the security provider so it can rely on the exception to section 440B (even if one of the security interests is much more valuable, in an enforcement scenario, than the other), while the security provider can generally ‘sell’ the featherweight security interest to third parties with minimal time and effort.
5. Featherweight security interests and the vexed issue of secured lends to trusteeborrowers
What happens if the security provider is a trustee of a trust, as is common in property financing deals? Is it enough that the security interest be granted by the security provider in its trust capacity only, or does the security interest also need to cover the personal capacity of the company?
What if the company is trustee of one trust initially, but will be used again in the future by ‘bolting on’ additional trusts – does each new trust mean that the Lender’s security interest over the trustee company is lessened, if the Lender has security over the trustee in one particular trust capacity only?
As these questions indicate, the analysis becomes much more complex and uncertain when the security provider is the trustee of a trust and is entering into the security interest or interests in its trust capacity. Some of the additional questions a Lender needs to consider, and address, when taking security interests over a trustee company include:
- is the company the trustee of a single special purpose trust, or is it also trustee of other trusts unconnected with the purpose of the Lender’s particular financing?
- if it is trustee of a single special purpose trust, what is the impact if the company becomes trustee of a new, additional trust or trusts at some future point?
- what property does the trustee company have in its personal capacity?
All of these questions go to the issue of what is the whole or substantially the whole of the assets of a trustee company, at the time the security interest is granted and into the future. On a technical read of the Corporations Act, a company’s (including a trustee company’s) ‘property’ is defined in section 9 of the Corporations Act as ‘…any legal or equitable estate or interest (whether present or future and whether vested or contingent) in real or personal property of any description and includes a thing in action…’ (emphasis added).
It is the express recognition of an ‘equitable estate’ in the property that is problematic, in terms of defining the scope of a trustee company’s property for administration risk purposes.
That is, ‘property’ for the purposes of sections 9 and 441A of the Corporations Act arguably includes all property of the trustee security provider: legal, equitable, present and future, held in all capacities, including as trustee of a present or future trust or trusts.
While this conclusion is not universally accepted (particularly by the trustee company and its legal counsel), and relies on a highly technical read of the Corporations Act concept of ‘property’, it is not an inarguable position for a Lender, particularly a highly risk adverse Lender, to take.
In practice, though, Lender’s generally must accept that, in transactions where a trustee company will provide a security interest in one particular trust capacity only, that security interest will be in the capacity of the company as trustee of that trust only. To request that a trustee company grant a security suite that consists of:
- a substantive security interest from the trustee security provider over all of the property it holds in its trustee capacity, with exceptions for property held in its personal capacity and in its capacity as trustee of any other trusts, present or future, for which it is the trustee;
- a featherweight security interest from the trustee security provider in its personal capacity over all of its personal property; and
- a featherweight security interest from the trustee security provider in its capacity as trustee of any other trust for which it is, or becomes, the trustee over all of the property it holds in those other trust capacities,
to address the issue of administration risk is very unlikely to be commercially acceptable.
Further, for professional trustee companies that might be trustee for hundreds, if not thousands, of trusts, it would be impossible for them to grant featherweight security interests in their capacity as trustee of all of those trusts.
Finally, to ask a trustee company to enter into a security interest in one trust capacity, to secure obligations incurred in another trust capacity, may well be in breach of the trustee company’s obligations with respect to that first trust, or in breach of that first trust’s constituent documents.
In practice, when dealing with a trustee company that has provided a security interest in its capacity as trustee of a trust, the Lender will always be left open to technical arguments of administrator risk and the threat of having to wait out the moratorium period should an administrator be appointed to the security provider. Unfortunately, there is as yet no guidance from the common law in Australia as to what a court might decide.
The most likely outcome in these circumstances is that a Lender will have the benefit of the following security suite from a trustee company security provider:
- a substantive security interest from the trustee security provider over all of the property it holds in its trustee capacity; and
- a substantive security interest from the trustee security provider over all of the property it holds in its personal capacity, to ensure the Lender has access to the trustee company’s right of indemnity out of the trust property.
Whether this position is acceptable to a Lender is then ultimately a call for the Lender’s credit team, weighing up the technical risks versus the commercial realities of the situation.