The Supreme Court, in its first decision on the Personal Property Securities Act 1999,1 has clarified some fundamental aspects of the regime – in particular that all security interests are fixed in nature.  Assets are permitted to circulate by operation of the statutory rules.

One of those rules is the extinguishment of security interests following a “debtor-initiated payment”.2

The context

Receivers were appointed to partners in a forestry venture.  The forest was in due course sold, for a price that included over $120 million of GST.  The receivers arranged for the GST part of the sale proceeds to be paid to the IRD.  They did this against the possibility that they might have a personal liability for that GST, in which event they would have incurred significant penalties had it gone unpaid. 

However, the unusual facts of the case meant that the Supreme Court accepted (for the purposes of the strike out application) that the receivers were agents of the two partner companies, not agents of the taxpayer partnership, and so were arguably not personally liable for the GST.3

PPSA – an entirely new set of rules

Having reached that conclusion, the Supreme Court needed to consider the priority rules under the PPSA.  The secured creditors argued that they were entitled to the proceeds of sale under their security interests and that the Commissioner was merely an unsecured creditor.  In effect, they said he had received their money.  When the taxpayer received the sale proceeds, it held them for the secured creditors, as bare trustee only.

Justice Blanchard, giving judgment for the Supreme Court, disagreed.  The creditors could not rely on any common law or equitable interests to resolve the priority dispute because:

the PPSA has introduced, in the place of the general law, an entirely new set of rules governing priorities in the case of an insolvency.” 

Under the PPSA regime, the priority of a security interest, and the secured creditor’s entitlements arising from it, depend entirely on those rules.  Common law notions of title, equitable notions of beneficial interest and the equity of redemption are simply not relevant.  Instead:

Any secured creditor simply has a security interest whose priority depends upon the rules”.

The floating charge is dead – long live the fixed charge

The Court noted that all PPSA security interests are, at all times, fixed in nature, even where they cover circulating assets.  This had been widely assumed but it is helpful to have Supreme Court confirmation – particularly as it represents a departure from the former regime of fixed and floating charges.

It is for this reason that s95 is necessary.  It gives priority to a creditor who receives payment of a debt through a “debtor-initiated payment”.  The absence of such a rule could result in a (fixed) security interest continuing in funds after they had been used to pay an ordinary business debt.  That would have a “suffocating effect” on debtors’ businesses.  The Court considered it would be highly unlikely that creditors would accept encumbered funds as payment of a debt if not for s95.

The same analysis applies to s94, which allows for the free circulation of money (being notes and coins only, for the purposes of the Act).  Together, sections 94 and 95 are, in the Court’s opinion, a replacement for the rules that allowed assets to circulate under a floating charge, before its crystallisation.

Section 95 applies during insolvency

The Court acknowledged that the operation of s95 in insolvency may seem “curious”.  However, there is nothing in s95 to suggest that it does not give priority to payments made during insolvency.  Nor is there anything in the section that limits its application to payments made in the ordinary course of business.  Accordingly, the Court interpreted s95 broadly, in favour of creditors receiving debtor-initiated payments over secured creditors.

A payment by a receiver will therefore be subject to s95.  Funds to which the secured creditor is entitled can be removed from the secured creditor’s reach, as a result of the mere act of payment of those funds to another creditor.

The Court did read one limit into the section.  The priority rule will not protect a creditor who receives the “debtor-initiated payment” knowing that it is being made in breach of a security agreement.  That was not the case here, in the Court’s view.  Mere knowledge of the competing security interest was not enough.

Section 95 does not preclude personal claims

The secured creditors argued that the funds were recoverable from the Commissioner as they had been paid under a mistake. 

The Court agreed that recovery of money paid under a mistake is a personal claim (rather than a claim to enforce a property interest), so is not precluded by s95.  The section merely operates to extinguish security interests.  It does not extinguish personal (“in personam”) claims. 

The Court accepted that a sufficient “mistake” existed here.  The decision to pay the Commissioner was carefully considered, in light of uncertainty around the legal position, but, ultimately, the Court held that it was arguable that the receivers may not have been obliged to make the payment. 

The Commissioner’s submission, that s95 barred this claim because ultimately it was founded on a priority position, was rejected (the Supreme Court disagreeing with the Court of Appeal on the point).  Section 95 did not preclude the claim.

The Commissioner’s next submission was, however, accepted.  A payment made under mistake is not recoverable where the recipient gives consideration, including by discharge of a debt.  Here, the payment was applied to a tax debt, so consideration had been given by the Commissioner.

It would appear that this will be the answer in all cases under s95.  The section only applies to payments of debts.  Where the section prevents the recovery of a payment, the payment will similarly be unrecoverable as a mistake, because the payment would have discharged a debt.

How can this problem be avoided?

In our earlier article on the Court of Appeal decision, we suggested ways to avoid the predicament that making a payment may destroy priority for a secured creditor.  In some cases it may be possible to agree with the creditor that the payment itself is not to affect priority, or that funds are held in escrow.  In other cases a rapid application to Court might be possible.  If neither of those options is available, it may be possible to structure the payment so that it is not a “debtor initiated” payment.

Key points

  • Priority turns on the rules under the PPSA alone
  • Security interests are always fixed, not floating
  • Section 95:
    • replicates the freedom to circulate assets that was previously a feature of the floating charge
    • applies to payments made by receivers
    • applies to payments made whether or not in the ordinary course
    • does not apply where the creditor knows that the payment breaches the security agreement
    • does not prevent personal claims
  • A mistaken payment that in fact discharges a debt will not be recoverable

PPSA case-law index

The New Zealand Courts have, over the last decade or so, been building up a body of case law that explains and clarifies the Personal Property Securities Act.  We have collated all of those cases, and will continue to monitor further developments. 

For a copy of each case and our commentaries on them, including the Supreme Court judgment and the preceding Court of Appeal decision, please visit our Index of NZ PPSA Cases.

For a copy of our article about the Court of Appeal decision, click here.