How the PPSA will affect leases

The amendments to the Commercial Tenancy (Retail Shops) Agreements Act 1985 (WA) will have a significant impact on retail leases.  However, the Personal Property Securities Act 2009 (Cth) (PPSA) is likely to have an impact on all leases.

This is not intended to be a comprehensive statement on the PPSA; it is intended only as a general discussion of how the PPSA is likely to affect leases.  You should seek advice if you have any specific queries.

Brief background on the PPSA

The PPSA is designed to be a ‘one stop shop’ for security interests in personal property.  It replaces over 70 Acts (both State/Territory and Federal) and over 40 registers and covers an extremely wide range of interests which are not ‘security’ in the traditional sense.  The PPSA came into effect on 30 January 2012.

PPSA terms

The definition of ‘security interest’ in the PPSA is far reaching.  In essence, a security interest is an interest in personal property created in a transaction which secures payment or performance of an obligation.

Personal property is defined as property, but not land (or other specified rights, entitlements, etc).  The definition of ‘land’ includes leasehold interests and therefore the PPSA does not apply to leases of land.

The PPSA introduced a new term, 'PPS lease'.  This refers to a lease of serial numbered property (such as motor vehicles, watercraft and aircraft) for a period of 90 days or more or other property for a period of one year or more.  These PPS leases should be registered but as they have no relevance to leases of land they will not be discussed in this bulletin.

Security interests under leases

Despite leases being excluded from the operation of the PPSA, many leases include a provision which requires a tenant to provide a security deposit ‘as security for the performance of the tenant’s obligations’ (Lease Security) or a bank guarantee.

The PPSA is not concerned with the form of the transaction and because the Lease Security secures performance of the tenant’s obligations the Lease Security creates a security interest and the landlord becomes a secured party.

The PPSA does not apply to contractual promises to pay because a contractual promise to pay does not confer a security interest in personal property.  Consequently a personal guarantee in a lease does not create a security interest as it only creates contractual rights against the guarantor and does not give the landlord any interest in the guarantor’s property.

Similarly, a bank guarantee is a contractual promise to pay and, consequently, does not create a security interest for PPSA purposes.

Landlord’s ability to deal with tenant’s property

Some leases also include a provision which allows a landlord to deal with tenant’s property which is left on the premises after the end of the lease.  An example of such a clause would be:

The Landlord may treat as the Landlord’s own any property the Tenant leaves behind at the Premises when this Lease ends or is ended.

This kind of clause usually applies regardless of how the lease ends (either by termination or expiry).  These clauses do not create a security interest, even where the clause provides that the landlord can deal with the property as it sees fit at the tenant’s cost, because they do not secure payment or performance of an obligation.

However, a clause which allows a landlord to realise any property left behind by the tenant at the end of the lease and use the proceeds to either reduce the tenant’s debt or use the proceeds in satisfaction of the obligation is likely to be a security interest.

Effect

Existing leases: Existing leases which give rise to a security interest will enjoy temporary perfection for two years, in other words up to 30 January 2014 and therefore no immediate action is required.  Notwithstanding this, it would be prudent to register any existing security interests on the Personal Property Securities Register (PPSR) (see comments below regarding registration).

New leases: A security interest contained in a lease entered into after 30 January 2012 will be an unperfected security interest unless or until it is perfected.  The most common method of perfection is registration on the PPSR.  An unperfected security interest means that the landlord’s rights in respect of the security may be outranked by another secured party who has a perfected security interest.  Moreover, an unperfected security interest vests in the grantor (ie the tenant) upon insolvency of the grantor.  In effect, this deprives the secured party (ie the landlord) of the collateral.

Perfected security interests

For a security interest in personal property to be perfected, it must either be temporarily perfected (as with existing leases) or all of numbers 1 to 3 below must apply:

1. the security interest has ‘attached’ to the collateral (attachment has a specific meaning in section 19 of the PPSA); and
   
   
2. it is enforceable against a third party; and
   
   
3. if one of the following applies:
   
   
   • there has been effective registration; or
     
     
   • the secured party is in possession of the collateral; or
     
     
   • certain types of collateral of which the secured party has control.

Registration has two key benefits for secured parties, it:

• prevents the secured party from losing its priority as against most other secured parties; and
  
  
• ensures the secured interest survives bankruptcy or insolvency.

As mentioned above, the most common form of perfection is registration on the PPSR.  Therefore, if a landlord perfects its security interest as soon as practicable by registration, the landlord has put itself in the best position possible in relation to the security.

If a landlord has possession of the security (possession is a method of perfection), it is not required to register its interest on the PPSR.  Therefore, it would be sensible for landlords also to register their interest on the PPSR even if they have possession of the security, because their security interest would otherwise become unperfected if they parted with possession.

To enable registration

Leases may need to be amended to accommodate PPSA provisions.  While no particular clause is necessary in documents, the creation of a security interest must be consensual.  This can be inferred from the tenant signing the lease.  However, a landlord may prefer a specific provision in which the tenant agrees that providing the lease security is a security interest for the purposes of the PPSA and allows the landlord to register its interest.  In addition, landlords will need a certain amount of information from the tenant if they wish to register the security interest on the PPSR, which they may contractually require the tenant to provide to them.  Landlords may also contractually require tenants to advise them of any changes during the life of the security interest.

Registering a financing statement (or financing change statement) costs between $7.40 and $130.00, depending on the length of the registration.  Security interests created in leases are most likely to be registered for up to seven years at a cost of $7.40.  If the lease (and therefore the security interest) exceeds seven years, a financing statement can either be registered for between seven and up to 24 years at a cost of $37.00 or the landlord’s registration for up to seven years can be extended for a further seven years at $7.40.  The latter option may be a better alternative if the lease contains options to renew which, if not triggered, would not extend beyond seven years.  However, the risk is that the landlord may forget to update its financing statement.  There is no reason why these costs cannot be passed on to the tenant.  However, it may become an administrative burden to distribute reasonably small amounts to many different tenants (for examplin a shopping centre) and therefore it may not be efficient to pass the cost on.

Time to register

A security interest can be registered before or after a security agreement is made or the security interest attaches to the personal property (section 161).  However, a financing statement cannot be registered unless the secured party believes on reasonable grounds that it is or will become a secured party (section 151).  There are tight time frames for correcting a registration by lodging a financing change statement (section 151(3)).

Once registered

Immediately following registration, the landlord will receive a verification statement.  A copy of this statement must be provided to the tenant as soon as practical after registration, unless the tenant has waived the right to receive it.

Once the landlord has registered its interest on the PPSR and provided a verification statement to the tenant (and perhaps conducted a search (at a cost of $3.70) to confirm that the registration was effective), no further action is required in respect of the registration unless or until something in respect of that security changes.

A registration will become ineffective if (and only if) there is a defect in the registration.  Defects will occur when the financing statement is seriously misleading or a specified defect occurs (section 165).  Registration is quick and easy.  However, those registering financing statements must be incredibly particular and careful when completing the registration - in Canada and New Zealand (countries which already have PPSAs) very minor defects have been held to render financing statements invalid.

Time to discharge

There is no time specified in the PPSA by which a discharged security needs to be removed from the register.  However, discharging a financing statement is free and is easy enough to do.

If nothing is done to a registered financing statement, it will ‘drop off’ the PPSR after the registration time expires.  For example, if your financing statement is for up to seven years and no financing change statement is registered, the financing statement will ‘drop off’ the PPSR regardless of whether the security has been discharged.  This means the secured party will lose any priority it may have enjoyed and would need to lodge a fresh financing statement if the security interest continues.

A provision in the lease may have a clause which requires the landlord to remove its financing statement once it is clear that there are no longer any obligations being secured by the security.

Conclusions

The PPSA is primarily concerned with security interests in personal property.  However, the PPSA can affect landlords in respect of security deposits and rental bonds and personal property left behind by a tenant.  For this reason, landlords should ensure that their leases are reviewed in light of the PPSA to ensure that their interests are protected.  They should also take steps to register any security interest in personal property without delay.

Finally, this article is designed to highlight how the PPSA is likely to affect leases and is not intended to be a comprehensive statement on the PPSA.  You should seek advice if you have any specific queries.

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