PPSA "wool" case revisited

The Court of Appeal has reversed the High Court's decision in JS Brooksbank & Co (Australasia) Limited v EXFTX Limited (in receivership and liquidation) by finding that a supply arrangement between the parties was not a "security interest" under the PPSA and allowing the supplier to sue in conversion for its goods. In this article, senior associate Hamish Taylor analyses the decision and discusses some practical implications of the decision for suppliers.

Background

Last year we commented on the High Court decisions in Segard Masurel (NZ) Ltd v Nicol¹ and JS Brooksbank & Co (Australasia) Ltd v EXFTX Limited (In receivership and liquidation)² ( JS Brooksbank ) regarding the Personal Property Securities Act 1999 (PPSA), including remarks on the resulting practical implications for people not wanting to find themselves with an unperfected security interest ranking behind a bank where a customer is in financial difficulties. (See our article "Suppliers beware: take the extra step and register your interest" in the Autumn 2008 issue of Commercial Quarterly for further details.)

The decision in JS Brooksbank was recently considered by the Court of Appeal³, bringing the application of the PPSA back into the spotlight and, in particular, whether the transaction in this case had in fact resulted in a security interest being created.

The facts

The case centred on a supply agreement between JS Brooksbank & Co (Australasia) Ltd (JSB) and EXFTX Limited (Feltex) which provided that Feltex would obtain neither possession nor title to the wool supplied by JSB until JSB received cleared funds. However, when Feltex went into receivership, certain wool, mistakenly delivered by JSB's brokers to Feltex and not paid for by Feltex, was on Feltex's premises and the receivers took control of it.

The High Court's decision

The High Court held that claims in conversion and constructive trust could not succeed and that JSB had an unperfected security interest in the wool over which ANZ's perfected security interest (in all present and after-acquired property of Feltex) took priority.

The High Court based the existence of this security interest upon the delivery of the wool by JSB through its agents and that, subsequent to the delivery, JSB's interest in the wool amounted to a security interest for the purposes of section 17 of the PPSA because the supply agreement was a conditional sale contract including an agreement to sell subject to a retention of title. JSB's security interest then attached to the wool when Feltex obtained possession on delivery which, in accordance with section 40(3) of the PPSA, gives a debtor rights in the collateral from possession under a conditional sale agreement. With the security interest attached, JSB had not perfected it by registering a financing statement on the PPSR which meant that JSB lost the "super-priority" it would otherwise have been accorded and ANZ's perfected security interest over all Feltex's assets took priority.

The Court of Appeal's decision

The Court of Appeal disagreed and overturned this decision on the basis that no security interest was created in favour of JSB.

In reaching its conclusion, the Court of Appeal went back to the definition of security interest in section 17 of the PPSA itself and asked the question: whether JSB had an interest in personal property (the wool) provided for by a transaction (the supply agreement) that in substance secured payment, ignoring the form of the transaction and the fact that JSB retained title.⁴

The key aspect the court focused on was whether the supply agreement "in substance" secured payment. It concluded that while the accidental delivery of the wool prior to JSB receiving cleared funds resulted in Feltex obtaining possession and JSB effectively retaining title, the supply agreement was not intended to secure payment by Feltex. It was specially formulated to prevent JSB from having any credit exposure to Feltex. The supply agreement contemplated no delivery until payment had been made and it did not enable JSB to have recourse to the wool if payment was not made, which is the typical retention of title situation.

As a result the Court of Appeal noted that, despite the fact that on this occasion delivery was mistakenly made prior to payment with title not transferring, an arrangement that did not in substance create a security interest (because it did not secure payment), could not turn into one that did.⁵

The Court of Appeal also rather helpfully looked at whether the ANZ's security interest had attached to the wool. On this point the court looked at section 40 of the PPSA which says that a security interest attaches where the debtor has rights in the collateral. A debtor has rights in goods sold under a conditional sale agreement (including an agreement to sell subject to retention of title) no later than when the debtor obtains possession of the goods. It concluded that the goods were not "sold" under the supply agreement and Feltex had no right of possession as against JSB. ANZ's security interest had not, therefore, attached to the wool.

As to whether JSB could sue for conversion, while the High Court had previously determined that an action for conversion was not available because JSB through its agents had voluntarily delivered the wool, the Court of Appeal made it clear that because Feltex employees were aware of the terms of agency (i.e. that the wool was not to be released prior to the receipt of cleared funds) and that JSB had not acquiesced to the wool's release or made any representations to Feltex that the agents were authorised to deliver it; JSB was entitled to sue in conversion for return of the wool.

Practical implications

The original High Court decision in this case created some controversy, as it seemed to cast the net quite wide in terms of when a security interest might arise. The Court of Appeal's decision does not serve to limit the scope of what might constitute an "in substance" security interest, it instead reminds us that to have an "in substance" security interest the transaction involved must secure payment or performance of an obligation. Some practical matters to keep in mind are:

• When drafting or interpreting a supply contract, take care when considering whether the transactions set out in the contract will give rise to a security interest. Seek professional advice if you have a concern, as it is better to identify an issue at the outset than find out when you come to enforce your contract that you have an unperfected security interest.
• As priority between competing security interests is now determined under the PPSA regime, you should ensure that you perfect any security interest by registering a financing statement on the PPSR within the applicable timeframe. Failure to do so could result in your security interest being defeated by perfected security interests in respect of the same goods.
• When drafting a supply contract which creates a security interest, ensure that the contract contains an adequate description of the goods being supplied by item or kind such that it will enable the goods to be identified. Failure to do so may affect the enforceability of your security interest.
• Ensure that the information provided in the financing statement (including the description of the collateral) is accurate. If a registration is "seriously misleading" because of an error or omission in a financing statement, the supplier's security interest may be rendered unenforceable.
  

¹[12 February 2008] HC, Auckland, CIV 2007-404-003603

²[2008] NZBLC 102, 113

³[2009] NZCA 122

⁴See above n3, at [49]

⁵See above n3, at [54]

Enquiries and information

For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.