Suppliers beware: take the extra step and register your security interest

Two recent High Court decisions highlight the importance for suppliers to ensure that they have a registered security interest in goods supplied to customers but not paid for.

It is common practice for suppliers to try to secure payment for goods supplied to a customer by including either a retention of title clause or a more general security interest in their terms of trade or supply agreements. However, without taking the extra step to perfect those security interests by registering a financing statement on the Personal Property Securities Register (the PPSR), the supplier will not be afforded any protection against non-payment where there are other creditors with competing registered security interests over the same goods.

In two recent High Court cases involving suppliers caught up in the receivership and subsequent liquidation of EXFTX Limited - formerly Feltex Carpets Limited, neither supplier had registered financial statements on the PPSR. In order to avoid being merely an unsecured creditor for the amounts owed to them, they had to argue that their respective arrangements did not fall under the Personal Property Securities Act 1999 (the PPSA) regime. Both were unsuccessful.

Had these suppliers taken full advantage of the PPSA regime by registering a purchase money security interest (a PMSI), they would have had what is known as a "super-priority" over all other secured parties, including both of Feltex's banks' general security interests.

Segard Masurel (NZ) Ltd v Nicol¹

Segard routinely supplied wool to Feltex under the terms of a supply agreement. The supply agreement provided that "payment will be made in cash on delivery on the contractual date of delivery, or actual received date if delivery has been delayed, or receipt of invoice if invoice not received until after delivery date." In the weeks leading up to Feltex being placed in receivership, Segard provided three batches of wool for which payment was not made on delivery. However, Segard had allowed the wool to remain on Feltex's premises after receiving an undertaking that the wool would be stored separately and not touched until payment was made.

When Feltex was placed in liquidation, Segard applied for summary judgment in the District Court for the outstanding amount of the invoices on the ground that, since payment was not received at the time of delivery, title had not passed to Feltex and the goods were being held on trust for Segard until payment was made.

The District Court found that Segard had unconditionally appropriated title in the wool to Feltex on delivery and that Segard was simply an unsecured creditor of Feltex.

As an unsecured creditor, Segard didn't have an interest in the wool and its claim was defeated by the perfected security interests of the two banks, both of which had registered financing statements on the PPSR.

The District Court also held that, if title had not passed to Feltex on delivery of the wool, in any event the supply agreement would have been a conditional sale agreement which would have been caught by the PPSA, but at least Segard would have been a secured creditor.

When Segard appealed to the High Court, it upheld the District Court's findings on both grounds.

On the question of whether Segard had unconditionally appropriated title in the wool to Feltex on delivery, the court noted that:

• there was no express retention of title clause in the supply agreement;

• the supply agreement contemplated that payment could be made after delivery of the wool where an invoice was not received on the delivery date; and

• factual evidence indicated that, as was the case regarding the outstanding invoices, Segard did not usually insist that payment occur at the time of delivery.

As such, under the Sales of Goods Act, Segard was deemed to have unconditionally appropriated the wool to the contract and title in the wool passed to Feltex on delivery.

On the second issue, the High Court agreed with Segard that it was not necessary as a matter of business efficacy to imply a retention of title term into the supply agreement where Segard chose not to exercise its right to insist on payment at the time of delivery. However, the court did not agree with Segard that the supply agreement was simply an agreement for cash on delivery, rather than a conditional sale agreement.

In the High Court's view, by failing to insist on payment on delivery, Segard was effectively granting credit when the goods were delivered without payment. Further, in order for this part of Segard's argument to succeed, the court noted that it must be assumed that title in the wool had been retained by an implied term to that effect. Accordingly, there was an agreement to sell, subject to retention of title, and the transaction therefore fell within section 17(3) of the PPSA and was a security interest under the PPSA.

JS Brooksbank & Co ( Australasia) Limited v EXFTX Limited (in receivership and liquidation)²

In the second case, JS Brooksbank (JSB) also supplied wool to Feltex.

The parties entered into a supply agreement that included a security interest in the form of a retention of title clause. If JSB had perfected its security interest by registering it on the PPSR, it would have amounted to a PMSI and had priority over Feltex's other secured creditors.

JSB did not do this and instead tried to protect its position by requiring payment before delivery. The supply agreement provided that delivery of wool was only to be made on receipt of cleared funds and that upon receipt of notification of cleared funds, unconditional ownership of wool would pass to Feltex. Wool brokers were therefore only authorised to release the wool to Feltex on receipt from JSB of a buyer delivery order.

Subsequently, an employee of Feltex mistakenly wrote to wool brokers requesting that they release wool owned by JSB to Feltex when payment had not yet been made. Brokers then released wool to Feltex without JSB's authority.

JSB applied for judgment against Feltex, claiming that Feltex had deliberately requested delivery of the wool disregarding JSB's right to possession and that Feltex's subsequent failure to return the wool, which had been set aside on JSB's request, amounted to conversion.

Feltex opposed the application on the basis the JSB had an unperfected security interest in the wool, which was subject to the perfected security interest of Feltex's bank lenders.

JSB contended that Feltex's affirmative defence was not relevant given that JSB had no security interest in the goods because Feltex had no right to an interest in the wool until payment had been received under the terms of the supply agreement.

The court disagreed with JSB's submission that no security interest had been created in the wool, stating that, where goods have been delivered to the customer without receipt of payment for such goods, and where the supplier has retained title in such goods, then a security interest arises under the PPSA. The court determined that it is irrelevant whether possession has passed to the customer by mistake or by agreement and it affirmed that conditional sale agreements, including an agreement to sell subject to retention of title, are expressly included within the definition of a security interest in the PPSA.

The court noted that, although an element of consensus is necessary for the creation of a security interest, such consensus is only required in relation to the transaction pursuant to which the security interest arises (in this case, the supply agreement containing a retention of title clause) and not in the circumstances under which possession was transferred from one party to another.

Therefore, the court held that JSB had a security interest in the wool supplied to Feltex under the PPSA. However, the failure to register a financing statement in respect of that security interest meant that JSB lost the "super-priority" it would otherwise have enjoyed due to its retention of title in the wool and, accordingly, the bank's claim over Feltex's assets took priority.

The court dismissed the claim for conversion as, while JSB itself did not intend to deliver the wool, JSB's agents voluntarily delivered the wool to Feltex and a voluntary transfer of possession from the agent of the supplier to the buyer is a lawful transfer and cannot amount to conversion. There was no fraud or deliberate deception involved on the facts.

¹ 12 February 2008 High Court, Auckland, CIV 2007-404-003603

² [2008] NZBLC 102, 113

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