These notes are derived from Ian D Osborne, Peter A Healey and Michael R Riches, ‘Finance and Securities’ (Practice Paper No CC205, College of Law, July 2015) [205.350]–[205.510].

  • In legal terms, a security is the rights or interest being granted to a financier over the interest or rights in certain property to support a debt or other obligation.
    • In common usage it also refers to the property secured, and the document that creates the security interest.
    • Shares in a company are often referred to as securities; this is yet another usage.
  • ‘Borrower’ refers to the person/entity providing security, but terminology can vary:
    • Under the PPS Act the borrower is called the ‘grantor’.
    • If security over real estate is being given, the borrower is called a ‘mortgagor’.
  • ‘Financier’ refers to the person/entity taking the benefit of the security.
  • Financiers are interested in taking securities because:
    • The rents or profits from the rights or interests granted may generate enough income to service the debt or meet an obligation.
    • Sale of the security may generate proceeds sufficient to pay out the debt and accumulated interest, charges and sale costs.
  • If the sale does not raise sufficient proceeds, the financier will usually retain full recourse for any outstanding loan.

Types of assets

  • Most assets can be offered as security, but are usually:
    • Land/interests in land.
    • Plant, equipment and stock-in-trade.
    • Choses in action (eg, book debts).
    • Money on deposit.
    • Shares.
    • Life insurance policies.
    • Intangibles (eg, goodwill).
    • Intellectual property.
  • Under the PPS Act, ‘personal property’ is broadly defined as any property excluding land and fixtures thereon attached.
    • Includes intellectual property and licences; may exclude statutory licences (eg, water rights).
  • Possible exceptions relate to personal rights such as licences created by statute.
    • The terms of the licence may prevent it from being mortgaged or transferred.

Types of security interest

  • At common law a financiar will have the option to take:
    • A legal mortgage.
    • An equitable mortgage.
    • A ‘quasi-security’ such as an option or lien.
  • Generally a legal mortgage will provide the better protection, such as a registered mortgage of land.
    • Sometimes this is not possible — a borrower may only be able to offer an equitable interest.
      • This might be because they do not want to approach an existing legal mortgagee for consent to a second mortgage.
  • The PPS Act creates a statutory framework for the consideration of priorities between competing security interests.
    • The rules in the PPS Act override the common law priority regime for security interests over personal property.
    • The common law scheme remains unaffected where a security agreement also charges real estate.
      • Real estate is not personal property under the PPS Act.

Status of the security provider

  • Some rules differ depending on the nature of the security provider (sole trader/partnership, corporate entity, trustee, unincorporated association or club).

Searches and enquiries

  • Checkes and searches should be made to ensure that the security interest is valid and enforceable.
  • Each financier will have its own requirements and the transaction may pose issues which need to be addressed.

Relevant law

  • In taking security over assets, a financier and its lawyer may need to consider various legislation including:
    • Real Property Act 1900 (NSW).
    • Conveyancing Act 1919 (NSW).
    • Personal Property Securities Act 2009 (Cth).
    • Corporations Act 2001 (Cth).
    • Duties Act 1997 (NSW).
    • Competition and Consumer Act 2010 (Cth) sch 2 ‘Australian Consumer Law’.
    • Australian Securities and Investments Commission Act (Cth), especially ss 12BF–12BM.
    • National Consumer Credit Protection Act 2009 (Cth) sch 1 ‘National Credit Code’.
  • The PPS Act calls the interest granted a ‘security interest’ and the actual property subject to the security interest is ‘collateral’.
  • An agreement that grants a security interest over all property of the grantor may include personal and real property: the PPS Act will apply in respect of the personal property, but not the security over land.
  • Mortgage duty has been abolished for individuals taking out mortgages on owner-occupier and investor-residential properties in NSW.
    • Duty on mortgages is to be abolished from 1 July 2016.
  • Interstate legislation may be relevant if the asset to be secured is located in or has some connection with another state.
    • There is no mortgage duty payable in Queensland, Victoria, the ACT, Northern Territory and Western Australia.
  • The asset to be secured or the individual or company giving the security may be located outside Australia.
    • Financiers and its lawyer will need to consider the laws of another country in which the asset, individual or company is located.
    • This may require consultation with or retention of a lawyer in the relevant country.

Security over land

  • Almost all land or interests in land (except land or interests held under Crown tenure) can be mortgaged or charged.
  • Common interests in land offered as security include:
    • Land regulated by the Real Property Act (ie, Torrens title land).
    • Old system title land.
    • Leasehold interests of Torrens and old system land.
  • A financier can take a legal security or equitable security over land.
  • When security is taken over all assets of an individual or company it will constitute an equitable mortgage over the real estate.
    • A caveat would need to be lodged on the title of the real estate to give notice of the equitable interest or to take a mortgage over land and register it.
  • Legal or statutory mortgage of Torrens title land gives strong protection to a financier.
  • It is prudent for a financier to make the same enquiries and searches as a purchaser.
    • They may rely on the same searches where the financier is providing finance to a purchaser.
  • A valuation of the property and environmental audit may be conducted if necessary.
  • A financier should ensure that improvements on the land are insured with an acceptable insurer for their replacement value, and that its interest is noted on the policy — it should obtain the original policy on or before settlement.
  • If security is taken over old system land, the financier usually obtains a certificate as to good title from the mortgagor’s solicitor.
    • It does not normally instruct its own solicitors to investigate title.

Equitable mortgage over land

  • Equitable interests over land can be created by:
    • An express agreement to create a mortgage, including some kind of general security agreement over all assets where some are real estate.
    • An implied agreement to create a mortgage, such as by the deposit of title deeds for security purposes.
    • An executed but unregistered legal mortgage.
  • Equitable mortgages do not offer the same protection as legal mortgages:
    • They can be defeated by prior created equitable interests.
    • They can sometimes be defeated by legal interests, especially if a caveat has not been registered.
      • It is important to register a caveat over the title when a security interest is created.
  • Equitable mortgages in registrable form is useful in short-term property financing.
    • The financier can hold the title deeds and a signed mortgage in registrable form, which can be later registered if needed.
    • It is still prudent to protect an equitable mortgage by lodging a caveat immediately.
  • The holder of an unregistered mortgage over Torrens title land cannot exercise the statutory power of sale without first becoming a registered mortgagee.
    • A court order would be required if the equitable mortgage cannot be registered.
  • A registrable mortgage will require a deposit of the title deed to allow registration.
  • An equitable security over land can prevail over a legal security if the conduct of the holder justifies the postponement of its rights.

Leasehold interests

  • A financier may require a mortgage over a lease if lending to a business proprietor, so that they can sell the business with the premises if there is a default.
  • The lease should be registered if its term exceeds three years, or be in registrable form.
  • A financier can take an equitable mortgage over an unregistered lease, but it will not have the same protection.
  • The financier should review the terms of the lease to ensure they are satisfactory as a security as well as being commercially acceptable.
    • Confirm that under the lease the lessee how power to mortgage its interest.
      • The lessee cannot ordinarily do so without consent of the lessor.
      • Failure to obtain consent will be a breach of the lease, and may allow the lessor to terminate.
  • Other issues when reviewing the lease include:
    • Whether the premises are clearly defined.
    • Whether the lease is or will be registered.
    • Whether the lessor is the owner of the property (verifiable by title search).
    • The term of the lease, whether it will expire before the term of the loan and whether there is an option to renew.
    • Whether the rent review mechanism is commercially satisfactory.
    • Responsibility for paying the outgoings on the property.
    • Whether the use of the property complies with relevant planning regulations.
    • Whether the use is authorised by the lease.
    • Whether the lessee is obliged to make structural repairs or alterations to the property.
    • The terms which must be satisfied before the lessor will consent to the lease being transferred or assigned.
    • Provisions for the destruction or damage of the premises.
    • Any prohibitions on change of use in the lease.
    • Any onerous obligations that may affect the commercial value of the lease.
    • Whether the lessee has to restore the premises to the original condition at the end of the lease.
    • Whether the lease is governed by the Retail Leases Act and whether it has been complied with.
  • To protect the financier’s interests it is essential that the lessor:
    • Consents to the financiers mortgage.
    • Agrees not to terminate the lease on default by the lessee without giving prior written notice to the financier, so that they can rectify the default.
    • (If the financier rectifies any monetary default) agrees to permit the financier or its agent or receiver access to the leased premises as mortgagee in possession in the event of default.
      • This right of access is to permit the financier or receiver to run the business from the premises until it can be sold.
  • A financier taking security over a lease should require a mortgagee to sign the deed of consent so that its rights will be recognised.

Security over personal property

  • Security over personal property of a business coupled with a mortgage over the lease of premises will allow the financier to sell the business with the premises as a going concern; business are generally easier to sell in this way.

Personal Property Securities Act 2009 (Cth)

  • The PPS Act replaced various state, territory and Commonwealth schemes with a single national law and register of personal property securities.
  • Personal property is essentially any property excluding land, fixtures attached to land, and certain statutory licences.
  • Common examples include motor vehicles, household goods, business inventory, intellectual property, licences and company shares.
  • Under the PPS Act a ‘security interest’ is ‘an interest in personal property provided for by a transaction that, in substance, secures payment or performance of an obligation (without regard to the form of the transaction or the identity of the person who has title to the property)’.
  • Transactions that may create a security interest include a fixed charge, floating charge, pledge, chattel mortgage, hire purchase agreement, and lease of goods: s 12(2).
  • The PPS Act does not apply to certain rights or interests, including a lien and right of set-off: s 8.
  • The security agreement must generally be in writing and signed by the grantor in order to be enforceable against third parties: s 20.
  • The PPS Register is a notification register — it does not confer any title to the secured property.
  • Registration may confer priority over an unregistered or later-registered interest; the register assists in resolving disputes.
  • Registration can ensure that the security interest survives the bankruptcy or insolvency of the grantor, so that the secured party remains a secured creditor.
  • Registration is not compulsory but failure to do so may impact on priorities.
  • Failure to advise a client to register their interest is likely to be professional negligence.

Security interests over personal property of a company

  • All assets of a corporation other than real estate are (generally) considered personal property under the PPS Act.
  • ‘Floating charges’ have been replaced by security interests attached to a circulating asset (eg, cash, stock-in-trade, book debts).
  • ‘Fixed charges’ have been replaced by security interests attached to non-circulating assets (eg, capital business equipment, intellectual property).
  • ‘Fixed and floating charges’ are now security interests that have attached to non-circulating and circulating assets.
  • Agreements may continue to use the old terminology, but the PPS Act applies regardless.
  • A security interest over all assets is the usual security a financier will take when lending to a company.
  • The security agreement must describe the property or state that the interest is taken in all of the present and after-acquired property.
  • Registration has to be made against a ‘class’ of ‘collateral’ set out in the Personal Property Securities Regulations 2010 (Cth).
    • For circulating assets, these will include ‘accounts’, ‘inventory’, ‘all present and after-acquired property’ and ‘all present and after-acquired property, except’.

Pledge

  • A pledge is created by the transfer of possession of goods with intent to pledge.
  • When goods are pledged the financier has the right to retain possession until the obligation is discharged.
  • If the pledger defaults, the financier can sell the goods and recover money owing.
  • There will a letter of pledge setting out the financier’s rights, but transfer of possession is what creates the pledge.
  • A pledge is recognised under the PPS Act; possession of the goods perfects the security interest.

Chattel mortgage

  • Some loans are made to assist in the purchase of a new asset or financing of an existing asset.
  • A chattel mortgage is a security interest under the PPS Act.
  • A chattel mortgage is created by the borrower providing security for the loan by way of a mortgage over the asset financed.
  • A chattel mortgage may be given by an individual, partnership or company.

Purchase money security interests

  • Certain transactions by which the person wishing to acquire the goods gets possession of, but not title to, the goods are recognised as giving rise to a security interest under the PPS Act.
  • These transactions are:
    • Retention of title clauses in contracts providing that a purchaser has possession of the property/goods, but does not acquire title from the vendor until the full purchase price is paid.
    • Certain financing or operational leases of personal property that are essentially leases of more than 12 months (or 90 days of vehicles, boats and aircraft).
  • These interests are purchase money security interests: ss 13–14.
  • Registration gives the retention of title supplier or lessor ‘super priority’ if registered within the required timeframe.

Chose in action

  • A chose in action is a right of proceeding in a court to procure the payment of a sum of moneys or to recover damages.
  • Choses in action are assignable at law: Conveyancing Act 1919 (NSW) s 12.

Money on deposit with an authorised deposit-taking institution

  • Money on deposit with a bank is generally accepted to be a debt owed by the bank to its customer.
  • Money on deposit is a form of personal property under the PPS Act.
  • A bank may take a security interest over an account kept with it: PPS Act s 12.
  • If a bank has a security interest over an account held with it, it is perfected because they have control.
  • If a bank has a security interest over an account held at another bank, it should register it to perfect it.

Shares — certificated share holdings

  • A financier can take a security interest over shares owned by a company or natural person.
  • Shares in an unlisted company are personal property under the PPS Act.
  • Shares in a listed company are not personal property under the PPS Act.

Un-certificated shares

  • The ASX Clearing House Electronic Subregister System (‘CHESS’) settlement process does not easily facilitate an equitable mortgage by deposit of a borrower’s share certificates.
  • The CHESS settlement process requires investors to hold un-certificated holdings of ‘approved’ listed shares via a participating broker, except in very limited circumstances.
    • ‘Approved’ shares are transferred electronically, without any documents being signed.
  • A person with un-certificated holdings in listen company shares has no documents of title to those shares, which could be deposited with a financier by way of equitable mortgage for security for a loan.
  • In order to take security the financier will usually require the security provider to either:
    • Hold the shares in a broker-sponsored account (where the broker requires the financier’s consent to any sale of the shares).
    • Transfer the shares into the name of a nominee (thus only the nominee can deal with the shares which effectively prevents the security provider from selling the shares).

Insurance policies

  • An interest in a life insurance policy is not covered by the PPS Act: s 8(1)(f)(v).
  • A financier may require the owner or director(s) of a business or company to take a ‘key person’ life insurance policy and assign the benefit of it to the financier as additional security.
  • A legal mortgage or assignment may be taken over the policy by complying with the Life Insurance Act 1995 (Cth).
    • The assignment must be by a memorandum endorsed on the policy and be noted in the register of assignments kept by the insurance company.
  • Disadvantages:
    • The insurance company may have the right to reject a claim because of non-disclosure of a material fact by the insured.
    • Some life policies become void if the insured commits suicide.

Intangible assets

  • Most common intangible asset of a business is its goodwill; this is personal property under the PPS Act.
  • A financier usually includes the goodwill of the business of a company when it takes a security interest of its business assets.
  • Taking a security interest over business goodwill enables the financier to sell the business as a going concern.

Intellectual property

  • Intellectual property is personal property under the PPS Act and can have a security interest taken over it specifically or as part of general property.
  • IP rights are often licensed to other parties; a security interest created over a licence can and should be registered.

Licences

  • A licence to conduct a particular business is a valuable asset.
  • To ensure it can sell the business as a going concern, the financier must take a security over the licence.
  • Business licences are often personal to the licensee and cannot be transferred or encumbered by a security without consent of the licensor.
  • Financiers should review the terms of the licence and obtain necessary prior written consent.

‘Quasi-securities’

  • Guarantees, letters of comfort, negative pledges and rights of set-off are not strictly securities. - They do not give the financier an interest in property.
    • They do not constitute a security interest under the PPS Act.
  • Financiers may regard them as securities, and may be referred to as such in business finance transactions.

Guarantees

  • A guarantee is a contractual promise given by a third party to a creditor, which makes the guarantor jointly and individually liable to repay the debt in the event of a default by the debtor.
  • The standard guarantee used by financiers will commonly include a provision that makes the guarantor liable as the principle debtor as well as guarantor.
  • A guarantee will typically be in deed form so that no consideration is required.
  • In the case of an individual guarantor the financier and its legal advisers should consider:
    • The benefit, if any, that the guarantor will derive from executing the guarantee.
    • Whether the guarantor understands the nature and extent of the obligations to be guaranteed.
    • Whether the guarantor has obtained independent legal advice before signing the guarantee.
    • Whether the guarantor has obtained independent financial advice concerning the underlying transaction.
    • Whether the guarantor is the victim of any duress or undue influence by the debtor.
    • Whether the taking of the guarantee is unconscionable conduct.
    • Whether anyone has misrepresented the facts of the underlying transaction to the guarantor.
    • Whether the guarantor has, or will have, the capacity to repay.
  • A well-drafted guarantee will contain:
    • An obligation as guarantor to pay the debt, including interest and recovery costs, if not paid by the debtor, plus an obligation to pay the debt as principal debtor.
    • If the debt is not enforceable against the debtor, a provision that the guarantor must indemnify the financier against any loss.
    • A provision that the guarantor will not be affected by:
      • Any variation of the transaction documents.
      • The failure by the financier to enforce any other security.
      • The release of any other security held by the financier for the debt.
      • The insolvency of the debtor.
      • An increase in the debt.
      • The debt not being recoverable from any other guarantor or security provider.
    • A clause prohibiting the guarantor from exercising any right of set-off or subrogation or proving in the liquidation or bankruptcy of the debtor until the debt has been paid.
    • A clause under which the guarantor must pay the financier’s costs in relation to enforcing the guarantee, plus interest if necessary.
  • Guarantors should always receive independent legal advice.

Letter of comfort

  • Letters of comfort are sometimes issued to relieve a supplier’s concerns over the ability of a potential customer to pay for products to be ordered.
  • These letters do not create any legal commitments, but this will depend on the circumstances in which it was issued and the language used.
  • Words that are reassuring do not create obligations, but words expressly taking on an obligation may.
  • Ensure that instructions clearly indicate whether a client expects a legally binding commitment or not.

Negative pledge

  • Well-drafted security documents should prohibit the mortgagor from granting a further security over the mortgaged asset without prior written consent of the financier — a negative pledge.
  • Negative pledges are not security; they are promises not to grant a further security.

Right of set-off

  • Two parties may have a course of dealing under which each has financial claims against the other.
  • If one party becomes insolvent, the other may be liable to pay a debt to the trustee or liquidator.
  • They may wish to deduct from the debt the amount owed to it by the other party.
  • This is a right of set-off.
  • The Bankruptcy Act 1966 (Cth) and Corporations Act 2001 (Cth) provide for statutory set-off.
  • There must be a mutuality of dealings for a person to have the benefit of statutory set-off.
  • Security documents should contain an express right of set-off because financiers regularly take steps to enforce security before the winding up or bankruptcy of the mortgagor; a contractual right protects the financier.
  • In business finance transactions the financier will usually require the right of set-off at any time and without notice.

Terms of security documents

  • Security documents for loans made by a financial institution should include:
    • A description of money secured.
      • This should not state a fixed amount, but simply all money owing.
      • The borrower may be able to negotiate that it be limited to money owing under agreed transaction documents only.
      • It would include all expenses and fees that the financier is entitled to charge.
    • A covenant to repay.
      • A personal covenant by the borrower to repay the amount, on demand or by a fixed date.
      • Covenant should cover both principal and interest.
      • If the security cannot be enforced or if there is a shortfall after the security is realised, the financier will need to rely on the personal covenant.
    • A description of the property over which the security interest is created.
      • In the case of a general security agreement covering all assets, a careful description using broad language.
      • In the case of a specific security agreement, a careful description of the specific property and words of limitation.
    • Warranties, depending on the status of the security provider:
      • In the case of a company, warranties that it has power to enter into and perform the obligations, and has taken necessary action to execute the documents.
      • For companies and individuals, warranties that they are not aware of any current or threatened litigation against it, that all information provided is accurate, that it is not in default under any other agreement relating to borrowed money, and that it is the beneficial owner of all security assets.
    • Undertakings or covenants:
      • Prohibition against creating any other security interest over the asset without prior written consent of the financier.
      • Prohibition on selling assets.
      • Obligation to comply with all laws relating to the business.
      • Obligation to insure the mortgaged property for its full value.
      • Obligation to carry on the business in a proper manner.
      • Obligation to provide financial information at specific intervals.
      • Obligation to provide notice to the financier of any material litigation.
    • Events of default.
      • Failure to pay any money when due (monetary default).
      • Various non-monetary defaults (delay in performing obligations, breaches of warranties, etc).
    • Receiver provisions — usually a security document gives the financier power to appoint a receiver to the mortgaged assets after default.
      • These are set out in the Conveyancing Act 1919 (NSW) but may be extended.
    • Power of attorney clause:
      • The borrower should appoint the financier as its attorney to do all things which the borrower is obliged to do.
      • Borrowers will usually accept this clause if the power of attorney cannot apply unless a default event has occurred.
    • Further assurance clause obliging the borrower to do all things and sign all documents to properly or more effectively secure the property.
    • Maximum prospective liability where the security is given by a company.