29 February 2012
PPSA: Enforcement of securities in a commercially reasonable manner
The Personal Property Securities Act 2009 (Cth) (the Act), which came into effect on 30 January 2012, has ushered in a new era in Australian commercial law including in relation to the enforcement of security interests in personal property.
Outline of security enforcement rights
Chapter 4 of the Act, Enforcement of Security Interests, deals with how to enforce a security interest in personal property.
It should be noted that the parties can contract out of some of the enforcement provisions and the enforcement provisions do not apply to property that is in the hands of receivers or controllers. There are also other exceptions that may apply (which will not be outlined in this bulletin).
There is an overarching obligation that the rights, duties, and obligations that arise in relation to the enforcement provisions of the Act be exercised or discharged:
In a commercially reasonable manner.
Commercially reasonable manner
The requirement to act honestly is a statutory duty that is contained in other Australian legislation, such as the Corporations Act 2001. There are many cases that provide guidance on what it means to act honestly. This will not be a focus of this bulletin.
However, the same is not true for the concept of acting “in a commercially reasonable manner”. This concept is not included or referred to in any other Australian legislation and there are no Australian cases that have considered what this concept actually means in practice.
Surprisingly, and contrary to the purpose of the Act to provide certain outcomes in commercial dealings, the Act does not provide a definition or any other guidance on what constitutes conduct that would be classified as commercially reasonable.
Hence, until the Australian courts have decided cases on point, guidance will need to be obtained from other jurisdictions where similar legislation has been introduced incorporating a similar standard of conduct to that contained in the Act. In this bulletin we consider how courts in New Zealand and Canada have approached the issue.
New Zealand guidance
The Act is largely based on the model that applies in New Zealand under the Personal Property Securities Act 1999 (NZ).
When the PPSA was enacted in New Zealand, there was an identical obligation on a secured party to exercise its enforcement rights honestly and in a commercially reasonable manner. That obligation was repealed in 2004 and replaced with the requirement to act in good faith and in accordance with reasonable standards of commercial practice. The amendment was made in order to ensure that cases considering the Credit Contracts Act (now repealed), which included an equivalent test, would be consistent with and relevant to the interpretation of the Personal Property Securities Act 1999 (NZ). Whilst the phrases are different, it is considered that either of them imposes a similar core obligation.
A recent New Zealand case considered an application to re-open three loan contracts (and mortgages), made to two pensioners who were 65 years of age, on the basis that the loan contracts were oppressive. The loans were advanced based on the security provided by the borrowers, being their residential home, without taking into account their income. The borrowers were represented by an independent solicitor in the transaction. Section 118 of the Credit Contracts and Consumer Finance Act 2003 (NZ) defined ‘oppressive’ to include conduct “in breach of reasonable standards of commercial practice”. The ground of oppression relied upon was that the financier did not investigate the borrowers’ ability to repay the substantial sums advanced to them.
At first instance, the High Court observed that the expression breach of reasonable standards of commercial practice required proof of contractual terms, or the use of means to induce someone to enter into a credit contract, which are more than simply out of line with normal commercial practice. Further, the Court provided that some evidence as to what the standards of commercial practice are, relative to the particular type of contract under consideration, would be necessary before the Court could conclude that those standards were contravened in the particular case. The Court was not persuaded that the contracts were oppressive as there was no evidence before the Court that the lender was aware of the borrowers’ inability to repay the loans.
On appeal, the Court of Appeal found that the contracts were oppressive as they were made in contravention to the lender’s own guidelines when approving loans to pensioners. In relation to reasonable standards of commercial practice, the Court stated that whilst evidence of commercial practice was relevant to the Court’s determination, the ultimate decision as to what constituted reasonable commercial practice was a matter for the Court to determine. The Court indicated that the lender’s compliance with an industry standard will not, of itself, be sufficient to satisfy the requirement that conduct was within reasonable standards of commercial practice in circumstances where a lender is in possession of information which should have put it to inquiry.
Despite the slightly different phrase under consideration, this case provides some guidance on how the Australian Courts may approach the question of what constitutes commercially reasonable conduct. Consideration of this phrase in Australia may well involve considering the standards of commercial practice that apply to the enforcement of a particular type of security interest in the particular circumstances, subject to the Court’s view of the reasonableness of the conduct engaged in.
Similar PPSA legislation to the Act is also in force in Canada.
A recent case decided in Vancouver considered whether HSBC, a secured lender, acted in a commercially reasonable manner in disposing of personal property (trucks and other equipment) provided as security for monies advanced to a company. The company director, who had provided a personal guarantee in favour of HSBC for the debts of the company, alleged that HSBC failed to dispose of the security in a commercially reasonable manner, thereby increasing the shortfall which became due and payable by the director pursuant to the personal guarantee.
The Court noted that:
Unlike the standard of good faith, which is subjective, the standard of commercially reasonable is objective, and depends on what is considered reasonable in the particular industry.
Various considerations that needed to be taken into account included:
The method of sale (private sale or public auction);
The extent to which the sale was advertised;
The time and place of the sale;
Whether an opportunity to inspect the goods was provided;
Whether the collateral was sold as one parcel or in smaller lots;
The costs associated with a sale or delaying a sale; and
Whether collateral should have been repaired or improved prior to sale.
The question in each case is whether the secured party took all reasonable steps to obtain the best price for the collateral.
The debtor bears the onus of proof to establish both that the secured party departed from industry norms, and that a higher price would have been obtained if the secured party had done what is considered to be reasonable in that particular sector or industry. It may be necessary to call expert evidence as to the industry standard that applied in a particular circumstance.
The director failed to adduce any expert evidence on the applicable industry standards. On that basis, the Court found that the director did not establish that HSBC failed to deal with the collateral in a commercially reasonable manner.
The Act stipulates that the enforcement provisions of the Act apply only to security interests provided for by security agreements made at or after the registration commencement time. The registration commencement time is 30 January 2012. Hence, we currently have a situation whereby security interests created prior to 30 January 2012 must be enforced under laws applicable prior to the introduction of the Act, and post 30 January 2012 security interests will attract the application of the enforcement provisions of the Act.
The Canadian and New Zealand experiences suggest that what constitutes acting in a commercially reasonable manner will depend upon what is considered reasonable in the particular industry at the relevant time. This will probably require the Court to consider expert evidence on a case-by-case basis to determine what the appropriate commercial standard or process is, and whether conduct was objectively reasonable in the discharge of the standard or process adopted.
According to the recent Canadian authority at least, the debtor may well bear the onus of proving that a security holder has not complied with this obligation. Whether the Australian courts take the same view when considering the Act remains to be seen.
Given the application of the transitional provisions, it is not expected that any judicial guidance on what will constitute conduct that is commercially reasonable will be available in the short term.