Chattel Mortgage: a Worked Example

The name is old, but the structure is a plain secured loan. The dealer sells the asset to the business, the financier pays the dealer, and the business repays the financier in instalments over a term matched to the asset's working life, sometimes with a balloon at the end. The business is the owner from the start, and the financier holds security over the asset until the last instalment is paid.

That ordering matters most in Australia, where it is one of the most common ways to finance a business vehicle. Because the business owns the asset, it can claim the deductions and the GST credit that come with ownership. Because the financier relies on security rather than title, it depends on the register to protect its position against the business's other creditors and against anyone who later buys the asset.

In Australia and New Zealand, personal property securities law names the chattel mortgage as one form of security interest, judged by substance like any other. The financier registers on the PPSR. A financier that lends to buy the asset holds a purchase money security interest, which ranks ahead of an earlier general security over the same goods if it is registered in time and, in Australia, the registration says it is a purchase money interest. For equipment that is not inventory, the window runs from the day the business takes possession: 15 business days in Australia, 10 working days in New Zealand. In Australia, where the regulations allow goods such as motor vehicles to be described by serial number, a registration that a serial-number search would not find can let a buyer take the vehicle free of the financier's interest.

In the UK the same arrangement is normally called a secured or asset loan. A company that borrows against a vehicle or machine gives a charge over it, and the charge has to be delivered to Companies House within 21 days, beginning with the day after it is created, or it is void against a liquidator, an administrator and the company's creditors. In England and Wales, lending to individuals, sole traders included, against goods they keep falls under the Victorian Bills of Sale Acts, which the Law Commission has recommended replacing. Much UK vehicle and plant finance is written as hire purchase or leasing instead.

A landscaping business in Australia, constructed for this page like every figure in it, buys a tipper truck and a compact track loader from one dealer for US$165,000 plus GST of US$16,500. A financier lends the full US$181,500 over five years at 7.9% under a chattel mortgage, with no deposit and no balloon. The business is registered for GST and uses both machines wholly in the business. Its bank has held a general security agreement over all its present and future property, registered on the PPSR, for four years. The rate and terms belong to the example.

Two things follow from ownership. The business recovers the GST in the price as soon as it accounts for the purchase, rather than over the term, so the cash it borrowed for the GST comes back within one reporting period. And the business can sell either machine whenever it chooses, provided the financier is paid out from the proceeds and its registration is removed.

Registration decides what happens if the business fails. Registered on day 12, the financier's interest ranks ahead of the bank's general security on the truck and the loader, and the bank's charge reaches only any surplus after the financier is repaid. Registered on day 20, the financier has lost the special priority, and the ordinary rule of first registration would generally put the bank ahead on those machines. The difference turns on eight business days of back-office work. A company faces a second deadline: an interest registered more than 20 business days after it was granted can vest in the company altogether if administration or liquidation follows within six months of the registration.

Under a chattel mortgage, title is the business's on the day of purchase. Under hire purchase the financier owns it until the final payment. Under a finance lease the financier owns it throughout, while the business carries most of the cost and the residual. For a credit desk all three are secured debt on one asset. The differences are legal and fiscal.

GST is the difference most often quoted in Australia, and it is narrower than it is often made to sound. Under a lease, the GST is in each rental and is claimed period by period. Under a chattel mortgage, the GST in the price can be claimed up front. Since 1 July 2012 a hire purchase agreement is treated as a purchase for GST as well, so the up-front credit separates a chattel mortgage from a lease, not from hire purchase. Income tax treatment differs between the structures too, and belongs with the business's accountant.

DEFINED IN ONE PARAGRAPH → · EQUIPMENT LOAN VS LEASE → · HIRE PURCHASE, WORKED →

For the financier, the file is the asset: what it will sell for at each point in the term, how quickly it loses value, and whether it can be found and moved. A generic truck is good security. A machine built for one site is not, and a financier lending against one is relying on the business, not the asset.

For the business's bank, every chattel mortgage is an asset that has left its security. The bank searches the register, adds the instalments to debt service and the balances to debt, and leaves the financed machines out of what it expects to recover. Its facility agreement usually allows purchase-money finance only up to a stated amount, so a business that adds vehicles without checking that limit can be in breach of its own bank's terms before the first instalment is due.

PRODUCT FILE: EQUIPMENT FINANCE → · WHAT YOUR BANK HOLDS AS SECURITY →