Purchase Money Security Interest: a Worked Example

The ordinary rule in New Zealand and Australia is that security interests rank by registration, so a lender whose general security agreement covers after-acquired assets would automatically rank ahead on anything the company later bought. A supplier or equipment financier would then be lending behind a charge that existed before its asset did. Purchase money priority answers the fairness point: the bank did not lend against the new machine, and the machine would not be in the company without the money that bought it.

The priority is not limited to banks' competitors. It covers a seller who retains title, a financier whose advance is used to acquire the goods, a lessor under a lease long enough to fall within the Act, and a consignor under a commercial consignment. It is confined to what was financed. Australia's Act gives the status only so far as the interest secures the price or value applied to acquire the asset, and excludes a sale and leaseback, so raising money against an asset the borrower already owns does not qualify there. Refinancing an existing purchase money loan is a different case: Australia's Act keeps the status, while a New Zealand High Court decision in 2007 held that a refinancing could not create a new purchase money interest. An all-monies clause in the same contract ranks in the ordinary way for anything above the price.

The inventory deadline is stricter, because stock turns over and an inventory financier's claim moves to the proceeds. Timing runs from possession, so a financier registers before delivery wherever it can. Australian courts have read possession as possession in the capacity of grantor under the interest, so goods already held under an earlier arrangement need care. Leases need checking in each market: more than one year in New Zealand's definition and, in the usual case, more than two in Australia's.

The UK has no PPSR and no statutory purchase money rule. Hire purchase, leasing and retention of title reach a similar result by keeping ownership with the financier or seller, so the bank's charge does not attach to the asset while that remains so. A UK lender that simply lends the price and takes a charge ranks under the general rules on charges and any priority agreement.

A stone benchtop fabricator in Australia, constructed for this page like every figure in it, gave its bank a general security agreement, registered years ago. It then buys a waterjet cutter for US$1.25m, with US$0.25m of its own cash and US$1.0m from an equipment financier secured on the machine. Later the fabricator fails. The bank is owed US$2.5m and the financier US$0.9m. The machine realises US$0.7m and all other assets US$1.9m, after the claims the law pays first. Figures in US$m.

Three business days past the deadline move US$0.6m from the financier to the bank. On business day 18 the registration is still good, and the financier is still secured, but it has lost the special rank and falls back behind the bank's earlier registration, taking only what is left from the machine. The total recovered is the same in both versions. The financier's shortfall, in the first case, becomes an unsecured claim. In New Zealand the deadline would be 10 working days. The timing and values are the example's.

A deed of priority reorders security by agreement between the lenders, and can apply to anything. Purchase money priority arises by statute, without the bank's agreement, and applies only to the asset financed and its proceeds. Retention of title is one way of creating such an interest, and in New Zealand and Australia it is usually how a supplier obtains it. A floor plan facility applies the inventory version to a dealer's stock.

Priority and permission are also separate questions. The statute may give the financier first rank, but a negative pledge in the bank's facility can still make the new security a breach, unless it falls within a permitted exception. Many facilities allow purchase money or asset finance up to a stated limit for that reason.

DEFINED IN ONE PARAGRAPH → · THE PPSR → · CHATTEL MORTGAGE →

For a bank holding general security, purchase money interests are one reason a charge over the whole company recovers far less than the whole company. The desk looks for them on the register, compares the fixed-asset note with the finance schedule, and values the general security excluding financed assets or including only any surplus above the finance owed. It also repeats the search, because a non-inventory interest can appear after the delivery date without warning. A sudden run of such registrations can suggest that a borrower is financing what it would once have paid for in cash.

For the financier, the file turns on sequence. Confirm whether the goods will be inventory or equipment in this borrower's hands, register against the correct details before delivery, mark the registration properly in Australia, and keep proof of the delivery date. The proceeds also need thought: where a financed asset is sold or insured, the financier's position depends on following the money into a bank account that may be pledged elsewhere, and a lender that registered first over receivables as original collateral, for new value, can outrank an inventory financier on them.

EQUIPMENT LOAN VS LEASE → · EQUIPMENT FINANCE → · WHAT YOUR BANK HOLDS AS SECURITY →