What is a PMSI – Purchase Money Security Interest?
In January of 2012, the Personal Property Securities Act (PPSA) was enacted. It affects all security interests in personal property in cases where either the personal property over which the security interest is being granted or the grantor of the security interest is located in Australia. One change of many brought about by the PPSA was the introduction of Purchase Money Security Interests.
As defined by Section 14(1) of the PPSA, a PMSI includes any of the following:
- A security interest taken in collateral, to the extent that all or part of its purchase price is secured;
- A security interest taken in collateral by a person who gives value for the purpose of enabling the grantor to acquire rights in the collateral, to the extent that:
o The value is used to acquire those rights;
o The interest of a lessor or bailor of goods under a Personal Property Securities (PPS) lease; or
o The interest of a consignor who delivers goods to a consignee under a commercial consignment
This essentially means that a PMSI is different to other security interests in two important ways – first, in the manner in which it is created, and secondly, in the priority that it receives over other interests in the same collateral. It is a security interest, or claim on a property, that gives a lender who provides the financing to acquire the goods or equipment with a priority ranking ahead of other secured creditors, who have a more standard security interest.
Arising most often in the context of commercial lending, a PMSI allows lenders to repossess the goods that were purchased with the funds they loaned if the borrower happens to default. A PMSI is likely to arise in the following four situations:
- Where money is lent to the grantor enabling them to purchase personal property, e.g. the money that covers the purchase of a motor vehicle, where financing is provided at the point of sale.
- Where the party holding the security interest has given the grantor personal property, but all or part of the purchase price remains outstanding. Retention of title arrangements are common transactions where this occurs. Under this type of arrangement, the transfer of possession of the collateral with title passing usually only occurs once the purchase price of the collateral has been received in full.
- PPS lease transactions – in other words, leases or bailments of goods for a term longer than one year, or for an indefinite period of time.
- Consignment transactions – transactions where the title holder (the consignor) delivers possession of personal property to the consignee, who is in the business of selling personal property of that type, and attempts to sell the consignor’s property.
An example of a transaction giving rise to a PMSI would be as follows: Company ABC might lend $200,0000 to Company DEF in order to enable Company DEF to purchase certain machinery equipment that it wants to acquire. In exchange for the loan, Company DEF grants Company ABC a security interest in the equipment that the loan was used for. This security interest in the property that was actually purchased with the funds loaned is a PMSI.
As another example, credit card issuers may also obtain PMSI’s, which gives them the authority to repossess goods purchased by the consumer on credit until 100% of the balance associated with those goods has been paid.
Why a PMSI?
A PMSI allows a grantor who has given security over all of their present and future property to obtain financing from another creditor that is secured by new assets. In that way, the PMSI secured party will have priority over the existing secured party with respect to the newly acquired assets. Thus, the PMSI provides an opportunity for different sources of financing. The PMSI secured party is protected by super-priority, which is a distinct and highly desired benefit. Thus, in the most practical sense, the benefit of a PMSI is primarily for the secured parties, more so than it is for the grantor.
What priority does my PMSI have?
The Personal Property Securities Act (PPSA) has implemented a single national register that applies to all personal property security interests. The PPSA has also provided us with a set of priority rules to determine disputes between competing security interests.
As many may know, the general rule of thumb when resolving competing security interests is that the interest which is perfected first will take priority over interests perfected after it. The PMSI is one significant exception to this general rule. The rationale behind applying superior priority to the PMSI is that a party, even if obtaining an earlier security interest, should not be able to satisfy their interest from assets that the grantor would not have even been able to acquire were it not for the PMSI secured party advancing the grantor the funds needed to acquire those assets.
To obtain super-priority, a Purchase Money Security Interest holder must register their security interest on the Personal Property Security Register (PPSR). In order to have and enjoy the benefits of super-priority, the secured party with the PMSI must register it within a strict time frame. The time frame required for registration may vary depending upon the nature of the collateral over which they are granted. More specifically, the factors that will determine registration timeframes include:
- Whether the collateral is inventory, or personal property other than inventory, and
- Whether the collateral at issue is tangible or intangible property
The Australian Financial Security Authority, as set forth under Section 62 of the PPSA, provides guidance:
- When the collateral is inventory that is tangible property: The PMSI must be registered before the grantor obtains possession of the collateral;
- When the collateral is inventory that is intangible property: The security interest must be registered prior to the time that the PMSI attaches to the collateral;
- When the collateral is tangible, personal property other than inventory: The security interest must be registered within 15 business days of the grantor obtaining possession of the collateral;
- When the collateral is intangible, personal property other than inventory: The security interest must be registered within 15 business days of the time of attachment, or creation of the PMSI.
Failing to register the PMSI within these time frames will not render it void, but it will prevent it from having super-priority. In those circumstances where registration is not made within the required time frame, general priority rules will apply.
What is NOT considered a PMSI?
According to Section 14(2) of the PPSA, there are certain interests specifically excluded from being considered a PMSI. These include, but are not limited to:
- An interest that is acquired under a transaction of sale and leaseback to the seller; or
- A security interest in collateral that the grantor intends to use predominately for personal, domestic, or household purposes at the time it is attached unless the collateral is required or allowed to be described by serial number (e.g. a motor vehicle);
- An interest in collateral that is either chattel paper, an investment instrument, an intermediated security, a monetary obligation, or a negotiable instrument.
What happens when PMSIs compete?
This essentially means that a registered, or “perfected” PMSI that is granted to a seller, lessor, or consignor will take priority over any other perfected PMSI. If none of the secured parties are sellers, lessors, or consignors, then the usual priority rules will apply. In that instance, the first PMSI perfected by registration will have priority.
How do I effectively enforce a PMSI?
Generally, the enforcement provisions of the PPSA apply in the same way to Purchase Money Security Interests as they do to other security interests. There is only one specific mention of PMSIs in the PPSA enforcement provisions, which is specifically in relation to seized collateral that a secured party plans to retain. If the security interest of the party wanting to retain the collateral is a PMSI, and if there is a registration that describes the collateral, then notice of the proposal to retain the collateral must be given to any secured party over whom the retaining party has priority, as well as to the granter. If the security interest of the retaining party is not a PSMI, notice needs to be given to each secured party who has a registration that describes the collateral, as well as to the grantor.
Are there any drawbacks to a PMSI?
As with most things in life, securities-related or otherwise, there are advantages and disadvantages. It is no different with a PMSI. For many, the primary challenge with a PMSI is ensuring that it is registered in time. This can particularly be an issue when the PMSI concerns inventory and the proceeds from that inventory. As noted, in those instances, perfection by registration must be made before either the grantor, or another person at the request of the grantor, obtains possession of the inventory (in the case of goods), or for any other sort of property, when the PMSI attaches to the inventory. In light of this, it is important for suppliers and financers to have a process in place to ensure that their registrations are made on time.
Another potential drawback to the PMSI is that if a security interest happens to be registered as a PMSI when it is actually not, to any extent, the registration is ultimately not effective. As a result, it is critically important that secured parties ensure that a PMSI is only registered where it truly qualifies. Along these lines, if a security interest begins as a PMSI, but then, for whatever reason ceases to be so, it is important for the secured party to amend the registration accordingly.
It is also important for those holding a PMSI to remember that, as discussed herein, it is possible for one PMSI to be out-prioritised by another. Secured parties should be aware of these exceptions, and the instances in which they apply.