Conflicts between secured creditors and shareholders

When a business enters insolvency and the division of assets is in question, the hierarchy can be complicated when secured creditors, or holders of a General Security Agreement (GSA), are involved. Often the property or business owner or shareholder is confused about rights and securities. It's important to understand the current legislation behind these issues, as well as conflicts that arise between the parties and how to manage them.

Secured creditors

When a company faces insolvency, secured creditors with specific securities are going to be at the top of the hierarchy and secured creditors with general securities are next in line. Secured creditors have a protected interest over specific or general assets of a business, and they have remedies such as a right to repossess secured assets if payments are not made on a mortgage, a hire, a loan or purchase agreement. For example, a bank is often a secured creditor.

An unsecured creditor, on the other hand, is likely one of the last groups to be paid following an insolvency, and has no interest to attach to assets or property. Certain unsecured suppliers will have retention of the title claims, however these rank behind the registered security holders.

Security interests may include a GSA, a retention of title clause, a lease of goods or equipment of more than a year or an agreement to provide goods on consignment.

The PPSA

In 2002, the Personal Property Securities Act 1999 (PPSA) came into force. This legislation allows suppliers and lenders to find out what security interests their customers already have. People can register security interests in personal property on the PPSR, almost like income protection insurance, so that they don't end up losing property to creditors. 

However, the PPSA is only concerned with security interest and not legal ownership, an important thing to remember.

What conflicts can arise between GSA holders and shareholders?What conflicts can arise between GSA holders and shareholders?

Conflicts and how to manage them

So what conflicts can arise between GSA holders, or secured creditors, and shareholders?

1. Ranking

General Security Agreements state that holders have security over all present after acquired personal property, including company assets. A supplier or shareholder will not rank ahead of a GSA holder in the distribution of assets through insolvency unless they have registered their interest on the Personal Properties Security Register (PPSR) and have valid documentation to support their registration and can clearly support advances made.

This is a fast and inexpensive process, so it is recommended. Registration on the PPSR is the main system for ranking priority in regards to secured parties and a debtor's general creditors.

Otherwise, the owner will lose priority to the GSA holder and any other preferential creditors. Instead of ranking by which GSA was issued first, the first GSA holder to register on the PPSR ranks at the top.

Often banks when lending funds will require earlier ranking GSA holders (such as shareholders for advances made) to enter into a deed of subordination so that the bank stands in higher priority.

2. Security interest vs. ownership rights

Because the PPSA deals with security interest and not legal ownership, many shareholders can become confused when their business enters insolvency. If they legally own property, it does not mean that a secured creditor cannot overtake it, and they often do not understand the distinction.

A shareholder of an insolvent company ranks at the end for any equity advanced in the business behind unsecured creditors. However, a shareholder who advances funds to the company and at a time when the company was not insolvent and records the advance by way of a GSA and loan documentation will rank as a GSA holder in the order of time registered.

3. Inaccurate PPSR registration

Another problem that can arise is if the collateral description of serial numbered assets are inaccurate in the PPSR registration. If this happens, priority would likely fall to the next registration that is correct. Likewise, a material flaw in the registration can lead to any security being deemed invalid.

In order to avoid or manage conflict, all of these considerations must be addressed. It is important to ensure that you have registered a security interest on the PPSR for that additional protection and to ensure that the serial numbered assets or general assets are described correctly in registration and the debtor and secured creditor details are accurate.

If you have concerns about secured creditors, GSAs, the PPSA, PPSR or the conflicts that can arise, contact the professionals at McDonald Vague today for more information. We are happy to assist you with navigating these complex issues and can point you in the right direction moving forward.

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