Whilst it is important to understand the risks of not registering a security interest on the PPS Register when you are entitled to, you can only register a security interest if the underlying security agreement actually creates a security interest which conforms with section 12 PPSA.

In the case of a supply agreement it is critical for the parties and their lenders to understand whether the terms of the agreement create a security interest, such as a retention of title.

In J S Brooksbank And Company (Australasia) Limited V Exftx Limited (In Receivership and Liquidation) formerly known as Feltex Carpets Ltd and Anor
[2009] NZCA 122 the New Zealand Court of Appeal decided that JSB’s interest in certain wool following its delivery to Feltex did not amount to a security interest for the purposes of the New Zealand PPSA and its failure to register did not affect its ownership rights.

ANZ had a charge over Feltex which was registered on the PPSR. If JSB had been required to register, ANZ would have had priority.

Facts
JSB supplied wool to Feltex Carpets Limited under a short-term supply contract. When Feltex went into receivership, certain wool mistakenly supplied by brokers on behalf of JSB and not paid for by Feltex was on Feltex’s premises. The receivers took control of it. JSB sued in conversion to recover it.

The effect of the supply agreement was that Feltex would obtain neither possession of, nor title to, any wool until after JSB had received payment by way of cleared funds. Once JSB had received cleared funds, title to the relevant wool passed immediately to Feltex, even although JSB still had possession. So title passed before delivery, rather than the other way round (as is typical in contracts containing retention of title clauses). The system broke down in relation to the wool in dispute.

Feltex had received the wool without having paid for it. Feltex’s manager arranged to have the wool put to one side. After the receivers had been appointed, one of Feltex’s employees said that Feltex could not use the wool as it had not been paid for and should not have been in Feltex’s possession. However, the receivers did not agree. They considered that Feltex was legally entitled to use the wool and was under no obligation to return it to JSB. Apparently, JSB first learnt that Feltex had the wool when the receivers advised them of it. JSB immediately sought return of the wool. The receivers refused to return it. The unpaid price for the wool the subject of the dispute was $132,839.11 (including GST).

There was no dispute that the ANZ debenture was a perfected security interest, and that, if JSB had a security interest, it was unperfected and did not take priority over the perfected security interest of ANZ, which had a composite debenture with Feltex creating a charge over all present and after acquired property.

Did the supply agreement create a security interest?
The key question for the NZ Court of Appeal was whether the supply agreement created a security interest.

The Court said:
“It seems clear that the supply agreement was not intended to secure payment … Rather, the basis of the supply agreement was that Feltex could not take delivery until it had received notification from JSB that JSB had received cleared funds, by which time title would already have passed to Feltex. Clause 4 of the supply agreement was not a retention of title clause as that term is generally understood.

Retention of title clauses commonly appear in contracts which contemplate the possibility of delivery of goods prior to payment and are intended to enable the supplier to have recourse to the goods if payment is not made subsequently….

Accordingly, we do not consider that the supply agreement gave rise to a transaction that “in substance” secured payment by Feltex. The supply agreement was specifically formulated to prevent JSB from having any credit exposure to Feltex. The fact that on this particular occasion, delivery was mistakenly effected prior to payment but title did not transfer does not change an arrangement that did not in substance create a security interest into one that did.

Looking at the matter from ANZ’s perspective, it clearly had a security interest. But, in our view, its security interest had not attached to the wool. …a security interest attaches to collateral when, among other things, the debtor has rights in the collateral. … a debtor has rights in goods sold under a conditional sale agreement (including an agreement to sell subject to retention of title) no later than when the debtor obtains possession of the goods. Here, however, the goods were not “sold” under the supply agreement and Feltex had no right of possession as against JSB.

It follows from the foregoing analysis that we do not agree with the Judge that once the wool was delivered, Feltex had an obligation to pay for it…..

The supply agreement did not provide for possession to be given prior to title passing.

When Feltex obtained possession of the wool prior to obtaining title by making payment, it did not, in our view, have any rights in the wool or any obligation to pay for it. The wool was not delivered in accordance with, or appropriated to, the supply agreement. Feltex could not utilise the wool but was obliged to return it….”

The result
The result was that:
(a) JSB was entitled to sue in conversion for the return of the wool;
(b) The PPSA did not apply as JSB did not have a security interest and ANZ’s security interest had not attached to the wool under the PPSA.

The lesson is that the security agreement is a critical document to understand the rights of the parties. In any dispute the security agreement is the starting point.