Appendix 3
Supplementary Submission provided by Allens Arthur Robinson, Blake Dawson,
Freehills and Mallesons Stephen Jacques
Background
Towards
the end of the public hearings into the Personal Properties Securities
(Consequential Amendments) Bill 2009 (the PPS Bill) that
were held by the Senate Standing Committee on Legal and Constitutional Affairs on
10 November 2009, we were asked by Senator Fisher to provide some further
commentary on two issues that the Committee had raised with both us and
representatives of the Attorney-General's Department at that hearing.
We
responded with a Supplemental Submission on 16 November 2009.
The
Attorney-General's Department made subsequent comments in relation to our
Supplemental Submission in relation to one of those issues relating to clause
101 of the PPS Bill.
Our further response in relation
to those issues are set out below.
Example 1
Our original example was as
follows:
Glenn's Gold Emporium is a
wholesale supplier of gold to the jewellery manufacturing market. It supplies
gold on retention of title terms, and registers its security interests in
accordance with the Act.
A small but important customer
of Glenn's Gold Emporium is an up-and coming boutique producer of reproduction
antique rings, Patchworks. Glenn's Gold Emporium sells $100 of gold to
Patchworks.
Patchworks also maintains a
number of banking facilities with Bobbin Bank. Patchworks has not given Bobbin
Bank an all-assets security, but instead has given Bobbin Bank a security
interest over all its stock of rings. Bobbin Bank has also perfected its
security interest over the rings by registration.
The gold price is notoriously
volatile, and shortly after the sale of gold by Glenn's Gold Emporium to
Patchworks, the price goes into a slump. Glenn's Gold Emporium is still owed
$100 by Patchworks, but the value of the gold that it sold has now dropped to
$80. This happens to still be the price on the day on which Patchworks uses
the gold to make some rings. As a continuation of the price volatility, the
slump reverses itself a few days later, and the gold price recovers to its
previous level.
Before Patchworks uses the
gold to make rings, Glenn's Gold Emporium clearly has priority, and for its
full $100.
Under clause 99 of the PPS Bill, Glenn's Gold Emporium's
security interest in the gold continues into the ring. Because of the vagaries
of the world gold price and the coincidental timing at which Patchworks used
that gold to make some rings, however, its priority under clause 101 is limited
to $80, even though Glenn's Gold Emporium is owed $100 and the current market
value of the gold in the rings is now back at $100 as well.
The Department in its response addressed the example on the
assumption the gold is not mixed with anything else in manufacturing the ring..
Our point is more clear if it is assumed that the rings
are manufactured not only from the gold supplied by Glenn's Gold Emporium, but
also from some gold held in stock by Patchworks, and some silver supplied by
Archimedes Ltd without any retention of title or other PMSI, which is alloyed
with the gold. The gold supplied by Glenn's is worth $100 on supply,
$80 on commingling, but at the time of sale of the ring, would have been worth
$100 if separate.
Say the ring, taking into account the increased value of the
gold supplied by Glenn's, the gold and silver of Patchworks, and its design, is
worth $200.
At that stage, clause 99 clearly applies as the
identity of the gold has been lost in the product or mass. The difficulty
arises under section 101. That limits priority to the $80 value on
commingling.
Under our example, Glenn's is owed $100, but is only
entitled to recover $80, even though the value of its contribution has
increased to $100. s103 might have helped but it does not override
section 100.
A more stark example of the operation of the section in
relation to non-fungibles is the following example.
Example 1A
Glennbank has a perfected security
interest over 800 oz of gold , which secures (with other assets)
$1,000,000. The other assets subject to its security are dissipated.
The gold is worth $400,000 at the time of commingling, and the price of
gold subsequently rises to $1000 an oz, giving a value of $800,000.
The gold is mixed with other
gold and silver and manufactured into rings. Patchwork Bank has an all assets
security which has been registered after Glennbank's security, and therefore
ranks second. The rings are worth $2 million.
Under this scenario Glennbank only has priority for
$400,000, less than both the amount secured and the value of the assets
contributed at the time of realisation.
Firms' Example 2
We had said that the amount owed to each farmer, and the
price of wheat at the time of supply by each farmer, is different.
Our example was:
A wheat exporter buys wheat on retention of title terms
from Farmer A (3,000 tonnes) and Farmer B (2,000 tonnes). The wheat is
fungible, and mixed so that is becomes a mass of 5,000 tonnes. The price of
wheat was different when supplied and added to the mass, and each farmer is
owed different amounts because they had different payment terms.
We had proposed that if the mass is sold, then Farmer A
should be able to have priority over, and first recourse to, 3/5 of the sale
proceeds of the mass, and Farmer B should similarly have priority over and
first recourse to 2/5 of the mass, regardless of the value at the time of
contribution or the amount owed.
The Attorney General's Department commented on this example
in their question on notice response dated 18 November 2009. With respect, we
think that the result of the example we gave is clearly not
as stated by the Attorney General's Department in that response, which seems to
assume the ratio of amounts owed is the same as the wheat contributed.
To illustrate, say Farmer A (who had supplied 3/5
of the wheat) is owed $2000 and Farmer B (who had supplied 2/5) is owed
$3000, and the wheat as a whole is now worth $4000 (because the price
of wheat has gone down) and is sold on enforcement for that amount. Under
subsection 102(2) the two farmers participate in the mass in the ratio of
the secured amounts. Farmer A is entitled to 2/5 and Farmer B is entitled to
3/5 of the whole even though they had supplied wheat in the reverse
proportion. That has the result that Farmer A receives $1600, and
Farmer B receives $2400, even though the wheat supplied by them is worth $2,400
in the case of Farmer A, and $1600 in the case of Farmer B.
Example 2A
The example becomes even more dramatic if the secured
parties are not farmers with PMSIs in wheat but financiers with security
interests over respective contributions of gold.
Say, instead of Farmer A,
there is Bank A who is owed $10,000 and had a security interest in 3/5
of the gold before commingling (and other assets), and instead of
Farmer B. there is Bank B that is owed $90,000, and had a security
interest in 2/5 of the gold before commingling (and security over other
assets), and before commingling their gold was worth $135,000 and $90,000
respectively, but on enforcement the mass was worth $50,000 in total (so that
the contributions at those values are worth $30,000 and $20,000).
In that case Bank A recovers $5,000, and Bank B
$45,000. Bank B receives a windfall.
In each case the result would be radically different if the
wheat or gold had not been mixed.
It is hard get past the basic proposition that the
financiers of two separate loads of wheat or gold will be able to realise their
securities for up to the value of their respective loads at the time of
realisation, as long as the loads are kept separate. Why should they risk loss
(and others make a windfall gain) just because the two loads get mixed
together?
Fungible goods
We think that this principle in particular is something that
is easy to understand and easy to draft. It is not complex.
The proposition is simply that contributors of fungible
goods to a mass should participate according to the respective goods
contributed to the mass. It should not matter who is owed what in apportioning
priority, or what the price was at the time of commingling. The mass is
divisible, the proceeds of realisation on enforcement are divisible, and they
should be divided according to the contribution to the mass.
We are suggesting that there be a special provision
that governs what happens with commingled fungible goods. We think we should
take the opportunity to improve on foreign models, and this would be a clear
and easy improvement. That would be an opportunity for Australia to have
a significant improvement on other jurisdictions, and a valuable one in an
economy in which commodities are so important. Of course, the principles do not
only apply to commodities, examples in previous cases in the case law include common
stores of bottles of wine and gold coins. The principle could be
extended to fungible intangibles.
Non-fungible goods
The principles that should apply to non-fungible goods are
more complex, and may be open to debate, but it seems to us that the principles
that have been applied in the drafting of sections 101 and 102 are not the
appropriate ones, as is demonstrated in our examples 1 and 1A, and
again the opportunity should be taken to fix them up. A fairer
proposition for section 101 would be to look at the value of the goods at the
time of realisation, not at the time of commingling.
That preserves the value of the security
that had been taken over goods and would have been the value had the
goods remained separate. It also prevents the other unfairness that
can arise to subsequent secured creditors if a secured creditor has contributed
goods which have significantly declined in value after commingling. That would
apply equally to gold used in rings, to resin or woodchips used in chipboard,
and to wheat used in bread (though in the latter cases there is unlikely to be
any difference between value as at commingling and value as at realisation).
Section 101 limits priority to an historical figure
which may have little relevance to the current value at the time of
realisation.
Section 102 again has arbitrary results because it looks at
the value of the secured obligation, rather than the value of the
security. We suggest that a more reasonable principle in section 102
would be to divide up the proceeds according to the respective values of the
goods contributed as at the time of realisation.
We cannot see the policy reason for limiting priority
to an historical value or, when priorities are equal, dividing proceeds
according to amounts secured rather than goods
supplied.
Supplementary Submission provided by the Attorney-General's Department
Inquiry into the PPS
(Consequential Amendments) Bill 2009 – Question on Notice
On 16 November 2009, Senator
Crossin asked the Department the following questions on notice:
Allens Arthur Robinson, Blake
Dawson, Freehills and Mallesons Stephen Jacques have provided further
information about their view of the operation of clauses 101 and 102 of the PPS Bill (reply to a question on notice provided 17 November 2009 https://www.aph.gov.au/senate/committee/legcon_ctte/pps_consequential/submissions.htm).
Does the department agree that, in
the example provided about Glenn’s Gold Emporium, the result is not a
commercially balanced outcome? In light of the view of the four law firms about
the operation of clause 101, could the department provide further information
about the policy justification for it?
Could the department also provide
information about the policy justification for clause 102?
Allens Arthur Robinson, Blake
Dawson, Freehills and Mallesons Stephen Jacques (‘the law firms’) have
suggested that the priority amount for the purposes of clause 101 should be
determined by reference to the value of the relevant goods from time to time,
rather than at the time the goods were commingled. The Department considers
that the law firms’ suggestion is not supported by the examples they provided.
Law firms’ example 1
The law firms provided the
following example in support of their suggestion:
Glenn's Gold Emporium is a
wholesale supplier of gold to the jewellery manufacturing market. It supplies
gold on retention of title terms, and registers its security interests in
accordance with the Act.
A small but important
customer of Glenn's Gold Emporium is an up-and coming boutique producer of
reproduction antique rings, Patchworks. Glenn's Gold Emporium sells $100 of
gold to Patchworks.
Patchworks also maintains a
number of banking facilities with Bobbin Bank. Patchworks has not given Bobbin
Bank an all-assets security, but instead has given Bobbin Bank a security
interest over all its stock of rings. Bobbin Bank has also perfected its
security interest over the rings by registration.
The gold price is notoriously
volatile, and shortly after the sale of gold by Glenn's Gold Emporium to
Patchworks, the price goes into a slump. Glenn's Gold Emporium is still owed
$100 by Patchworks, but the value of the gold that it sold has now dropped to
$80. This happens to still be the price on the day on which Patchworks uses
the gold to make some rings. As a continuation of the price volatility, the
slump reverses itself a few days later, and the gold price recovers to its
previous level.
Before Patchworks uses the
gold to make rings, Glenn's Gold Emporium clearly has priority, and for its
full $100.
Under clause 99 of the PPS Bill, Glenn's Gold Emporium's security interest in the gold continues into the ring.
Because of the vagaries of the world gold price and the coincidental timing at
which Patchworks used that gold to make some rings, however, its priority under
clause 101 is limited to $80, even though Glenn's Gold Emporium is owed $100
and the current market value of the gold in the rings is now back at $100 as
well.
Clause 99 of the Bill provides as
follows (so far as is relevant):
99 Continuation of security interests in goods that
become processed or commingled
- A security interest in goods that
subsequently become part of a product or mass continues in the product or mass
if the goods are so manufactured, processed, assembled or
commingled that their identity is lost in the product or mass.
Three conditions must be satisfied
before section 99 will apply:
-
there must be a security interest in goods,
-
the good must become part of a product or mass, and
-
the goods must be so manufactured, processed, assembled or commingled
that their identity is lost in the product or mass.
When these circumstances exist,
the security interest in the goods continues in the product or mass.
In the example provided by the law
firms, the first two conditions are satisfied, that is:
-
there is a security interest in the gold supplied by Glenn’s Gold
Emporium to Patchworks, and
-
the gold becomes part of a product (that is, the rings manufactured by
Patchworks).
However, the gold supplied by
Glenn’s Gold Emporium has not been so manufactured, processed, assembled or
commingled that its identity is lost in the product or mass (that is, the third
condition is not satisfied). All of the gold in the rings manufactured by
Patchworks is traceable to the gold supplied by Glenn’s Gold Emporium. Because
of this, clause 99 does not apply to the scenario provided by the law firms.
The Department considers that the
security interest in the gold granted by Patchworks to Glenn’s Gold Emporium
would continue in the gold despite the gold being manufactured into the rings.
The gold is the same collateral despite having been manufactured into rings. To
use an analogy, a security interest in a pile of sand would continue in all of
the sand if the pile were divided into two piles of sand (without recourse to
clause 99 of the Bill).
If Patchworks were in default
under the security agreement, Glenn’s Gold Emporium would be able to seize and
dispose of the rings with a view to realising the amount owed to it (see Part
4.3 of the Bill). This assumes that Glenn’s Gold Emporium has not contracted
out of these rights (see clause 115 of the Bill). The Department understands
that this is the outcome favoured by the law firms.
Law firms’ example 2
The law firms have also
provided the following example in support of their suggestion:
A wheat exporter buys wheat
on retention of title terms from Farmer A (3,000 tonnes) and Farmer B (2000
tonnes). The wheat is fungible, and mixed so that it becomes a mass of 5000
tonnes. The price of wheat was different when supplied and added to the mass,
and each farmer is owed different amounts because they had different payment terms.
They have proposed that:
If the
mass is sold, then Farmer A should be able to have priority over, and first
recourse to, 3/5 of the sale proceeds of the mass, and Farmer B should
similarly have priority over and first recourse to B 2/5 of the mass, regardless
of the value at the time of contribution or the amount owed.
The Bill as drafted would
deliver the result suggested by the law firms in most situations as the
following examples illustrate. The examples assume that the wheat was
initially held separately by the wheat exporter and later mixed.
AGD example 1
If the price of wheat has
fallen below that purchased from both Farmer A and Farmer B, the Bill will
require the amount realised on the sale of the wheat to be paid 3/5th
to Farmer A and 2/5th to Farmer B. This is the result suggested by
the law firms.
AGD example 2
If the price of wheat has
fallen to below that owed to Farmer A (but not that owed to Farmer B), the
wheat exporter could sell 2,000 tonnes of wheat, pay out Farmer B and keep the profit.
Farmer A would be entitled to enforce its security interest against the
remaining 3,000 tonnes of wheat. This is the result suggested by the law
firms: as each farmer has been paid out of the proportion of the wheat supplied
by them.
AGD example 3
Similarly, if the price of
wheat has fallen below that owed to Farmer B (but not that owed to
Farmer A), the wheat exporter could sell 3,000 tonnes of wheat, pay out
Farmer A and keep the profit. Farmer B would be entitled to enforce its
security interest against the remaining 2,000 tonnes of wheat. This is the
result suggested by the law firms: as each farmer has been paid out of the
proportion of the wheat supplied by them.
AGD example 4
If the price of wheat has not
changed since it was mixed, or has increased, the wheat exporter would in the
ordinary course of its business sell all the wheat and pay out Farmer A and
Farmer B the amounts they are owed. This is the result suggested by the law
firms: as each farmer has been paid out of the proportion of the wheat supplied
by them.
If the price of the wheat has
not risen to the amount owed to Farmer A, Farmer A may nevertheless benefit by
being paid out of profit made by the wheat exporter on the sale of the wheat
supplied by Farmer B. Farmer A would therefore be better off than under
the law firms’ suggestion.
A scenario in which the law
firms’ suggestion may change the outcome delivered by the Bill is described in
the following example.
AGD example 5
The law firms’ suggestion may
change the outcome if the price of wheat fell after it was purchased from
Farmer A, rose after the wheat supplied by Farmer A was mixed with the wheat
supplied by Farmer B (but not to the amount owed to Farmer A), and Farmer A
enforced its security agreement against the wheat exporter.
Under the Bill, Farmer A
would not benefit from any increase in the value of the wheat after it was
mixed (clause 102(4)).
The law firms have suggested,
in effect, that Farmer A should benefit from any increase in the value of the
wheat after it was mixed.
Clauses 101 and 102
The Committee’s March 2009
report on Exposure draft of the Personal Property Securities Bill 2008 included
the following comments:
4.13 One of the examples
given of unnecessary length in a provision was that of sections relating to a
'commingling' of goods question. One overseas model addresses the issue in six
lines of text, one in 40 lines of text, and the Australian draft bill in
approximately 112 lines of text covering four and a half pages.
4.14 Again, it is a question
of policy as to the appropriate balance to be struck between the two goals of
certainty and simplicity. The committee agrees that it is important to ask the
question generated by Professor Duggan's submission – are the benefits of
greater drafting precision worth the cost?
4.15 This is another area in
which the committee's view is that too much weight has been given to certainty
at the expense of comprehensibility.
The Committee made the
following recommendation at paragraph 4.19 of its report:
4.19
The committee strongly recommends that the Department reconsiders the balance
between certainty of the law and the accessibility of the provisions with a
view to:
The Government accepted the
Committee’s recommendation.
The provisions in the Bill
relating to commingling were amended so that they now reflect as closely as
possible the provisions in the New Zealand Personal Property Securities Act
1999. As outlined above, the provisions drawn from New Zealand achieve the
outcome sought by the law firms in most circumstances.
While it would be possible to
amend the Bill to include a special provision achieving the outcome sought by the
law firms when fungible goods are mixed, the price falls before the goods are
mixed, but rises after the goods are mixed, this would add to the complexity of
the Bill. It would represent a departure from the overseas models and reduce
the capacity for overseas experience to provide guidance for those working with
the Australian legislation.
Accepting the law firms’
suggestion may also result in the need to decide difficult questions of fact.
For example, Farmer A and
Farmer B each supply 10 containers of grapes to a winemaker. It is not
possible to work out which farmer supplied any particular container of grapes
held by the winemaker. Should Farmer A be able to argue that the special rule
should apply because its grapes are identical to the grapes supplied by Farmer
B? Would it matter that the winemaker intended to mix all the grapes into the
same barrels of wine? Would it matter if another winemaker would not mix all
the grapes into the same barrels of wine? Alternatively, should Farmer B and the
winemaker be able to argue that Farmer B’s grapes are sweeter than those
supplied by Farmer A, and that because of this the special commingling rule
should not apply? The court would need to decide whether the grapes supplied
by the 2 farmers were sufficiently similar as to be substitutes, and so
fungible, with the result that the special fungibles commingling rule would
apply.
Even if the court decides
that the proposed special fungibles commingling rule should apply because the
grapes supplied by the 2 farmers are perfect substitutes, this might in some
circumstances result in an outcome that is not commercially balanced. For
example, the winemaker might have incurred considerable expense in
transporting, storing and otherwise dealing with the grapes prior to the
farmers making their claim. Would it always be commercially balanced to give
priority to the grapegrowers over the expectations of the haulage and storage
companies that they would also be paid out of the moneys realised from the
grapes?
Non-fungible goods
In addition, it should be
noted that the existing provisions of the Bill also apply in scenarios
involving the commingling of goods that are not fungible.
For example, Farmer A might
supply flour to a baker, and Farmer B might supply eggs to a baker. The baker
uses the eggs to manufacture bread. The value of the bread may be greater than
the sum of the value of the flour and the eggs. Under the Bill, the amount
that may be claimed by the farmers is limited to the value of the flour and the
eggs on the day that the bread is made. This outcome recognises that there may
be others who also have a claim to the bread because they have contributed to
the increase in the value (for example, the owner of the recipe used to make
the bread, the electricity or gas supplier, and the lessor of equipment used in
the bakery).
It may not be a commercially
balanced outcome to give the supplier of non-fungible goods priority over any
increase in the value of the goods after the commingling occurs when there are
claims made by others who have also contributed to the increase in the value of
goods.
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