Many businesses are reluctant to register all their customers on the PPSR, due to cost. The reluctance may increase if they need to register multiple security interests against each customer to obtain the desired level of protection.
This is understandable; if you have 5,000 customers, each requiring dual registrations, the Registrar's fees alone are $80,000 for 7 year registrations – and more if you opt for a longer period. A typical response is to select a credit limit and only register customers with a higher limit, or actual exposure.
If this is your policy, there are 6 reasons to reconsider. Let's work through an example where the business has chosen not to register against any customers with a credit limit of less than $30,000.
1. Overtrading – it is well known that overtrading is a primary cause of insolvency. The customer with a $25,000 limit manages to get $75,000 of goods before being placed on stop credit. Six weeks later the company goes into administration. It is no use trying to register when you start to get worried about the account. If your customer is using your goods as inventory you lose the super priority of your Purchased Money Security Interest (PMSI) for all goods delivered prior to registration. If your customer is not using your goods as inventory, you would still only get the PMSI priority for goods delivered during the 15 business days prior to registration on the PPSR.
2. The “6 month rule” – most people are unaware that the Corporations Act was changed to take account of the PPSA, to prevent companies with knowledge of imminent insolvency fraudulently granting security to related or preferred parties. The rule can also catch the innocent. The (abridged) rule is that if (i) you register your security interest more than 20 business days after the security agreement is created and (ii) your customer becomes insolvent within 6 months of registration then your security interest will vest in the insolvent company. In other words, you will lose your goods. This means that if you delay registration until you become concerned about your customer, you are taking on a 6 month risk with your highest risk customer on the other side.
3. The hidden cost of monitoring – if you do decide on credit limits as your registration criteria, someone in your organisation has got to monitor this. You may have to redesign your business processes to tightly monitor your sales team so that customers cannot go above their limit. There may be a direct cost in lost sales and there is certainly the hidden staff costs of monitoring the credit limits in this way. And in any event, doesn’t your staff have better things to do?
4. The scourge of unfair preference claims – your team has done a fantastic job and collected lump sums on account from your customer in the months leading up to liquidation. It is then that the liquidator comes knocking to claw some of that money back under the unfair preference regime in the Corporations Act. If the claim is for $30,000 or less, it is probably not worth fighting in court. A properly registered security interest is a very good line of defence.
5. And then there are “shoot throughs” – businesses with a “long tail” of low value debtors will be well aware of businesses which sell their assets and disappear without settling their debts. Even if the location of the proprietor is known, it is often not economic to pursue him/her. This is where registration can sometime provide an unexpected benefit. If the business is being sold it is common practice for the purchaser’s solicitor to complete a PPSR search to see if the business assets are encumbered. If your interest is disclosed, the vendor has no choice but to approach you with a discharge request – which you will gladly provide on full settlement of your account.
6. Ledger integrity – is a task often left until tomorrow (which never comes). Everyone knows that having accurate legal names for customers and signed terms of trade is best practice and increases the chance of successful legal action against slow payers. But it is a task we often put off, particularly for businesses with large ledgers and mature companies who have been trading for many years. There may soon be no choice. As Australia’s concern with terrorism increases it is likely that the scope of anti-money laundering and counter terrorism initiatives will be broadened to include many more companies. At that point “knowing your customer” will become mandatory. Why wait for the inevitable? Your PPSR project requires you to have accurate customer details and your ledger integrity will be greatly improved as a result.
Please do not think, “It won’t happen to me.” The following example demonstrates the risks of relying on credit management alone, rather than the PPSR.
Risky business: A true story
We had one very frustrated business approach us after losing out twice with the same customer. The business had failed to register against its customer, but was otherwise pretty good at credit control. The customer had been placed on “stop credit” and a payment was offered to secure the next delivery. The goods had been delivered and had not even been cleared from the loading dock when receivers were appointed. The cheque was dishonoured, the vendor could not get any goods back and was understandably annoyed. Regrettably, they had no one to blame but themselves. To make matters worse, if the customer now goes into liquidation, there is the risk of earlier lump sum payments being clawed back as preferences.
Striking the right balance
If businesses wish to achieve a higher level of protection after reading this, there is normally some remedial work that will be necessary on existing customers, particularly to overcome the adverse impact of the “six month rule”. There will always be risk in business and good credit management is all about managing the risk involved in extending credit. The PPSA can be an excellent risk management tool if used properly. We hope this article will be of some assistance when deciding your registration policy.
ABOUT THE AUTHOR: Kim Powell is co-founder of EDX a national firm specialising in PPS registration and consulting. EDX has its roots in New Zealand where similar legislation was enacted in 2002. In his earlier career, Kim has been an insolvency practitioner, headed the commercial credit recovery division of a major bank, as well as a period as a business banker advancing funds on a secured basis. This background made the PPSA a natural area of interest. Kim moved to Australia in 2010 to lead EDX’s entry in to the local market and is based in Melbourne
Contact Kim: firstname.lastname@example.org or 0410 475 100.
December 2014 - FNSCRD505 - Respond to corporate insolvency situations - FNS51520 Diploma of credit management