1

CHATTEL PAPER

By

Anthony Duggan*

ABSTRACT

Chattel paper is one of the categories of personal property identified in the Personal

Property Securities Act 2009 (Cth) (“PPSA”). The concept derives from Article 9 of the

United States Uniform Commercial Code and it appears also in all the Canadian

provincial personal property security statutes and the New Zealand Personal Property

Securities Act 1999. The main reason the PPSA distinguishes between chattel paper and

other types of personal property is that, following the United States and Canadian lead,

PPSA, s.71 enacts special priority rules for security interests in chattel paper. The

purpose is to facilitate chattel paper financing which, in the United States and Canada, is

the primary method for financing the purchase of motor vehicles and other large-ticket

consumer durables. In Australia, chattel paper financing traditionally has not been used,

at least on a large scale, to finance consumer purchases, and alternative financing

techniques have been employed instead. This paper argues that, given the prevalence of

these other methods, there is no particular need to encourage chattel paper financing in

Australia and, in any event, the chatter paper financier is sufficiently protected by other

provisions in the statute. Therefore, PPSA, s.71 could safely be repealed. The paper also

identifies drafting defects in PPSA, s.71, some inherited from the Article 9 and Canadian

models, which should be corrected if the provision is to be retained. Finally, the paper

discusses the provisions in PPSA, ss 37-38 and 76 governing security interests in

returned or repossessed goods and their application to chattel paper, with particular

reference to the failure of these provisions to account for the standard methods of

financing motor vehicle and other large-ticket consumer purchases in Australia.

1. Introduction

The Personal Property Securities Act 2009 (Cth) (“PPSA”) divides personal property into

four main categories: goods; financial property; intermediated securities; and intangible

property. Chattel paper is a sub-category of financial property, along with currency,

documents of title, investment instruments and negotiable instruments. “Chattel paper” is

defined to mean, in effect, one or more documents that evidences both a monetary

* Acting Dean and Hon. Frank Iacobucci Chair, Faculty of Law, University of Toronto; Professorial

Fellow, Melbourne Law School.

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obligation and a security interest in, or lease of, specific goods.1 For example, assume a

motor vehicle dealer sells a car to a customer on hire-purchase terms. The hire-purchase

agreement is chattel paper within the meaning of the statute. Likewise, if a bank lends a

customer money to buy a car and takes a security interest in the car to secure repayment,

the loan and security agreements together constitute chattel paper.2

Chattel paper is personal property in its own right, distinct from the collateral it relates to.

This means that the chattel paper holder (the dealer in the first of the above examples and

the bank in the second example) can trade the chattel paper or offer it as collateral to a

third party. If the chattel paper holder sells the chattel paper outright, the transferee

effectively takes over the chattel paper holder‟s rights against the customer: it becomes

entitled to the stream of payments generated by the chattel paper holder‟s transaction

with the customer (the hire-purchase agreement in the first of the above examples and the

loan contract in the second example) and it takes over the security interest which it can

enforce against the customer if necessary. If the chattel paper holder offers the chattel

paper to a third party as security for a loan, the lender can look to the chattel paper as a

source of repayment. Specifically, the lender may take over the collection of amounts

owing by the chattel paper customer and, if the chattel paper customer defaults, enforce

the security interest against the customer up to the amount owing under the lender‟s loan

contract with the chattel paper holder. The PPSA applies to both outright transfers of

chattel paper and security interests in chattel paper.3

Because chattel paper is an item of property distinct from the property it relates to (the

motor vehicle in the above two examples), the chattel paper holder can trade or otherwise

deal with the chattel paper without affecting the chattel paper customer‟s title to the

underlying personal property (the motor vehicle). A further, and related, implication is

that perfection of a security interest in chattel paper is a separate matter from perfection

of the security interest to which the chattel paper relates. In the first of the above two

1 PPSA, s.10. The definition also refers to one or more writings that evidences a monetary obligation and a

security interest in specific intellectual property or a specific intellectual property licence. The definition

excludes documents of title, intermediated securities, investments and negotiable instruments. 2 This is the case whether the two agreements are in separate documents or combined in a single document.

3 PPSA, s.12(1), (3).

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examples, the dealer may perfect its security interest in the motor vehicle, for example by

registering a financing statement. The dealer‟s financing statement will identify the motor

vehicle as the collateral and, if the motor vehicle is commercial property, it will also

identify the customer as the grantor. If the dealer subsequently trades, or creates a

security interest in, the chattel paper, the grantor vis-à-vis the chattel paper is the dealer

(not the chattel paper customer) and the collateral is the chattel paper (not the motor

vehicle). Therefore, the chattel paper transferee or secured party must take separate steps

to perfect its security interest in the chattel paper either by taking possession of the

chattel paper or registering a financing statement which identifies the chattel paper holder

as the grantor and the chattel paper as the collateral. Likewise, in the second of the above

two examples, perfection of the bank‟s security interest in the motor vehicle is a separate

matter from perfection of any security interest in the chattel paper which the bank may

give to a third party.

In the PPSA taxonomy, chattel paper is also distinguishable from an account. The statute

defines “account” to mean a monetary obligation (whether or not earned by performance)

that arises from: (a) disposing of property; or (b) granting rights or providing services in

the ordinary course of business.4 Examples include accounts receivable (or book debts)

and credit card receivables. According to the statutory definition, an account is the

monetary obligation itself. By contrast, the statute defines chattel paper to mean the

writing that evidences the chattel paper holder‟s entitlement. In other words, chattel paper

is tangible personal property, whereas an account is an intangible. In this respect, chattel

paper is analogous to a negotiable instrument or a bill of lading: a bill of lading is a

document of title to the goods it covers; a negotiable instrument is like a document of title

to the underlying monetary obligation owed by the person liable on the instrument; and

chattel paper is like a document of title to the underlying secured obligation. It is for this

reason that the statute groups chattel paper, documents of title and negotiable instruments

together under the heading, “financial property”.

4 PPSA, s.10.

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An account obligee may trade the account to a third party or use the account as security

for a loan. The PPSA applies to both outright transfers of accounts and security interests

in accounts.5 The transfer of an account entitles the transferee to the amount owing on the

account and, correspondingly, a security interest in an account entitles the secured party

to the amount owing on the account if the account obligee defaults on its loan obligation

to the secured party. A transferee of chattel paper acquires similar rights, as does a party

with a security interest in chattel paper. The difference is that chattel paper evidences a

secured obligation so that the transferee or secured party also acquires a security interest

in the personal property to which the chattel paper relates; but an account is an unsecured

obligation and so the account transferee or secured party acquires only the right to

payment from the account obligor.

The PPSA enacts special rules for accounts and chattel paper (this is the reason for

separating them out from other types of personal property) and, for the most part, the

rules for accounts are the same as the rules for chattel paper. So, for example: section

12(3) extends the application of the statute to an outright transfer of accounts and also an

outright transfer of chattel paper; section 80 deals with the rights of an account debtor

following the transfer of an account or chattel paper; section 81 deals with the effect of an

anti-assignment clause on the transfer of an account or chattel paper; section 120 governs

the rights of a secured party holding a security interest in an account or chattel paper to

enforce its security interest by collecting directly from the account debtor or chattel paper

customer; and section 268 shields an outright transfer of an account or chattel paper from

the operation of section 267 dealing with the status of an unperfected security interest in

insolvency proceedings. On the other hand, PPSA, section 71 enacts special priority rules

for chattel paper alone. Section 71 came to Australia from Article 9 of the United States

Uniform Commercial Code, via the Canadian Personal Property Security Acts.6 The

purpose of the provision, in its Article 9 manifestation, was to facilitate chattel paper

financing which, in the United States and Canada, is the primary method for financing the

purchase of motor vehicles and other large-ticket consumer durables. In Australia, chattel

5 PPSA, s.12(1), (3).

6 Uniform Commercial Code – Secured Transactions, s.9-330; Personal Property Security Act 1993, SS

1993, c.P-62, s.31(7). See also Personal Property Securities Act 1999 (NZ), s.98.

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paper financing has not been used, at least on a large scale, to finance consumer

purchases and alternative financing techniques have been employed instead. It follows

that there may not be the same justification in Australia as there is in the United States

and Canada for special priority rules favouring the chattel paper financier. This point

appears to have been overlooked in the drafting of PPSA, section 71. PPSA, sections 37-

38 and 76, which deal with security interests in returned and repossessed goods, pay

special attention to the rights of the chattel paper financier but the drafting appears to

overlook the point that chattel paper financing is not the predominant method for

financing consumer purchases in Australia. This paper explores the implications of the

oversight and suggests how it might be corrected.

The structure of the paper is as follows. Part 2 provides an account of various methods

that might be used to finance larger-ticket consumer purchases, with particular reference

to the techniques that are most commonly employed in Australia. Part 3 explains and

critically analyzes PPSA, section 71 with particular reference to the differences between

United States and Australian financing practices. Part 4 discusses PPSA, sections 37-38

and 76, arguing that, while the provisions protect the chattel paper financier, they

overlook the need for equivalent provisions to protect financiers other than chattel paper

financiers. Part 5 is the conclusion.

2. Consumer sales financing techniques

(a) Introduction

A consumer who is planning to buy a car or some other large ticket item may need

finance to assist with the purchase. The consumer may have her own sources of finance,

such as her bank or credit union, but in many cases she will depend on the dealer to

provide the finance. The dealer will want to oblige because otherwise it may lose the sale.

On the other hand, many dealers depend on immediate payment and lack the resources to

provide finance themselves. The solution is to enlist the co-operation of a financial

institution to take over the finance aspect of the transaction. There are various ways an

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arrangement of this kind might be structured, but the three most common approaches are

as follows.7

(b) The hire-purchase method

The first technique is most commonly associated with hire-purchase and lease

agreements. Once the consumer has decided on the goods she wants, the dealer sells the

goods to the financial institution in return for an immediate payment representing the

cash price less any deposit the consumer may already have paid the dealer. The financial

institution then contracts to supply the goods to the consumer on hire-purchase terms or

on lease. The method can be represented diagrammatically as follows:

Financier Dealer

Consumer

The key feature of this type of arrangement is that the consumer‟s contract is with the

financial institution, not the dealer. On the other hand, the consumer‟s dealings are all

typically with the dealer; the dealer has a stock of the financial institution‟s application

forms; the consumer completes her application in the dealer‟s office; the dealer forwards

the application to the financial institution; and the consumer takes delivery of the goods

directly from the dealer. The consumer makes her payments to the financial institution

but, assuming she does not default, she may have no other direct contact with the

financial institution during the life of the agreement.

In PPSA terms, the contract between the financial institution and the consumer is chattel

paper, but the chattel paper is not traded and so the PPSA provisions governing chattel

7 See Anthony Duggan and Elizabeth Lanyon, Consumer Credit Law (Butterworths Sydney, 1999), paras

[1.3.8]-[1.3.11].

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paper are not attracted. The contract between the financial institution and the consumer is

a transaction which in substance secures payment or performance of an obligation and so

the PPSA applies, but the collateral is the goods themselves, not the chattel paper. Of

course, the financial institution might assign its contract, perhaps as part of a

securitization program or block discounting arrangement. This would involve a transfer

of chattel paper and so there would be two contracts to which the PPSA applied: (1) the

contract between the financial institution and the consumer where the financial institution

is the secured party, the consumer is the debtor and the collateral is the goods

themselves; and (2) the contract between the financial institution and the assignee, where,

at least for the purposes of the PPSA, the assignee is the secured party; the financial

institution is the debtor and the collateral is chattel paper. However, assignment of the

chattel paper is not an integral part of the so-called hire-purchase method and in many,

perhaps most, cases the financial institution will not assign the chattel paper.

(c) The tied loan method

A second alternative is for the dealer to arrange a loan for the consumer from the

financial institution. The dealer then sells the goods to the consumer; the financial

institution pays the loan proceeds to the dealer; and the consumer gives the financial

institution a security interest in the goods to secure repayment of the loan. The contract

between the financial institution and the consumer would once have been subject to the

money lending laws and the bills of sale legislation and so the tied loan method used to

be unpopular with financial institutions. But these laws have now been repealed and the

consumer credit laws which have replaced them do not present the same obstacles to the

tied loan method of transacting. As a result, the method is now widely used. It can be

represented diagrammatically as follows.

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Financier Dealer

Consumer

In contrast to the hire-purchase method, the dealer, not the financial institution, supplies

the goods to the consumer and there is no contract between the dealer and the financial

institution. The financial institution lends the money but, in common with the hire-

purchase method, the consumer will usually fill out the financial institution‟s loan

application form in the dealer‟s office and the dealer will forward the application to the

financial institution for approval.

The loan contract and the security agreement between the financial institution and the

consumer are together chattel paper within the meaning of the PPSA, but the chattel

paper is not itself the subject of any transaction and so the PPSA provisions governing

chattel paper do not apply. The PPSA does apply to the security agreement between the

financial institution and the consumer, but the collateral is the goods themselves, not

chattel paper.8

(d) The assignment method

The third approach is for the dealer to supply the goods to the consumer on hire-purchase,

lease or conditional sale terms and then to assign the contract to the financial institution

in return for a cash payment. The result is that the financier steps into the dealer‟s shoes,

taking over the dealer‟s right to the payments and also the right to repossess the goods if

the consumer defaults. The contract between the dealer and the consumer is chattel paper.

The assignment may be on either a notification or a non-notification basis. In the first

case, the dealer will typically deliver the chattel paper to the financial institution which,

8 The financial institution might assign the loan and security agreement, perhaps as part of a securitization

program, but the implications are the same as in the context of the hire-purchase method.

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in turn, will notify the customer of the assignment and take over the payment collections.

In the United States, this is known as the “direct collection method” and it is widely used

for automobile financing.9 In the second case, the financial institution will leave the

chattel paper in the dealer‟s hands and the dealer will continue collecting payments from

the customer and remit them to the financial institution. In the United States, this is

known as the “indirect collection method” and it is more commonly associated with sales

of household appliances and furniture.10

The assignment method can be represented

diagrammatically as follows:

Financier Dealer

Consumer

The contract between the dealer and the consumer is a security agreement to which the

PPSA applies: the dealer is the secured party, the consumer is the debtor and the

collateral is the goods the dealer supplies. The PPSA applies to the transfer of chattel

paper whether or not the transaction in substance secures payment or performance of an

obligation.11

Therefore the PPSA also applies to the contract between the dealer and the

financial institution: for the purposes of the statute, the dealer is the grantor, the financial

institution is the secured party and the collateral is the chattel paper.

(e) Conclusion

In the United States and Canada, the assignment method is widespread, but it is much

less common in Australia, where the hire-purchase and tied loan methods are used

instead. Following the North American lead, PPSA, section 71 enacts special priority

9 Grant Gilmore, Security Interests in Personal Property (Little, Brown & Co., Boston, 1965), Vol.II,

s.25.5. 10

Ibid. 11

PPSA, s.12(3).

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rules governing competing claims to chattel paper. The provision is relevant mainly to the

assignment method of transacting and the purpose is to facilitate chattel paper financing.

Given that the assignment method is not widespread in Australia, this policy

consideration is less pressing. Furthermore, PPSA, section 71 is less important, in

practical terms, than the corresponding provisions in the United States and Canada.

These points are developed in Part 3, below.

3. The chattel paper priority rules12

(a) Introduction

The Article 9 provision from which PPSA, section 71 derives was drafted with the direct

collection version of the assignment method specifically in mind: it applies only if the

assignee is a dedicated chattel paper financier; the assignee must take possession of the

chattel paper, giving new value in return; and the transaction must be in the ordinary

course of its business.13

In recognition of industry practice, the provision expressly

acknowledges that, by taking possession of the chattel paper, the direct collection chattel

paper financier perfects its security interest and it gives the chattel paper financier

priority over an earlier perfected security interest in the chattel paper. The policy is to

facilitate chattel paper financing for consumer sales. If the chattel paper financier could

not be sure of obtaining priority in the cases the provision addresses, it might be less

willing to buy the chattel paper in the first place.14

The effect of the chattel paper priority

rules is to give chattel paper negotiable, or at least quasi-negotiable, status and to

approximate the chattel paper purchaser to the holder in due course of a negotiable

instrument.

In common with its North American antecedents, PPSA, section 71 applies to security

and non-security transfers of chattel paper, but only if the transferee is in the business of

12

The following is adapted from Anthony Duggan and David Brown, Australian Personal Property

Securities Law (Lexis Nexis Sydney, 2012), paras 10.72-10.80. 13

Uniform Commercial Code – Secured Transactions, s.9-330. 14

Gilmore, loc.cit.

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chattel paper financing, the transaction is in the ordinary course of its business and it

gives new value in exchange for the transfer. The provision enacts two priority rules, in

paragraphs 71(2)(a) and (b), respectively. The first rule provides that the transferee‟s

interest in the chattel paper has priority over any perfected security interest in the chattel

paper if the transferee took possession of the chattel paper15

without actual or

constructive knowledge of the security interest.16

The second rule gives the transferee

priority over any security interest that has attached to the chattel paper as proceeds of

inventory. In contrast to the other PPSAs, and Article 9, the second rule applies whether

or not the transferee takes possession of the chattel paper. In other words, the transferee

obtains priority even if it has not perfected its security interest. It is unclear what

motivated this feature of the Australian version or for that matter, whether it was intended

at all.

(b) PPSA, section 71, Rule 1

Example 1, below illustrates one application of the rule in PPSA, paragraph 71(2)(a).

Example 1. Dealer sells motor vehicles. On Date 1, Dealer sells a car to Consumer on

conditional sale terms and transfers the chattel paper to Financier 1 who does not take

possession of the chattel paper, but registers a financing statement. On Date 2, Dealer

transfers the chattel paper again, this time to Financier 2, a commercial purchaser of

chattel paper, who gives new value and takes possession of the chattel paper without

knowledge of Financier 1‟s claim.

15

PPSA, sub-s.24(5) enacts a special definition of “possession” which applies where chattel paper is in

electronic form: for discussion, see Duggan and Brown, op.cit. at paras 5.16-5.18.

16

The corresponding provision in the other PPSAs turns on the transferee‟s actual knowledge and

constructive notice is irrelevant: see, e.g., Saskatchewan PPSA, ss 30(7) (purchaser of chattel paper) and

1(3) (meaning of “knowledge”); New Zealand PPSA, ss 98 and 19.

Australian PPSA, s.297 provides that “a person (the first person) has constructive knowledge of a

circumstance if the first person would have had actual knowledge of the circumstance if the person had:

(a) made the inquiries that would ordinarily have been made by an honest and prudent person in the first

person‟s situation; or

(b) made the inquiries that would be made by an honest and prudent person with the first person‟s actual

knowledge in the first person‟s situation.”

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In this case, Financier 1 and Financier 2 both hold deemed security interests in the chattel

paper and they are subject to the PPSA on that basis. Financier 2 acquired the chattel

paper for new value, by means of a consensual transaction with Dealer. The transaction is

in the ordinary course of Financier 2‟s business. Financier 2 took possession of the

chattel paper. The result is that Financier 2 prevails over Financier 1, provided Financier

2 had no actual or constructive knowledge of Financier 1‟s deemed security interest.

Financier 1‟s registration is not sufficient to put Financier 2 on notice of Financier 1‟s

security interest.17

Financier 1 could have avoided this outcome either by taking

possession of the chattel paper itself or by marking the chattel paper so that third parties,

including Financier 2, were aware of Financier 1‟s claim. Note that the application of

paragraph 71(2)(a) depends on Financier 2‟s taking possession of the chattel paper. If

Financier 2 had instead left the chattel paper in Dealer‟s hands and perfected its security

interest by registration, the provision would not apply and the case would be governed

instead by the default priority rules in PPSA, section 55. On that basis, Financier 1 would

have priority over Financier 2 because Financier 1 was the first to register.

Example 2, below, illustrates a second application of the rule in paragraph 71(2)(a).

Example 2. Dealer sells motor vehicles. SP holds a security interest in all Dealer‟s

present and after-acquired personal property, perfected by registration. Dealer sells a

car to Consumer on conditional sale terms and subsequently transfers and delivers the

chattel paper to Financier, a commercial purchaser of chattel paper. Dealer defaults

on its obligations to SP. SP and Financier both claim the chattel paper.

In this case, Financier acquired the chattel paper, presumably for new value, under a

consensual transaction with Dealer. The transaction is in the ordinary course of

Financier‟s business. Financier took possession of the chattel paper. The result is that

Financier‟s claim prevails over SP‟s security interest provided Financier had no actual or

constructive knowledge of the security interest. However, the proviso is significant

17

PPSA, s.300.

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because, while Financier may not have actual knowledge of SP‟s security interest, it

should realise that there may be a general lender in the picture and this may be enough to

fix Financier with constructive knowledge of SP‟s security interest.18

The implication is

that, in a case like Example 2, Financier may lose if paragraph 71(2)(a) applies. Financier

may argue that the rule in paragraph 71(2)(b) applies instead and this possibility is

discussed further below.

(c) PPSA, s.71, Rule 2

Example 3, below illustrates the application of the rule in paragraph 71(2)(b).

Example 3. Dealer sells motor vehicles. SP holds a security interest in Dealer‟s

inventory, perfected by registration. Dealer sells a car to Consumer, in the ordinary

course of business, on conditional sale terms and subsequently transfers the chattel

paper to Financier, a commercial chattel paper financier. Dealer defaults on its

obligations to SP. SP claims the chattel paper as proceeds of inventory. Financier also

claims the chattel paper, relying on its agreement with Dealer.

In this case, Financier acquired the chattel paper, presumably for new value, by means of

a consensual transaction with Dealer and the transaction is in the ordinary course of

Financier‟s business. The result is that Financier‟s claim prevails over SP‟s security

interest under paragraph 71(2)(b). It makes no difference whether Financier took

possession of the chattel paper or whether Financier had actual or constructive knowledge

of SP‟s security interest. In this context, the chattel paper is even more freely negotiable

than a negotiable instrument where the status of a holder in due course turns on both

delivery of the instrument and the holder‟s ignorance of the competing claim.19

The

18

This argument is open under the Australian PPSA, because sub-s.71(2) refers to the chattel paper

purchaser‟s “actual or constructive knowledge”. The other PPSAs are differently worded and so the

argument is not open there: see note 16, above. 19

Gilmore expresses the point with typical colour as follows: “no amount of actual knowledge will serve to

defeat the purchaser. It seems indeed that he would prevail even though he knew that his transferor was

under a duty (by virtue of terms in the inventory security agreement) to turn the „specific‟ chattel paper

over to the inventory secured party. Almost everywhere in the law „good faith‟ goes with „purchaser‟ as

ham goes with eggs and the meaning of „good faith‟ is lack of notice‟. The [chattel paper] „purchase‟ goes

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policy underlying the Article 9 version of PPSA, paragraph 71(2)(b) is to further facilitate

the chattel paper financing of consumer sales by giving the dedicated chattel paper

financier priority over the dedicated inventory financier. The provision is based on the

Article 9 drafters‟ assumption that the commercial benefits of facilitating chattel paper

financing in this way exceed the costs to inventory financiers. But the rule means that an

inventory financier wanting to protect its proceeds security interest in chattel paper must

monitor inventory sales and ensure that the grantor physically hands over all resulting

chattel paper.20

Under the Australian version of the rule, the inventory financier is even

more vulnerable because paragraph 71(2)(b) gives the chattel paper transferee priority

whether or not it takes possession of the chattel paper. This means that the inventory

financier is unprotected even if it does take possession of the chattel paper itself.

(d) The uncertain scope of Rule 2

There is a division of opinion over whether, in a case like Example 2, above paragraph

71(2)(a) or (b) applies. The issue turns on what paragraph (b) means when it refers to a

„security interest that has attached to proceeds of inventory‟ (or, as the Article 9 version

puts it, „a security interest which is claimed merely as proceeds of inventory‟). According

to one school of thought, SP‟s security interest in Example 2 is an „all assets‟ one, and so

it attaches to the chattel paper as original collateral, not proceeds. Therefore, paragraph

71(2)(a) applies and, to succeed, Financier must show that it took possession of the

chattel paper and that it had no knowledge of SP‟s security interest in the relevant

sense.21

According to the other school of thought, paragraph (b) applies: „if, in fact, the

forth stripped of the customary epithet and it is the evident meaning of the second sentence [of the Article 9

chattel paper priorities provision] that snapping up chattel paper claimed merely as proceeds is looked on as

an entirely legitimate transaction”: op.cit. , Vol.II, s.25.7. 20

Of course, the grantor may be unhappy about handing over the chattel paper to the inventory financier

because this will inhibit its capacity to discount the chattel paper. The result is that, at least in some cases,

the grantor may be forced to decide whether its access to inventory financing is more or less important than

its access to chattel paper financing. 21

This is the position of the Permanent Editorial Board for the Uniform Commercial Code. See

Commentary No. 8:

the Board believes that [in an Example 2-type case] [SP] has more than a mere proceeds interest in the

chattel paper on hand whether or not at any specific time there is sufficient inventory on hand to secure

the amount of the loan outstanding at that time. The structure of the deal is such that the chattel paper

is part of the primary collateral for the debt. That interest extends to any chattel paper subsequently

15

chattel paper is proceeds of inventory, [paragraph (b) applies] even though the chattel

paper may be viewed as original collateral under the wording of the security agreement

and the understanding of the parties‟.22

On this reading, paragraph (b) applies in both

Examples 2 and 3, while paragraph (a) is limited to cases like Example 1. If the first

school of thought is correct, an inventory financier can avoid the application of

paragraph (b) by ensuring that the collateral clause in its security agreement includes not

only inventory, but also chattel paper as original collateral. Furthermore, on this reading,

section 71 turns out to give only limited protection to the chattel paper financier against

the general lender with an all assets security interest. The main argument against this

approach is that “it would result in easy circumvention of the policy that the priority

provisions of [PPSA, section 71] embody”.23

(e) Assessment

The policy considerations which motivated the Article 9 drafters do not apply in

Australia, at least with the same force because, in Australia, in contrast to the United

States and Canada, chattel paper financing is not the primary method for financing

consumer sales. As explained in Part 2, above, in Australia financiers rely predominantly

on the hire-purchase method and the tied loan method, not the assignment method. Given

the prevalence of these other methods, there is no particular need to encourage chattel

paper financing. In any event, in cases like Examples 2 and 3 above, SP may have

expressly or impliedly authorized the transfer of the chattel paper; in that case, SP‟s

security interest does not attach to the chattel paper and so PPSA, section 71 does not

apply anyway.24

Even if SP has not authorized the transfer, Financier may still take the

chattel paper free of SP‟s security interest under the buyer in ordinary course provision in

generated by a sale of inventory whether or not at any particular time the existing inventory is adequate

security for the debt actually outstanding.

The Commentary goes on to indicate that the US case law supports this position. 22

Ronald CC Cuming, Catherine Walsh and Roderick J. Wood, Personal Property Security Law (Irwin

Law Toronto, 2005) at p.393. 23

Ibid. 24

See PPSA, sub-s.32(1).

16

PPSA, sub-section 46(1).25

It follows that PPSA, section 71 could safely be repealed.26

On the other hand, if the provision is to remain on the books, paragraph (2)(b) should be

amended to clarify what is meant by “proceeds”. The provision should also be amended

so that, as in the other PPSA jurisdictions and under Article 9, it only applies if the

chattel paper transferee takes possession of the chattel paper.

The main justification for recognizing chattel paper as a discrete category of personal

property is that PPSA, section 71 enacts special priority rules covering security interests

in chattel paper. It follows that if section 71 were repealed, it would be possible to write

chattel paper out of the statute altogether. This would not preclude a secured party from

transferring or giving a security interest in its rights under the security agreement,

whether as part of a securitization program or otherwise. But whereas, as presently

drafted, the statute presupposes a dealing in the paper itself, without a chattel paper

concept the dealing would be in: (1) the account represented by the payment obligation;

and (2) the security interest that secures the payment obligation. These are both items of

intangible property within the meaning of the statute and the statute would apply to the

transaction on that basis. The first item is an account within the meaning of the statute,

accounts being a sub-category of intangible personal property.27

Provisions in the statute

relating specifically to accounts, for example, sections 12(3), 80, 81 and 120, would

apply to the transaction on that basis. On the other hand, if section 71 is repealed it would

probably do no harm to leave the chattel paper concept in place, despite its redundancy,

and, if stakeholders have got use to the concept, writing it out of the statute altogether

might cause confusion. In summary, the options are to repeal section 71 and leave things

at that, or to go further and write chattel paper out of the statute altogether.

25

PPSA, sub-s.46(1) is not limited to cases involving goods, but applies to all types of personal property

(including chattel paper). 26

The implications for Example 1, above if s.71 is repealed are that the default priority rules in s.55 would

apply and so SP1 would have priority. However, SP2 can protect itself by conducting a register search

before transacting with Dealer. If s.71 is repealed, sub-s.24(5) (possession of chattel paper that is evidenced

electronically) should also be repealed. If sub-s.24(5) is repealed, it would no longer be possible to perfect

a security interest in electronic chattel paper by possession and perfection by registration would be the only

option. But the ability to perfect by possession only matters in the context of s.71 so that if s.71 is repealed,

sub-s.24(5) becomes redundant. 27

See Duggan and Brown, op.cit. paras. 2.27-2.31.

17

4. Returned and repossessed goods

(a) Introduction

PPSA, sections 37-38 and 76 apply where a buyer or lessee takes good free of a security

interest under a PPSA, Part 2.5 provision and the goods are subsequently returned.

Example 7. Grantor is a car dealer. SP holds a security interest in Grantor‟s

inventory, perfected by registration. Grantor sells a car to Buyer in the ordinary

course of business. The car turns out to be defective, Buyer returns it and the contract

of sale is rescinded.

Buyer takes the car free of SP‟s security interest under PPSA, sub-section 32(1) because

SP expressly or impliedly authorised the sale or, alternatively, under PPSA, sub-section

46(1) because the sale was in the ordinary course of Grantor‟s business and Buyer was

unaware that SP had not authorized the sale. PPSA, sub-section 37(1) provides for

reattachment of SP‟s security interest when Buyer returns the car. Sub-section 37(2)

provides that SP‟s reattached security interest remains continuously perfected provided

that: (1) it was perfected by registration at the time of “the acquisition” (in other words,

the sale or lease); and (2) the registration was effective when the goods were returned

(“the repossession time”). Buyer may have given a security interest in the car to another

secured party (SP*) before rescinding the contract of sale. In that case, sub-section 76(3)

provides that SP* has priority over SP‟s sub-section 37(1) security interest provided that:

(1) SP*‟s security interest attached while the car was in Buyer‟s possession; and (2)

SP*‟s security interest was perfected at the repossession time.

Example 8. Grantor is a car dealer. SP holds a perfected security interest in

Grantor‟s inventory, perfected by registration. Grantor sells a car to Buyer, in the

ordinary course of business, on conditional sale terms. Buyer defaults on his

repayments to Grantor and Grantor repossesses the car.

18

This is a second case where sub-section 37(1) applies. SP‟s security interest is

extinguished when Grantor sells the car to Buyer, but it reattaches when Grantor

repossesses the car. Sub-section 76(3) also applies and so SP‟s sub-section 37(1) security

interest is subordinate to any perfected security interest given by Buyer before the

repossession time.

Example 9. Grantor is a car dealer. SP holds a security interest in Grantor‟s

inventory, perfected by registration. Grantor sells a car to Buyer on conditional sale

terms and transfers the resulting chattel paper to Transferee. The car turns out to be

defective. Buyer returns the car to Grantor and rescinds the contract of sale.

This is a tri-partite version of Example 7. As in Example 7, sub-section 37(1) applies and

SP‟s security interest reattaches to the car when Buyer returns it to Grantor (the dealer).

Buyer‟s rescission of the contract of sale effectively cancels the chattel paper, leaving

Transferee with nothing. Sub-section 38(1) counteracts this effect by giving Transferee a

deemed security interest in the returned car. Sub-section 76(2) provides that Transferee‟s

sub-section 38(1) security interest has priority over SP‟s sub-section 37(1) security

interest, but only if Transferee has taken possession of the chattel paper in the ordinary

course of business of acquiring chattel paper and for new value.28

Buyer may have given

a security interest in the car to another secured party (SP*) before rescinding the contract

of sale. Sub-section 76(3) gives SP* priority over both SP and Transferee provided that

SP*‟s security interest: (1) attached while the car was in Buyer‟s possession and (2) was

perfected at the repossession time.

Example 10. Grantor is a car dealer. SP holds a security interest in Grantor‟s

inventory perfected by registration. Grantor sells a car to Buyer on conditional sale

terms and transfers the resulting chattel paper to Transferee. Buyer defaults on his

repayment obligations and Transferee seizes the car.

28

Compare PPSA, s.71. SP‟s security agreement may provide that SP‟s security interest extends to any

returned or repossessed goods as original collateral. In that case, SP‟s claim to the returned car does not

depend on PPSA, sub-s.37(1) and so sub-s.76(2) does not apply. Contrast Saskatchewan PPSA, s.29(6): see

Duggan and Brown, op.cit. para.10.91.

19

This is a tripartite version of Example 8. As in Example 8, sub-section 37(1) applies and

SP‟s security interest reattaches when Transferee repossesses the car. Transferee‟s

security interest in the chattel paper would continue in the car as proceeds of the chattel

paper but, in any event, sub-section 38(1) gives Transferee a deemed security interest in

the car. As in Example 6, section 76 governs the priority of Transferee‟s security interest

relative to competing claims.29

As Examples 9 and 10 demonstrate, sections 37, 38 and 76 were drafted with chattel

paper financing specifically in mind. However, chattel paper financing (the “assignment

method”) is not widely used in Australia as a consumer sales financing technique and

both the hire-purchase method and the tied loan method are much more common. The

provisions overlook both methods and the implications of this oversight are discussed

below.

(b) The hire-purchase method

Example 11. Grantor is a car dealer. SP holds a security interest in Grantor‟s

inventory, perfected by registration. Grantor sells a car to Financier, in the ordinary

course of business, to facilitate a hire-purchase agreement between Financier and

Hirer. The car turns out to be defective. Hirer returns the car to Grantor and rescinds

the hire-purchase agreement.

Grantor‟s sale to Financier extinguishes SP‟s security interest either because SP expressly

or impliedly authorized the sale so that PPSA, sub-section 32(1) applies or because

Financier had no knowledge that the sale was unauthorized so that PPSA, sub-section

46(1) applies.30

Sub-section 37(1) is triggered if “the goods come into the possession of

29

SP‟s security agreement may provide that SP‟s security interest extends to any returned or repossessed

goods as original collateral. In that event, SP‟s claim to the returned car does not depend on PPSA, sub-

s.37(1), but PPSA, sub-para.76(2)(b)(ii) covers the case. 30

Note that the application of PPSA, sub-s.46(1) depends on the state of Financier‟s knowledge, not

Hirer‟s. In other words, if Financier does not know that the sale is in breach of Grantor‟s security

agreement with SP, SP‟s security interest is extinguished even if Hirer knew about the breach. The pre-

20

the grantor or debtor” when, “in the case of a sale – the contract of sale is rescinded”. The

provision is drafted on the assumption that Grantor contracts directly with the customer.

But in Example 11, Hirer‟s contract is with Financier and it is not a contract of sale.

Therefore, the return of the goods does not itself trigger sub-section 37(1). On the other

hand, following Hirer‟s rescission of the hire-purchase agreement, Financier is likely, in

turn, to rescind its contract with Grantor and this will trigger sub-section 37(1).

Example 12. Grantor is a car dealer. SP holds a security interest in Grantor‟s

inventory, perfected by registration. Grantor sells a car to Financier, in the ordinary

course of business, to facilitate a hire-purchase agreement between Financier and

Hirer. Hirer defaults on her repayment obligations and Financier repossesses the car.

Sub-section 37(1) is triggered if “the goods come into the possession . . . of a transferee

of chattel paper” when “the transferee seizes the goods in the exercise of a right in

enforcing the security agreement”. Financier is not a transferee of chattel paper and so its

repossession does not trigger sub-section 37(1) and SP does not acquire a deemed

security interest in the car. SP might protect itself by including in its security agreement

with Grantor a provision specifying that its security interest extends to any returned or

repossessed goods. However, the priority rules in PPSA, section 76 apply only to a

security interest arising under sub-section 37(1) and they do not apply to a security

interest in the car that is provided for in the security agreement itself. This means, for

example, that if Hirer gives SP* a security interest in the car before the repossession date,

the court must look outside the statute for a rule to determine the priorities between SP

and SP*. A redrafted version of sub-section 37(1) is set out in the Appendix, below.

Paragraph (b) of this provision would address a case like Example 12.

In Example 11, Financier does not acquire a security interest in the returned goods under

sub-section 38(1) because Financier is not a chattel paper transferee. However, Financier

is likely to have an arrangement requiring Grantor to take the car back and reimburse

PPSA chattel securities laws also struggled with this issue: see Anthony Duggan, Simon Begg and

Elizabeth Lanyon, Regulated Credit: The Credit and Security Aspects (Law Book Company Sydney, 1989),

para. [7.3.21].

21

Financier. The arrangement may include a provision giving Financier a security interest

in the car to secure Grantor‟s obligation to reimburse Financier. Any such security

interest would conflict with SP‟s sub-section 37(1) security interest. Sub-section 76(2)

enacts a priority rule for disputes involving a sub-section 37(1) security interest and a

sub-section 38(1) security interest but in the case under consideration, Financier‟s

security interest does not arise under sub-section 38(1) and so sub-section 76(2) does not

apply. A redrafted version of section 38 is set out in the Appendix, below. Sub-section (1)

of this provision would address a case like Example 11.

Sub-section 38(1) also has no relevance to Example 12. Applying the PPSA‟s substance

over form approach, the contract between Financier and Hirer should be treated as if

Grantor had sold the car to the customer with finance provided by Financier and

Financier had taken a security interest in the car to secure repayment. Financier‟s

repossession would not trigger PPSA, sub-section 37(1), as it is presently drafted,

because Financier is not a transferee of chattel paper. However, under the redrafted

version of sub-section 37(1) proposed in the Appendix, below, SP‟s security interest

would reattach when Financier repossessed the car. There would then be a priority

dispute between SP‟s sub-section 37(1) security interest and Financier‟s claim to the car.

Sub-section 76(3) states that a perfected security interest in goods that is granted by a

buyer has priority over a sub-section 37(1) security interest provided that: the security

interest granted by the buyer attaches while the goods are in the buyer‟s possession; and

(2) the security interest is perfected at the repossession time. Sub-section 76(3) should

apply on the basis that in substance, Financier holds a security interest in the car granted

by the customer.31

31

In a case like Example 11 or 12, Grantor may deliver the car to the customer before or after the hire-

purchase agreement between the customer and Financier is in place. If delivery occurs before the hire-

purchase agreement is in place, sub-s.76(3) will not apply because Financier‟s security interest does not

attach while the goods are in the customer‟s possession. Contrast the corresponding Saskatchewan PPSA,

s.29(7), which applies if the security interest attaches while the goods are in the possession of either the

dealer (grantor) or the customer. The proposed amendments to PPSA, sub-s.76(3), in the Appendix, below,

address this issue.

22

(c) The tied loan method

Example 13. Grantor is a car dealer. SP holds a security interest in Grantor‟s

inventory, perfected by registration. Grantor sells a car to Buyer, in the ordinary

course of business. Financier makes Buyer a loan to finance the purchase and takes a

security interest in the car to secure repayment. The car turns out to be defective.

Buyer returns the car to Grantor and rescinds the contract of sale.

When Grantor sells the car to Buyer, SP‟s security interest is extinguished under PPSA,

sub-section 32(1) or, alternatively, sub-section 46(1). However, sub-section 37(1) is

triggered when Buyer rescinds the contract of sale and SP‟s security interest reattaches to

the car at that point. National Credit Code, section 135 applies in a case like Example 13

and it provides that when Buyer rescinds the contract of sale, she may also terminate the

loan contract and the security agreement.32

It also provides that if the loan contract is

terminated, Financier may recover from Grantor (subject to any agreement between

them) the amount of any loss Financier may have suffered from the termination. The

agreement between Financier and Grantor may give Financier a security interest in the

returned car to secure Grantor‟s obligation to compensate Financier. Any such security

interest would conflict with SP‟s sub-section 37(1) security interest. Sub-section 76(2)

enacts a priority rule for disputes involving a sub-section 37(1) security interest and a

sub-section 38(1) security interest but, in a case like Example 13, Financier‟s security

interest does not arise under sub-section 38(1) and so sub-section 76(2) does not apply.

As indicated earlier, a redrafted version of section 38 is set out in the Appendix, below.

Sub-section (2) of this provision would address the case in hand.

If Buyer‟s loan contract and security agreement with Financier are not terminated, either

because National Credit Code, section 135 does not apply or Buyer elects not to

terminate the loan contract and security agreement, Financier‟s security interest will

continue in the car and it will conflict with SP‟s sub-section 37(1) security interest.

However, PPSA, sub-section 76(3) applies and Financier will have priority provided that

32

National Consumer Credit Protection Act 2009 (Cth) , Schedule 1 (National Credit Code), s.135.

23

its security interest: (1) attached while the car was in Buyer‟s possession; and (2) was

perfected at the repossession time.33

Example 14. Grantor is a car dealer. SP holds a security interest in Grantor‟s

inventory, perfected by registration. Grantor sells a car to Buyer, in the ordinary

course of business. Financier makes Buyer a loan to finance the purchase and takes a

security interest in the car to secure repayment. Buyer defaults on her repayment

obligations and Financier repossesses the car.

Sub-section 37(1) is not triggered when Financier repossesses the car because Financier

is not a chattel paper transferee. In this respect, Example 14 is comparable to Example

12. Paragraph (c) of the redrafted sub-section 37(1), in the Appendix, below, addresses

the case. SP‟s sub-section 37(1) security interest would conflict with Financier‟s

continuing security interest in the car. Again, however, sub-section 76(3) applies with the

result that Financier has priority provided its security interest: (1) attached while the car

was in Buyer‟s possession; and (2) is perfected.34

5. Conclusion

The PPSA provisions governing chattel paper derive from Article 9 and the Canadian

PPSAs. In the North American context, the purpose of the provisions is to facilitate

chattel paper financing, which is an important source of financing for consumer sales.

However, chattel paper financing is not as prevalent in Australia, where other financing

techniques (the “hire-purchase method” and the “tied loan method”) are more commonly

used instead. PPSA, section 71 enacts special priority rules which favour the chattel

paper financier‟s claim to the chattel paper over the competing claims of a general lender

or an inventory financier claiming the chattel paper as proceeds. The concern is that

unless the chattel paper financier can be sure of priority, it might be less willing to

provide the finance and, if finance becomes limited, consumer sales may be affected.

33

The observation in footnote 30 is also relevant here. 34

The observation in footnote 30 is also relevant here.

24

However, given that chattel paper financing is not widespread in Australia, this should be

a less pressing concern for the Australian law-maker. In any event, the chattel paper

financier is adequately protected by other provisions in the statute, in particular, PPSA,

sub-section 32(1) (continuation of security interest in collateral and attachment to

proceeds) and sub-section 46(1) (the buyer in ordinary course provision). There is

therefore a case for repealing PPSA, section 7135

and possibly for writing chattel paper

out of the statute altogether. On the other hand, if the provision is to remain on the books,

it should be amended to remove the ambiguity in paragraph (2)(b).

PPSA, sections 36-38 and 76, which deal with security interests in returned and

repossessed goods, pay special attention to the rights of the chattel paper transferee under

the assignment method of financing consumer sales. On the other hand, the provisions

overlook the position of the hire-purchase financier under the hire-purchase method and

the tied loan financier under the tied loan method. The assignment method, the hire-

purchase method and the tied loan method are simply different approaches to achieving

the same commercial result and so, as far as possible, the law should treat them on the

same footing. The proposed amendments set out in the Appendix below are drafted with

this consideration in mind.

35

And also, consequentially, sub-s.24(5): see note 25, above.

25

APPENDIX

Proposed Amendments

Section 37(1)

(a) If a grantor or debtor sells or leases goods that are subject to a security interest and the

buyer or lessee takes the goods free of the security interest because of the operation of

this Act, the security interest reattaches to the goods at a particular time (the repossession

time) if, at that time, the goods come into the possession of the grantor or debtor in any of

the following circumstances:

(i) in the case of a sale – the contract of sale is rescinded or discharged;

(ii) in the case of a lease – the leases expires or is rescinded; or

(iii) the grantor or debtor repossesses the goods in the exercise of a right in enforcing the

contract of sale or lease.

(b) Where -

(i) a grantor or debtor sells goods that are subject to a security interest;

(ii) the buyer acquires the goods for the purpose of supplying the goods to another person

under a lease, hire-purchase or conditional sale agreement; and

(iii) the buyer takes the goods free of the security interest because of the operation of this

Act –

the security interest reattaches to the goods at a particular time (the repossession time) if,

at that time, the buyer repossesses the goods in the exercise of a right in enforcing the

lease, hire-purchase or conditional sale agreement or, in the case of a lease or hire-

purchase agreement the lessee or hirer returns the goods to the buyer.

(c) If –

(i) a grantor or debtor sells goods that are subject to a security interest (the first security

interest);

(ii) the buyer takes the goods free of the first security interest because of the operation of

this Act; and

(iii) the buyer gives a purchase money security interest in the goods to another secured

party (the second security interest) –

26

the first security interest reattaches to the goods at a particular time (the repossession

time) if, at that time, the secured party holding the second security interest repossesses

the goods in the exercise of a right in enforcing the security interest.

(d) If –

(i) a grantor or debtor sells or leases goods that are subject to a security interest;

(ii) the buyer or lessee takes the goods free of the security interest because of the

operation of this Act; and

(iii) the grantor or debtor transfers the chattel paper created by the sale or lease –

the first security interest reattaches to the goods at a particular time (the repossession

time) if, at that time, the transferee of the chattel paper seizes the goods in the exercise of

a right under the sale or lease.36

Section 38(1)

(a) In this sub-section –

“first party” means a person who acquires goods for the purpose of supplying the goods

to another person under a lease, hire purchase or conditional sale agreement;

“second party” means the person who supplies the goods to the first party.

(b) The first party is taken to have a security interest (the deemed security interest) in the

goods if, at a particular time (the repossession time), the goods come into the possession

of the second party when the contract between the first party and the second party is

rescinded or discharged.

36

The provision could be redrafted without reference to chattel paper as follows:

(d) if –

(i) a grantor or debtor sells or leases goods that are subject to a security interest;

(ii) the buyer or lessee takes the goods free of the security interest because of the operation of this Act; and

(iii) the grantor or debtor transfers its rights under the sale or lease –

the first security interest reattaches to the goods at a particular time (the repossession time) if, at that time,

the transferee seizes the goods in the exercise of its rights under the sale or lease.

27

(c) The deemed security interest secures the second party‟s repayment obligation to the

first party arising from the rescission or discharge.

Section 38(2)

(a) In this sub-section –

“first party” means a secured party holding a purchase-money security interest in goods;

“second party” means the person who gives the purchase money security interest to the

first party;

“third party” means the person who sells the goods to the second party.

(b) The first party is deemed to have a security interest (the deemed security interest) in

the goods if, at a particular time (the repossession time) the goods come into the

possession of the third party in the following circumstances:

(i) the contract between the second party and the third party is rescinded or discharged;

and

(ii) the contract between the first party and the second party is rescinded or discharged.

(c) The deemed security interest secures the third party‟s liability to the first party for loss

or damage suffered by the first party resulting from the rescission or discharge of the

contract between the first party and the second party.

Section 38(3)

(a) In this sub-section-

“first party” means a person who acquires chattel paper or an account;

“second party” means the person who transfers the chattel paper or account to the first

party.

(b) The first party is taken to have a security interest (the deemed security interest) in the

goods to which the chattel paper or account relates if at a particular time (the

repossession time) the goods come into the hands of the second party in the following

circumstances:

(i) in the case of a sale - the contract of sale is rescinded or discharged; or

(ii) in the case of a lease – the lease expires or is rescinded or discharged.37

37

The provision could be redrafted without reference to chattel paper as follows:

28

Section 76

(1) A perfected security interest in goods that has reattached to the property under

subsection 37(1) has priority over a security interest in the goods that is granted by the

operation of subsection 38(3) to a transferee of an account.

(2) A security interest in goods that is granted by the operation of section 38 other than

to a transferee of an account has priority over the following perfected security interests:

(a) a perfected security interest in the goods that is granted by the operation of

section 38 to a transferee of an account;

(b) a perfected security interest in the goods

(i) that has reattached under subsection 37(1); or

(ii) as after-acquired property that attaches when the goods come into the

possession of the grantor or transferee in the circumstances mentioned in

section 37(1)(a)(iii), (b), (c) or (d).

(3) A security interest (the priority interest ) in goods that is granted by a person who

acquires an interest in the property has priority over a security interest in the goods that

reattaches under section 37, or is granted by the operation of section 38, if:

(a) the priority interest attaches while the goods are in the possession of the person or

the grantor; and

(b) immediately before the repossession time (referred to in section 37 and section 38,

the priority interest is perfected.

(a) In this sub-section-

“first party” means a person who acquires the rights of a seller or lessor under a sale or lease;

“second party” means the seller or lessor who transfers the rights to the first party.

(b) The first party is taken to have a security interest (“the deemed security interest”) in the goods to which

the sale or lease relates if at a particular time (the repossession time) the goods come into the hands of the

second party in the following circumstances:

(i) in the case of a sale – the contract of sale is rescinded or discharged; or

(ii) in the case of a lease – the lease expires or is rescinded or discharged.

29