Most owners of Australian businesses should be aware of the introduction of a significant piece of legislation earlier this year: the Personal Property Securities Act 2009 (Cth), now more commonly referred to as PPS. For those not in the know, and even those that are somewhat up to speed, PPS has been referred to as one of the more fundamental changes to commercial law to occur in recent times, seeking to address the minefield created by 70-plus Federal, State and Territory Acts (now superseded) previously dealing with the issue of security interests in property.
A quick summary of PPS: the Act covers the granting, enforcement and registration of security interests in personal property (excluding real estate). Such collateral includes both tangible (motor vehicles, plant & equipment, stock/inventory, financial interests, etc.) and intangible (intelectual property, contractual rights, etc.). A security interest is created when a transaction between two parties occurs that gives rise to one of the parties (the secured party) passing possession to the second party (the grantor) and in return retains an interest in the underlying collateral to secure future payment. An example of a transaction creating a security interest is a motor vehicle lease, whereby the “owner” of the vehicle (who has possession of the vehicle) grants a security interest to the leasing company (the secured party) as security for future payments.
Unfortunately, the implementation of PPS has been rather haphazard in practice, and countless businesses are either blissfully unaware of their rights and obligations under the Act, or have put ineffective processes in place to deal with them. Many are subsequently ignorant of the risks to the business of this failure to comply with PPS.
I won’t deal with the day-to-day risks of non-compliance at any level of detail in this M&A-themed overview, but suffice to say it will be dealt with in another post shortly. What I do want to convey, however, is how PPS impacts M&A transactions and more specifically, what business owners (and buyers) need to be aware of under this new regime.
Basic issues of statutory compliance
We live in a highly regulated business environment, with an ever-evolving legislative regime constantly placing businesses in a state of compliance flux. Privacy, Awards, EEO, OH&S, Industrial Relations, Taxation – the scope of legislation affecting business on a day-to-day basis is staggering (albeit necessary for the most part), and it’s not as though we are given a choice about compliance.
When considering a sale or other form of business exit, buyer/investor due diligence includes a thorough assessment of the degree to which the target company complies with its legal/statutory obligations. If it does not comply, the offer on the table can be significantly renegotiated or withdrawn completely. It stands to reason, then, that a business’ owner should do what it takes to ensure compliance with such a major piece of legislation as PPS.
Proof of ownership
Here’s a basic rule of selling a business or any of its assets: if you can’t prove you own it, you can’t sell it.
When you consider the myriad assets often included in an enterprise sale – tangible assets such as debtors, plant & equipment, fixtures & fittings, motor vehicles, furnishings, information and communication systems; and intangible assets such as trademarks, designs, patents and copyright – the need for proof of ownership is evident. Complications may arise if the vendor has claimed ownership of certain key assets, not realising that a third party (secured party) has registered a security interest over the same asset(s) on the Personal Property Securities Register (PPSR). A proof of ownership dispute may then arise.
Due diligence implications
Pre-PPS, the process for registering a security interest was more complex due to the volume of legislation, and the transition of migrated data to the PPSR has not been without its problems. The complication arises for M&A transactions whereby a security interest is registered over all or some of the company’s assets by third parties, which need to be extinguished before the company can complete a sale transaction. This is not an issue you want to be facing as a vendor (or a purchaser) at the pointy end of due diligence or pre-completion.
With the introduction of PPS and the overhaul of the security interest regime comes a requirement for contracts of sale to also change to accommodate new provisions. Such changes relate to warranties such as deemed disclosure and free of encumbrance, as well as the requirement for share certificates to be physically taken “free of security interest” in the event of a sale of shares. For buyers and sellers, the most critical requirement is to ensure that your legal advisor(s) have a detailed knowledge of the PPS Act so that such provisions are catered for correctly.
The key message I want to get across in this post is that you should take steps to get it right early on and avoid the potentially problematic consequences. Talk to your legal advisor about your business’ potential exposures from a compliance perspective, undertake a search of the PPSR to see the scope of the security interests registered against your company (or better yet, engage a specialist to do this for you) and ensure that you are up to speed on PPS well before you make the decision to put the business on the market. Leaving it too late could compromise the probability and value of a successful transaction.