Secured party loses its interest in assets sold in the ordinary course of business

This case¹ was about a secured party who financed the purchase of equipment that was subsequently sold by the debtor. Determination by the High Court that the sale was in the ordinary course of business meant that the secured party's security interest in the equipment was lost.

The debtor granted a security interest over three paving machines purchased with loans from the secured party. The debtor's sole shareholder guaranteed the loans.

The debtor transferred the paving machines to a related company, which had common ownership with the debtor. The paving machines were subsequently sold to third parties.

The proceeds of sale were used to pay creditors other than the secured party. When the debtor defaulted on its loan, the secured party sought to enforce the shareholder's guarantee. The shareholder claimed indemnity from the company's accountant, claiming that he had breached of a duty of care owed to the shareholder by failing to account to the secured party for proceeds of the sale of the paving machines.

The secured party also sought to recover one of the paving machines pursuant to its registered security interest. The purchaser argued that the paving machine was purchased free of the security interest because it was sold by the vendor in its ordinary course of business (in terms of section 53 of the Personal Property Securities Act (the PPSA)).

The High Court considered the following issues:

1. Was the shareholder bound by guarantees?

The shareholder argued that the secured party agreed to the transfer of the security and its acceptance of loan payments from the transferee gave rise to an estoppel which prevented it from relying on the guarantee.

The court found that the requirements for estoppel had not been met because the secured party never conveyed to the shareholder that it was releasing him from his obligations. If it agreed to transfer security from one company in a group to another, this could not have been understood to represent that the shareholder would not be personally liable.

2. Was the shareholder entitled to indemnity from his accountant?

The court found that it would not be fair, just and reasonable to impose a duty of care on the accountant, but even if it had, the shareholder was aware that the proceeds of the sale were not used to repay the loan, so there was no connection between the accountant's actions and the loss suffered by the shareholder.

3. Could the secured party rely on its registered security interest to recover the paving machine?

The purchaser sought to rely on section 53 of the PPSA on the basis that it was unaware that a security interest existed over the machine.

The court found that, while the transferor was the owner of the machine when it was sold, the actions of the debtor during the sale meant that the debtor was deemed to be the seller in accordance with section 2 of the Sale of Goods Act. The High Court's finding that the sale was in the debtor's ordinary course of business within the meaning of section 53 of the PPSA meant that the purchaser took the machine free of the secured party's security interest.

¹ Orix New Zealand Ltd v Milne HC, Auckland, Rodney Hanson J, 17 May 2007, CIV-2005-404-4394

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