Security holder loses priority

Murray Tingey, Partner | August 2005

A recent High Court case has cast doubt on the rights of a second ranking secured holder in an insolvency scenario.

Recently the High Court determined that where a receiver sells assets of a borrower, the sale automatically releases any security interest in those assets held by subordinate security holders. Effectively, this means that a second ranking security agreement may, in some circumstances, have little value.

This case does not apply to registered mortgages over land, only debenture securities.

The facts

The debtor company had granted a GSA in favour of a bank and a supplier. Those rights were subject to a deed of subordination and priority which provided that the bank would have priority up to $2.5 million. The bank enforced its security interest by appointing a receiver. The receiver sold the assets of the company for a sum substantially in excess of the bank's priority amount.

The issue for determination by the Court was whether the balance of sale funds realised by the receiver was held for the benefit of the second security holder or held for all creditors.

The Court considered the provisions of section 30A of the Receivership Act 1993. This section was added after the Personal Property Securities Act had been passed. The Court favoured a literal interpretation of the provision and held that the sale extinguished the supplier's security. This meant that the supplier was relegated to the position of an unsecured creditor in respect of the proceeds of assets sold by the receiver.

This anomaly is being rectified by amendments to the Receiverships Act made in the Statutes Amendment Bill (No.5) 2005. The Bill has received its first reading but the date upon which it will become effective is unknown.

This decision highlights that, until the amending legislation is passed, holders of second ranking security interest cannot rely on their security if a receiver sells the debtor's assets first.

What should you do?

Until the new legislation is passed, be very closely involved with any receivership process if you hold a second (or subsequent) ranking security interest over the assets subject to the receivership. Bell Gully can advise how to protect your position in such a situation.

The decision is subject to further submissions and may be the subject of appeal. We consider that there are good grounds for it to be reversed and will keep you updated on developments.