Why registering a security is important?

A husband and wife meet with their accountant and purchase a shelf company. They become equal company directors and shareholders. Their bank provides the directors with an overdraft for the company’s working capital; the directors lease some premises, and open the doors for trade.

When providing the overdraft, the bank takes security by registering an ALLPAAP over the company, personal guarantees, and a mortgage over the director’s home.

The company operates a manufacturing business. It buys material from various suppliers, manufactures a product and then on-sells this product to a national retailer. The company does not register a PMSI for the products it sells to the national retailer.

At any one time the company is owned significant monies in the form of trade debtors.

Over time the company traded at a loss. As a result the company used its entire overdraft, creditors are unpaid, and the directors advance personal funds to the company as working capital. They do not register an ALLPAAP to secure the monies they have advanced to the company.

Insolvency events

Unfortunately, the national retailer goes into liquidation. The liquidator assesses the national retailer’s position, including substantial amount of on-hand stock from the manufacturing company. The liquidator searches the PPSR and finds there is no PMSI registration over the stock supplied to the national retailer, and therefore rejects the manufacturing company’s claim for the return of the stock. The liquidator then deals with the stock in the national retailer’s winding up.

While the manufacturing company has a claim in the winding up for their debt owed by the national retailer, that claim is an unsecured claim.

As the manufacturing company cannot secure its goods from the national retailer in liquidation (due to it not having registered a PMSI) and the directors cannot advance further funds, the manufacturing company’s working capital runs out. Consequently, the directors are forced to appoint liquidators to the manufacturing company.

What happens next to the manufacturing company depends on its net asset position.

Scenario One: No funds available.

There are no assets of the manufacturing company for the liquidator to realise. To recover the overdraft debt, the bank exercises its personal guarantee against the directors, and enforces its mortgage over the family home. The directors lose their home in the sale, and the personal funds they advanced to the manufacturing company.

Scenario Two: Funds available.

Conversely, if there were sufficient assets of the manufacturing company for the liquidator to realise, and paid out the bank’s overdraft (meaning the bank do not need to sell the directors’ home), the surplus in funds would then pay a dividend to the unsecured creditors. Because the directors did not register an ALLPAAP for the funds they advanced to the company, their debt ranks alongside the other unsecured creditors.

If however, they had registered an ALLPAAP to secure the funds they advanced to the company then they would have ranked above unsecured creditors after the bank was paid out.


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