Vol 8 (2011) - Issue 2

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Contractual and Turnover Subordination in New Zealand and Australia and the Impact of Personal Property Securities Legislation

Introduction

Debt subordination may take a number of different forms. The two most common are contractual subordination and turnover subordination. This article considers some of the issues in relation to each type of subordination, including those arising out of the New Zealand Personal Property Securities Act 1999 ('New Zealand PPSA') and the Australian Personal Property Securities Act 2009 (C’th) ('Australian PPSA') (together the New Zealand PPSA and the Australian PPSA are referred to as 'the Acts').

The New Zealand PPSA took effect in 2002. The Australian PPSA is expected to take effect in May 2011. The Acts adopt a unitary concept of security and establish a set of priority rules that depend primarily on time of registration. The Acts govern the priority between security interests but also have other consequences. Each Act deals somewhat differently with debt subordination and, in particular, the consequence if a subordination arrangement falls within the definition of a security interest. This article considers some of those issues. Contractual subordination


Contractual subordination

involves creditors agreeing to change their priority in relation to a common debtor or debtors. There are two main forms of contractual subordination: (i) that the junior debt is not payable until the senior debt is paid, and (ii) that one creditor (the 'Junior Creditor') will not compete with another creditor (the 'Senior Creditor') for payment of the Junior Creditor’s debt on insolvency until the Senior Creditor’s debt is fully paid. Historically, some commentators have argued that contractual subordination is of doubtful validity because it infringes the principle of pari passu and cannot be contracted out of. That now appears not to be the case both as a consequence of statute and the decision in Re SSSL Realisations [2006] Ch 610 (the 'Save Case').



(a) New Zealand

In New Zealand, the validity and effect of subordination arrangements are confirmed by statute. Section 313(3) of the Companies Act 1993 ('Companies Act') states that where, before the commencement of liquidation, a creditor agrees to accept a lower priority in respect of a debt than that it would otherwise have, nothing prevents that agreement from having effect according to its terms.

Similarly, section 70 of the New Zealand PPSA expressly permits a secured party to subordinate its interest to any other interest. Section 70 stipulates that this subordination can be enforced by a third party if they are a person for whose benefit the agreement is intended. Section 70(3) also explicitly states that a subordination agreement in respect of security interests does not of itself create a security interest.

(b) Australia

The Australian equivalent to section 313(3) of the Companies Act is section 563C of the Corporations Act 2001 (C’th) ('Corporations Act'), which provides that nothing in Division 6 of Part 5.6 (including section 555, which provides for all debts and claims to rank equally) renders a subordination agreement unlawful or unenforceable as long as it does not disadvantage any creditor who is not a party to the subordination.

Similarly, section 61 of the Australian PPSA permits a secured party to subordinate its interest in the collateral to any other interest, and allows for the enforcement of a subordination agreement by a third party if that third