Tacking

At some point every secured lender will encounter a second lender attempting to provide additional secured financial accommodation to their borrower.  It is therefore important for the first secured lender to understand the concept of tacking and the complexities of the body of law that governs tacking and how those rules apply in light of the Personal Property Securities Act 2009 (Cth) (PPSA).

In short, the law on tacking will determine if the first secured lender should make further secured advances to their borrower at any time after a second lender:

1. takes security over the same assets of the borrower;
2. provides notice to the first secured lender of the second lender’s facility together with details of their securities; and
3. makes an advance to the borrower.

The most important question that the first secured lender will need to ask in these circumstances is: Will I be able to rely on my existing securities to recover any additional advances made after the second secured Lender enters the picture?

We will explore some of the applications and situations in relation to the rule against tacking in this article.

What is tacking?

Tacking refers to a scenario where a secured lender, having made advances to their borrower up to the facility limit, then seeks to provide additional advances to that borrower, relying on the existing security to secure those additional advances.

The additional advances by this lender that ‘bolt on’ or ‘tack’ to the existing securities are known as tacking.

Pre PPSA

Until recently, the common law determined that ‘tacking’ by a first secured lender is not permitted in the scenario where it has had knowledge of:

1. advances made by a second secured lender to the borrower; and
2. the second secured lender has taken security over the same assets whether personal property or real property.

Should an advance be made by the first secured lender despite this knowledge, then any additional advances will rank behind the advances made by the second secured lender.

The rule against tacking in Hopkinson v Rolt (1861) 9 HL Case 514; 1861 WL 7196 (Hopkinson v Rolt) provides that a first lender is not able to tack further advances if it had actual notice of the existence of a subsequent financier’s security.

When combined with the rule in Devaynes v Noble, Clayton’s Case (1816) 1 Mar 572 it has the added effect that following notice of the existence of a subsequent lender’s security, any payments made in reduction of the financial accommodation provided by the first lender will result in a reduction of that first lender’s priority amount in an amount equal to the amounts of those reductions.  For example, if the second lender or a third party pays down the obligations owed to the first lender, then the priority amount of that first lender will reduce by that same amount.

Personal Property Security

Since the introduction of security interests over personal property under the PPSA and the repeal of the prospective liability requirements in Chapter 2K of the Corporations Act 2001 (Cth) in relation to ASIC registered securities, tacking (in the majority of circumstances) has been permitted.

Section 18 of the PPSA does away with the rule in Hopkinson v Rolt by permitting tacking of future advances by the first lender regardless of any subsequent lender.  As a result, provided the security agreement provides for future advances, a first lender’s security interest will extend to all future advances made in relation to the security interests created under that security agreement.

However, there are some exceptions.  These exceptions include:

1. priority disputes of two competing transitional security interests under section 323 of the PPSA the rule against tacking will apply.  We note however that this situation is becoming more and more uncommon over time, especially as the transitional security registration period has passed; and
2. Purchase Money Security Interest (PMSI), the priority amount by a subsequent lender provided for the purpose of acquisition funding will provide that subsequent lender with first priority in relation to those particular assets.

Real Property Security

Although the rule against tacking has been largely negated in relation to security interests under the PPSA, the rule still generally applies in relation to real property mortgages, subject to a few exceptions.  Some of these exceptions to the rule are detailed in the matter of Matzner and others v Clyde Securities Ltd [1975] 2 NSWLR 293 – 29 August 1975 (Matzner v Clyde).

In Matzner v Clyde it was held:

1. subject to considerations of justice and fair dealing between the mortgagor and the mortgagees, the rule against tacking in Hopkinson v Rolt should be applied in relation to competing mortgagees
2. the court applied Bradford Banking Co. Ltd. v Henry Briggs, Son & Co. Ltd. (1886) 12 App. Cas. 29 and Deeley v Lloyds Bank Ltd [1912] A.C. 756, at pp.781, 782 and concluded that tacking was permitted in the context where the first lender is bound to make further advances to the mortgagor after the date of the second mortgagee, and the mortgagor is bound to accept those additional advances.  Further, in this case, the advances under the first mortgage had the additional effect of increasing the value of the mortgaged property;
3. on the basis of justice and fairness the court distinguished from the decision in West v Williams [1899] 1 Ch. 132 and concluded that the first mortgagee was entitled to priority over the second and third mortgagees for the instalment payments to which it was bound to make and did make under the first mortgage; and
4. the money expended by the first lender to complete the development, following the unsuccessful auction of the partially completed development, in the normal course would have been subjected to the rule against tacking, however, this expenditure by the first lender was considered to have been expended in order to preserve or perfect the security.

Accordingly, for the reasons outlined above, tacking by the first lender was permitted in these circumstances and the first lender was entitled to have priority over the claims of the second and third lenders.

Key security

As a lender or more importantly, a subsequent lender, it is important to identify your key asset and ultimately your key security that is being relied upon in the provision of financial accommodation to the borrower.

For example:

1. if you are the first lender secured by a PPSA security interest and a real property mortgage; and
2. a second lender takes both a PPSA security interest and a real property mortgage (in respect of the same real and personal property) and gives you notice of their advance together with details of their securities, the first lender may be in the situation where tacking is permitted in relation to the PPSA security interest, but no tacking is permitted in relation to the real property mortgage.

As a first lender in this scenario, where you are relying on the real property mortgage as your key security, the rule against tacking would apply and accordingly you should not make any further advances without entering into appropriate priority arrangements with the second lender.  If, however, your key security is the PPSA security interest, then you are free to continue making advances to the borrower as a first lender and retain your priority without entering into priority arrangements.

If, as a first lender, both the PPSA security interest and the real property mortgage are key securities, then you would need to confirm your priority position by entering into appropriate priority arrangements with the subsequent lender before making any further advances to the borrower.

Subsequent 3^rd mortgage by first lender

Theoretically, following the principles of tacking in relation to real property, if the first lender was granted a third mortgage behind the second lender’s mortgage, and gave the second lender notice of the same, then theoretically the first lender should re-gain priority for any advances beyond the limit of the second lender’s mortgage.

However we note that the ultimate outcome will depend on considerations of justice and fairness (equitable principles) as between the mortgagor and competing lenders.

Conclusion

In summary:

1. in relation to PPSA security interests over personal property, tacking is generally permitted (subject to certain exceptions some of which are detailed above);

and

1. in relation to mortgages over real property, the rule against tacking generally applies.

The best position to avoid uncertainty or a priority dispute between secured parties is to negotiate and enter into priority arrangements to confirm priority limits, ranking of securities and also to determine the distribution of proceeds, amongst other things.  However, we note that there are some situations where such terms are unable to be agreed and documented.