In brief
If an equipment lessee fails to register a sub-lease under the PPSA it risks losing its rights to the equipment whilst remaining bound by its obligation to make lease payments to the initial lessor.
The problem
The practice of sub-leasing equipment under the Personal Property Securities Act (PPSA) has been an unresolved issue for financiers and brokers since the PPSA’s inception over ten years ago.
The sub-lease can take the form of a lease, rental, hire, or hire-purchase agreement. If it is for two years or more it will be considered a PPS Lease under the PPSA. Similarly for the ‘head’ lease, although that lease can be a chattel mortgage as well.
The basic problem is that, if a lessee leases equipment from a lessor in the usual way, and then sub-leases to another party (the ‘sub-lessee’), if the sub-lessee goes into receivership or worse, the lessee/sub-lessor could lose its rights to the equipment entirely.
This will happen if the sub-lessor has failed to register its sub-lease on the PPSR. Such a registration would be in addition to the head lease registration by the lessor. The latter does not extend to protecting a sub-lease, and that is the nub of the problem.
If the sub-lessor does not register its sub-lease, it is it will lose its rights to the equipment in favour of the sub-lessee’s receiver or administrator. Unfortunately for the sub-lessor, it remains liable to make the lease payments under its (head) lease with the initial lessor.
In other words, in the absence of a second, sub-lease registration, the sub-lessee’s default means the lessee/sub lessor’s head lease obligations to the head lessor ‘decouple’ from the lessee/sub-lessor’s rights to the equipment. The lessee/sub-lessor is caught in the middle: no equipment on the one hand, but continuing payment obligations back up the chain to the head lessor on the other.
Some possible solutions
The first question is whether, by entering into a sub-lease the lessee defaults under the head lease. The existence of such a default clause should act as a deterrent to sub-hiring behaviour, and so provide a degree of risk mitigation for the lessor at least. Of course the sub-lessor is still exposed if it doesn’t register the sub-lease in any event.
Relying on a default clause may seem like a case of ‘shutting the gate after the horse has bolted’. However, if the sub-lessor could show that the sub-lessee had actual knowledge that the sub-lessor was breaching its head lease, the sub-lessor may yet retain its rights to the invalidly sub-hired equipment.
On the other hand, a default clause is unhelpful if the sub-lessor is in the business of plant-hire. The issue may then become whether the plant-hire company (as sub-lessee) takes the equipment as inventory, in which case the priority of the lessor’s PPSR registration could also be in trouble.
To cover off these risks a further contract between the parties may provide some protection for the sub-leasing imbroglio. This contract would be a ‘tripartite’ or three party agreement, such that the head lessor at least could control the sub-leasing scenario. But of course this a lawyer’s solution, not necessarily a financier’s preferred course.
Conclusion
The sub-leasing scenario is not dealt with satisfactorily under the PPSA. Active lease portfolio monitoring is the best remedy at the present time.
Allan McDougall, Consulting Principal, Keypoint Law, July 2023