When a company is presented with various business opportunities, but lacks certain resources to proceed and go on with prospective projects and ventures, what could be the company’s best recourse? Usually, one of the most viable options would be through debt-financing, whether with a bank or with an individual lender. With the loan proceeds, the company can maximize its potential for growth and expansion, as the proceeds could help finance its future acquisitions and investments. More projects would eventually contribute to the country’s economic growth through an increase in employment opportunities for the workers, and payment of taxes to the government, among others.
However, more than the promise of reasonable interest payment for the principal amount loaned, a lender would typically be more enticed to lend money in a secured loan transaction, as compared with the unsecured ones. And this is where collateral securities—either real or personal properties—come into play.
In this article, focus will be made specifically to transactions secured by personal properties. To be discussed herewith are the salient features of the Personal Property Security Act, the law that governs all transactions secured by certain movable properties, and how these features help enhance the accessibility of debt-financing to the borrowers, while at the same time, provide an efficient means of financing scheme for both the lender and the borrower.
The enactment of the Personal Property Security Act
To strengthen the secured transactions legal framework in the Philippines, the Congress enacted Rep. Act No. 11057, otherwise known as the Personal Property Security Act (PPSA), to provide for the creation, perfection, establishment of a centralized notice registry, and enforcement of security interests in personal property. Basically, the PPSA covers all transactions that secure an obligation with movable collateral, except interests in aircraft and ships which are subject to their respective special laws, i.e., the Civil Aviation Authority Act of 2008 and the Ship Mortgage Decree of 1978, respectively. The PPSA took effect on 9 February 2019, while its implementation is conditioned upon the establishment of an operational registration system—a centralized repository where notice of security interest or lien will be registered.
The PPSA repealed certain provisions of the Civil Code on Pledge and Chattel Mortgage, specifically Articles 2085 – 2123, 2127, 2140 – 2141, 2241, 2243, and 2246 – 2247. Under the PPSA, personal property used as collateral—whether pledged or mortgaged—is now called a security interest. Accordingly, the transitional period shall be from the date of the law’s effectivity, i.e., on 9 February 2019 until the date when the Registry has been established and operational. The importance of the transitional period will be discussed in the latter part of this article.
Expanded coverage of security interest
The PPSA and its Implementing Rules and Regulations (IRR) expands the nature of the security interest that may be used as collaterals in secured credit transactions. Accordingly, a security interest may be created over all forms of tangible and intangible assets, including, but not limited to:
- Rights arising from contracts such as securities, commodity contracts, or lease of goods including financial leases and operating leases for a period of not less than one year;
- Equipment;
- Inventory;
- Deposit accounts;
- Certain accounts receivable;
- Negotiable instruments/documents of title;
- Consumer goods;
- Intellectual property;
- Livestock; fixtures, accessions, and commingled goods; or
- Future property or after-acquired assets.
Note that prior to the enactment of the PPSA, the pledgor must be the absolute owner of the thing pledged, and that the person constituting the pledge must have the free disposal of the property. The same is not true anymore since the PPSA expressly allows future property or after-acquired assets to be constituted as a security interest, subject to the condition that the security interest in that property is created only when the grantor acquires legal rights in it, or the power to encumber it. Furthermore, under the PPSA IRR, security interest in a tangible asset may extend to its replacement, but then the security interest is limited to the value of the encumbered asset immediately before it was replaced.
With the security interest being no longer limited to personal properties absolutely owned by the borrower at the time of the constitution of the loan agreement (now called security agreement), the expanded concept and coverage of security interest under the PPSA is indeed of great advantage to the borrowers, especially to the medium-sized business entities. This means that they could maximize the use of their resources as collaterals to fund certain acquisitions and investments, thus, contributing to the business’ growth and expansion.
Stages in the life of a security interest
Another improvement under the PPSA is the provision for a uniform manner of establishment and enforcement of a security interest—from its creation, to its perfection, and finally its enforcement—thus simplifying the process as will be further discussed below.
- Creation and perfection of security interest
A security interest is created through a security agreement, which is a written contract containing a sufficient description of the collateral and signed by the parties, showing their intent to create a security interest. Once the security agreement is made, the perfection of the security interest follows, which may be done through the following:
- Registration of a notice (relating to security interest or lien) with the Registry;
- Possession (for tangible properties) of the collateral by the secured creditor;
- Control (for intangible properties) of investment property and deposit account; and
- Notation—which is permitted only in case of security interest in securities.
Generally, a security interest in any tangible asset may be perfected by registration or possession. However, for security interest in an investment property and a deposit account, which are considered intangible assets, the same may be perfected by registration or control. An initial notice would contain the following information:
- Grantor information;
- Secured Creditor information;
- Collateral type and description; and
- Transaction information such as loan amount, and term end date.
This uniform manner of creation and perfection of security interest gives a great deal of advantage to both the secured creditor and the debtor, by simplifying the rather tedious process under the old laws governing pledge and chattel mortgages. Previously, the collateral was needed to be placed in the possession of the creditor, or be first recorded in the Chattel Mortgage Register, as the case may be, to be valid.
- Enforcement of security interest
In relation to the creation and perfection of security interest, it is important to note that the priority of security interests involving the same collateral is determined according to the time of its perfection, i.e., registration, possession, or control, as the case may be, the time of the creation of the security interest being immaterial. The importance of priority interest finds relevance when enforcement of the security interest becomes inevitable, such as when the debtor becomes insolvent. Accordingly, the “first in time, first in right” rule applies, which means that the security interests of senior lienholders shall at all times be respected, and that the liquidation order shall not affect the rights of such secured creditors to enforce their lien in accordance with the applicable contract of law. (Financial Rehabilitation and Insolvency Act of 2010, Section 114)
Meanwhile, the proscription on the automatic appropriation of the collateral by the secured creditor in case of default by the debtor, otherwise known as pactum commissorium, remains under the PPSA. For one, upon default by the debtor, a secured creditor may sell or dispose of the collateral, but this does not amount to pactum commissorium since in this case, there is no automatic appropriation in favor of the secured creditor, who is then further required to sell the collateral. In relation to this, another change introduced by the PPSA is that it now allows the private sale of the collateral, unlike previously where the law requires that the sale of the thing pledged or mortgaged must be made at a public auction. Having options—whether to sell the security interest publicly or privately—gives the secured creditor more flexibility in the manner of enforcing its claims, not to mention the avoidance of the rigorous procedures and added costs in case of public sale.
Other than selling the security interest, the secured creditor may likewise propose to retain a portion or even the entire collateral, which still, does not amount to pactum commissorium, for the same is still subject to an affirmative consent of the debtor, grantor, other secured creditors, and other interested parties (for partial retention), or the absence of their written objection within the prescribed period (for total retention).
Relative to the sale of the collateral, the PPSA likewise provides for a uniform treatment of any excess or deficiency in the sale of the property, i.e., the secured creditor shall account to the grantor any excess, and unless otherwise agreed, the debtor is liable for any deficiency.
The establishment of a centralized Notice Registry
As mentioned earlier, the implementation of the provisions of the PPSA and its IRR is conditioned upon the establishment of an operational registration system. Thus, on 25 March 2021, the Land Registration Authority (LRA), per the mandate of the PPSA and its IRR, launched the Philippines Personal Property Security Registry (PPSR), a centralized registration system for the recording and monitoring of security interests.
Accordingly, anyone who registers and has an account in the Registry can conduct a search in the PPSR where an individual may track notices through a notice registration number which is generated upon payment of the initial, amendment, or termination notice. This notwithstanding, per the PPSR Information Center, the PPSR cannot yet be construed as already fully established and operational.
Therefore, during the transitional period, i.e., from 9 February 2019—the effectivity date of the PPSA—until the PPSR become fully operational, the creation, perfection, registration, enforcement of security interests, as well as the determination of priority interests, shall be governed by the PPSA, provided that the registration of the security agreement with the LRA must still be made in accordance with the Chattel Mortgage Law.
For any legal assistance you may need, you may send your inquiries and other legal concerns to info@gqlaw.com.ph.