part vii

a functional approachto security

Introduction

                    7.1               In Part IV we discussed the introduction of notice-filing for company charges, and in Part V we considered which charges should be registrable under such a system. However, the Crowther and Diamond reports recommended, and all the overseas notice-filing systems that we have considered provide, that all transactions that have the effect of securing repayment of a loan or performance of an obligation - the ‘quasi-securities’ described in Part VI - should be brought within the scheme (though not necessarily registrable), whether or not the transaction is traditionally considered to create a security.

                    7.2               A major criticism of the current law, made by the Crowther and Diamond reports and underlying all the overseas schemes to which we have referred, is that the current law does not have a functional basis. The law decides what should be registrable as a security, and to some extent the effects of the transaction, on the form of transaction the parties have chosen to use, rather than looking to the purpose that the transaction is designed to achieve.[1] In this Part we consider whether the notice-filing system we have provisionally proposed for company charges should take the ‘functional approach’ envisaged by the Crowther and Diamond reports and put into practice in the overseas systems.

                    7.3               The lack of functionality in the current law manifests itself in two ways. The first is that, as we saw in the last Part, there are a number of transactions that operate, in purpose, as securities, but that are not regarded by the law as creating a security. One obvious example is a sale and lease-back of goods,whereby the owner of goods sells them to a finance house and enters into, for example, an equipment lease with the finance house in respect of those goods.[2] The effect of this agreement is very much the same as a mortgage of goods to secure a loan.[3] A much more common example is that of the hire-purchase agreement. As the Diamond report noted:

although a hire-purchase agreement takes the form of a letting of goods on hire, and the debtor has merely an option to purchase those goods, it is generally acknowledged today that the real objective of the parties is a sale of the goods from the creditor to the debtor, the debtor paying by instalments. Neither the creditor nor the debtor looks on the agreement as a true hiring, the agreement taking the form it does to enable the creditor to repossess the goods if the debtor defaults and to get back the goods from a purchaser if the debtor wrongly sells them.[4]

                    7.4               However, a mortgage of a company’s goods would be a registrable charge whereas a sale and lease-back or a hire-purchase agreement between a company and a lender is not a charge and therefore is not registrable. Further, were the company to default and the lender to enforce its ‘security’, and were the goods to be worth more than the amount still due to the lender, the outcome would be different.

                    7.5               The second point is one that we made also in relation to charges: the law treats what are actually different situations as being the same, in that it fails to distinguish between a security that is a ‘purchase-money interest’ and one that is not.[5] A secured loan taken out for the purpose of buying a specific piece of equipment (such as a vehicle or computer hardware) which then becomes a possession of the company has not made the company’s position, or that of the other secured creditors, any worse, in that the debt is counter-balanced by the addition of the purchased equipment to the company’s pool of assets. However, such a loan is treated by the law in the same way as a charge over property that is already owned by the company to secure an outstanding loan to the company - an arrangement that is potentially more detrimental to other secured or unsecured creditors. This point would become even more important were quasi-securities to be brought within the notice-filing system, because many quasi-securities are in fact purchase-money interests which, on a functional approach, should be given priority. This is not true, however of all quasi-securities, as is shown by the example of the sale and lease-back. The present law gives effective priority according to the form of the transaction (whether it is in form a security or a quasi-security) and not according to function (whether it is a purchase-money interest).

                    7.6               This lack of functionality led the Crowther and Diamond reports to recommend that the law in relation to security, like the overseas systems, should take a different approach to the question of security interests: it should deal with both securities and quasi-securities, and it should distinguish between charges that secure purchase-money interests and those that do not.[6] However, although this important aspect was recognised to be an issue by the Steering Group when it recommended notice-filing in its Final Report, it was not considered in any depth either there or in its earlier consultation document.[7]

                    7.7               Given the criticisms of the current law and the way this area has been approached overseas, our terms of reference were drafted so as to enable us to look beyond a system that simply encompasses company charges, and to consider the wider question of whether a functional approach could be taken, which would include quasi-securities within the scope of any new system.[8]

Criticisms of the present law

                    7.8               One of the major difficulties resulting from the way the current law deals with quasi-securities is that, as they are not required to be registered under the Companies Act 1985, their existence will not be apparent to a person searching the Company Charges Register. Potential creditors, investors and purchasers of a company’s assets will therefore not know, in the absence of information from the company itself, that, for example, receivables or other assets that are apparently free from registered charges are in fact not the absolute property of the company, and will thus not be alerted to the existence of what amounts to a security over such assets of the company.[9]

                    7.9               In addition to not being registrable, quasi-securities are treated differently from securities in that the former are not subject to the same rules on default. Under a mortgage, for example, any surplus achievable on resale would have to be returned to the debtor; under a quasi-security such as a sale and lease-back it would be retained by the lender.[10] Despite both transactions being designed to achieve the same purpose - acting to secure repayment or the performance of an obligation - they are treated in different ways by the law.

                7.10               Apart from the criticisms caused by the lack of functionality in the law, there is another factor that would be appropriate at least to consider when deciding the scope of any new notice-filing system, and that is the international dimension. To introduce a system that relates only to charges - as with the current registration scheme - would be to ignore the developments made in many overseas countries when addressing the question of the creation and registration of security interests. The United States of America, Canada and New Zealand have all adopted systems that take a functional approach, and similar reform proposals are being examined in Australia. In addition, the system of security is also currently being examined by bodies such as UNIDROIT and UNCITRAL.[11] We wonder whether there might be a risk that in time overseas investors may be hesitant before investing in United Kingdom companies if we persist in having a system that does not take a functional approach, instead retaining the application of any system only to charges. We do not know how great such a risk might be, but we certainly think it is a factor that should be considered.

A radical re-think: quasi-securities

                7.11               Over the following paragraphs we consider in more detail how a system that took a functional approach might operate.[12]

                7.12               The approach of the Crowther and Diamond reports was that any transaction that was designed to perform a security function should, in principle, be treated as a security and registrable accordingly:

The definition of security interest should be such that it would include not only mortgages, charges and security in the strict sense but also any other transfer or retention of any interests in rights over property other than land which secures the payment of money or the performance of any other obligation.[13]

The intention to create a security should be all-important, and it would not matter what form of agreement was used, provided that the intention was manifested.[14] The new legislation proposed would not determine whether title to the secured property was in the creditor or debtor; where title lay would not affect the rules of the proposed system.[15]

Other notice-filing systems and registrable security interests

                7.13               All of the overseas systems which we have considered contain a section setting out the scope of the application of the statute concerned, and all take a functional approach to what amounts to a security interest. The UCC, Saskatchewan and New Zealand systems all apply to a transaction that creates a security interest in personal property, regardless of its form.[16] In addition, express provision is made in some of these systems that the relevant legislation applies to particular situations. Although not every system is identical, common inclusions are floating charges, chattel mortgages, conditional sale agreements (including an agreement to sell subject to retention of title), consignments, leases, and assignments.[17]

                7.14               Thus the SPPSA applies:

(b) without limiting the generality of clause (a), to a chattel mortgage, conditional sale, floating charge, pledge, trust indenture, trust receipt, or to an assignment, consignment, lease, trust or transfer of chattel paper that secures payment or performance of an obligation.[18]

                7.15               “Security interest” is defined to mean an interest in personal property that secures payment or performance of an obligation,[19] but also includes certain interests even though they do not secure payment or performance of an obligation.[20]

                7.16               The NZPPSA is similar, defining security interest as:

(ii)the identity of the person who has title to the collateral;[21]

It also includes certain interests within the definition, whether or not they secure payment or performance of an obligation.[22] To “avoid doubt”, and without limiting the definition of security interest, the NZPPSA applies:

to a fixed charge, floating charge, chattel mortgage, conditional sale agreement (including an agreement to sell subject to retention of title), hire purchase agreement, pledge, security trust deed, trust receipt, consignment, lease, an assignment, or a flawed asset arrangement, that secures payment or performance of an obligation.[23]

                7.17               It should be noted that not all transactions falling within the definition of security interest in the overseas legislation will be registrable: the comprehensive systems they set out allow for perfection of some security interests by means other than registration, such as possession. [24]

                7.18               It does not make any difference whether title to the property is in the creditor or the debtor.[25] UCC Revised Article 9, Section 9-202 provides that:[26]

Except as otherwise provided with respect to consignments or sales of accounts, chattel paper, payment intangibles, or promissory notes, the provisions of this article with regard to rights and obligations apply whether title to collateral is in the secured party or the debtor.

The systems in Saskatchewan and New Zealand contain similar provisions.[27]

                7.19               It is our provisional view that, were the notice-filing system to be extended to take a functional approach, the meaning of ‘security interest’ should be defined in a way similar to that of the overseas systems, so that it would apply to interests in personal property that secured payment or performance of an obligation. We are therefore provisionally in favour of following the approach of the SPPSA or the NZPPSA. However, as we have noted, not all transactions falling within the definition of a security interest would necessarily be registrable.[28] We will go on in this section to consider particular ‘quasi-security’ transactions. In addition with certain transactions there is a question whether they should be registrable even though they do not seem to have the aim of securing payment or performance of an obligation.

                7.20               We ask consultees whether they agree with our provisional view that if there is to be a functionally-based notice-filing system, the approach taken by the overseas systems as to the meaning of ‘security interest’ should be followed, so as to apply, in general, to transactions that secure payment or performance of an obligation.

                7.21               In this section we deal with some of the most obvious forms of quasi-security. However, we recognise that the taking of a functional approach to the question of what amounts to a security interest cannot hope to solve all problems of classification: there will still be disputes as to whether a particular transaction will fall within any functional definition. We address some of the difficulties below, including those in relation to finance leases[29] and sales of receivables.[30]

Hire-purchase agreements and conditional sales

                7.22               Both the Diamond and Crowther reports suggested that the reservation of title under a hire-purchase agreement or in a conditional sale should take effect as a security agreement. As we have noted above, such agreements and sales often also feature expressly within the scope of the overseas notice-filing systems.[31] We provisionally propose that transactions of hire-purchase and conditional sale should be registrable against the hirer or buyer company.

                7.23               We ask whether consultees agree with our provisional proposal that transactions of hire-purchase and conditional sale should be registrable against the hirer or buyer company.

Retention of title (Romalpa clauses)

                7.24               Retention of title clauses of the kind often known as Romalpa clauses[32] were not in use in the United Kingdom at the time of the Crowther report but were considered in detail in the Diamond report.[33] The Cork Committee had already said that:

the absence of any provisions requiring disclosure of reservation of title clauses is unsatisfactory and should be remedied as soon as possible.[34]

The Diamond report agreed. Retention of title clauses serve a clear security purpose (indeed in the case of ‘all monies’ clauses, security is effectively being taken over goods already delivered and paid for). We provisionally agree that retention of title clauses should be registrable.[35]

                7.25               The Diamond report suggested that, as in several of the overseas systems, there should be an exception to the rule that a seller’s reservation of title should be regarded as a security interest. This is where a seller ships goods to the buyer under a bill of lading, and either has the bill of lading made out to the seller or order, or has the bill made out to the buyer but retains the right to possession of it until payment, for example, by means of a documentary bill of exchange. It was suggested that these were such well-established types of commercial transaction that it would be unwise to interfere with them.[36] The SPPSA and the NZPPSA expressly exclude from the definition of security interest:

the interest of a seller who has shipped goods to a buyer under a negotiable bill of lading or its equivalent to the order of the seller or to the order of an agent of the seller, unless the parties have otherwise evidenced an intention to create or provide for a security interest in the goods.[37]

                7.26               We provisionally agree that the interest of a seller who has shipped goods to a buyer under a negotiable bill of lading or its equivalent to the order of the seller should not be regarded as a security interest, unless the parties have evidenced an intention otherwise.

Consignment of goods

                7.27               As we noted in Part VI, a consignment may be for a financing purpose or for some other commercial purpose.[38] Where cars are consigned on sale-or-return, with the dealer paying a deposit equal to the price less tax, this in itself does not seem to have a security purpose. However, the arrangements may include a finance house that provides the deposit, in which case the manufacturer may agree to consign the cars to the finance house which then sub-consigns them to the dealer. If the dealer defaults the finance house can then take back the cars. [39] This amounts to a form of security for the loan. The question is, then, whether all consignments should be made registrable or only those with a security purpose.

                7.28               The systems in Saskatchewan and New Zealand provide that the definition of security interest includes an interest created or provided for by a commercial consignment,[40] whether or not it secures payment or performance of an obligation.[41] However, the Saskatchewan and New Zealand systems do not subject commercial consignments that do not secure payment or performance of an obligation to the legislation on enforcement and default.[42] The consignor’s interest under a commercial consignment is also expressly made a purchase-money security interest, and thus would have the priority given to such interests.[43] We consider the question of enforcement and default further in Part XI and Appendix B. For the purposes of validity and priority (as opposed to enforcement and default), we would welcome the views of consultees on whether consignments should be registrable only if they secure payment or performance of an obligation, or whether all consignments should be registrable.

                7.29               We ask consultees for their views on whether a consignment should be registrable under a functional system only if it secures payment or performance of an obligation, or whether it should be registrable whatever its purpose. Should a consignment be expressly stated to be a purchase-money security interest?

Finance leases

                7.30               Leases also pose a difficulty because they are used both to finance the acquisition of property and for transactions that have nothing to do with financing.[44] In Part VI we noted that a distinction was drawn between the finance lease and the operating lease.[45] A finance lease has a security purpose (and hence would amount to a security in a system taking a functional approach); an operating lease does not. Thus the short-term hire of a car for a few days, for example, does not create a security interest but a finance lease for the economic life of the goods could. However, the difference is not always easy to define.

                7.31               The distinction between finance leases and operating leases might be drawn in one of at least three ways. The first would be to determine the function of the lease in each individual case; the second would be to take a rigid approach depending on the length of the lease; and the third approach would make longer leases registrable, but not necessarily subject to all the provisions of the system if it is shown that the particular lease is not a finance lease.

                7.32               The approach of the UCC has been to set out that whether a security interest had been created was to be determined by the facts, but to provide a number of situations where a lease would constitute a security interest, including where the original term of the lease is equal to or greater than the remaining economic life of the goods.[46]

                7.33               The third approach is the one taken in Canada, and the Diamond report suggested following the Canadian system. The parts of the legislation dealing with priorities and registration apply to every lease of more than one year (the Diamond report suggested three years[47]), but the parts of the legislation dealing with rights and remedies on default apply only to those leases that secure payment or performance of an obligation. A similar system is used in New Zealand.[48] In placing a minimum time limit for the life of the lease, the problems of including short term hiring (which are the transactions least likely to act as a security) can be reduced. As with consignments, we would like the views of consultees on whether a true functional approach should be applied, or instead whether leases over a certain minimum period should be registrable. As with consignments, we do not deal at this stage with the application of enforcement or default provisions.

                7.34               We ask consultees for their views on whether all leases should be registrable (if over a certain minimum period) or whether only those leases that perform a security function should be registrable.

Receivables Financing

                7.35               A security over receivables should be registrable under a notice-filing system as a charge. However, as we pointed out earlier, in practice there may be little distinction between such an arrangement and an outright sale.[49] The overseas systems again try to avoid the difficulty of distinguishing between sales that have a security function and those that do not by bringing both such situations within their scope, as we shall see, but only for some purposes.[50] Three particular transactions over receivables which might be subjected to a requirement to register are those of the factored debt, block discounting and transfers as part of a securitisation.

Factored debts

                7.36               Despite being an outright sale, the case for treating the factoring of debts as creating a security interest stems from the concept of assignment with recourse (that is, an assignment for cash coupled with an obligation to repurchase the account if the debt assigned is not paid) or with warranties that have the same effect.[51] Such cases are examples of transaction being akin to a loan secured on accounts receivable.[52]

                7.37               The overseas systems require registration of all sales of receivables. Under former UCC Article 9, Section 9-102, transfers of an interest in “accounts” and “chattel paper” - whether or not a transfer for security or a sale transfer - had to be perfected by filing. Similarly, UCC Revised Article 9 continues to apply to the sale of “accounts”.[53] Revised Article 9 (like its predecessor) extends to cover sales of accounts only in order to apply the filing requirement. It does not make the transaction a security transaction, which would have the effect of attracting restrictions on default remedies, including accountability to the seller for a surplus. These are thought to be inappropriate when the buyer has become the full owner and has paid the price of the accounts. As we have seen, the SPPSA and the NZPPSA provide that the term “security interest” includes an interest created or provided for by a transfer of an account receivable whether or not it secures payment or performance of an obligation.[54] However, neither system applies the part of the legislation on enforcement and default to a security interest created or provided for by a transfer of an account receivable or chattel paper. In New Zealand this provision, unlike the case of commercial consignments and leases for more than one year, does not depend on whether the account receivable or chattel paper secures payment or performance of an obligation.[55]

                7.38               Drawing on the experience of the UCC and Canada, the Diamond report suggested that its system should include the assignment of debts as if they were security interests, and remarked that:

An attempt to distinguish between assignments with recourse and those without would probably not be profitable.[56]

We agree, with the reservation (presumably intended in the Diamond report[57]) that, as in the UCC and Commonwealth legislation, the rules on default remedies, accountability to the seller for a surplus, and so on would not apply to outright assignments of receivables.

Block discounting or chattel paper

                7.39               The Diamond report referred to the concept of “chattel paper” in the UCC and the Canadian legislation, noting that it would apply to the block discounting of hire-purchase agreements.[58] It was not “clear … whether there would be any desire for this” in the United Kingdom.[59] We are also unsure as to the extent to which the concept of chattel paper is in use in this jurisdiction. As we noted above, the SPPSA and the NZPPSA provide that the definition of security interest includes an interest created or provided for by a transfer of a chattel paper, although the rules on surplus will not apply to outright sales of chattel paper.[60]

Securitisations

                7.40               Whether transfers as part of a securitisation should be registrable involves difficult issues. In Part VI we explained that a standard securitisation arrangement involves the sale of the receivables by the owner (the ‘Originator’) to a purchaser, often a specially incorporated company or a specially established trust (the ‘Special Purpose Vehicle’ or ‘SPV’) that is structured so that it will not be affected should the originator become insolvent.[61] The SPV will fund the purchase through the issue of debt securities, which are secured on the receivables by virtue of a security interest granted to a security trustee, who acts for the investors in the debt securities.[62] It is important that the transfer to the SPV should not be recharacterisable as a disguised security agreement.[63] Registration of the assignment of the individual receivables under the current scheme would be impractical, even if it were desired, and it is also impractical for the SPV to give notice of assignment to each debtor.

                7.41               The UCC Revised Article 9 provides that security interests over ‘accounts’ (which include most of the interests that we have termed ‘receivables’[64]) are registrable.[65] However, as we noted earlier, UCC Revised Article 9 covers outright sales of accounts purely to attract the filing requirement; it is not intended to make the transaction a security transaction, which would have the effect of attracting restrictions on default remedies, such as accountability to the seller for a surplus. As we said earlier, these are viewed as inappropriate, since the buyer has become the full owner and has paid the price of the accounts.

                7.42               Although in a securitisation the transfer of the receivables to the SPV is an outright sale, it can be argued that the case for requiring filing by the SPV is just as strong as for other assignees of receivables. It would also make it easier to discover any previous assignment as part of a securitisation and to preserve priority against any subsequent party to whom the Originator might assign the same receivables.

Conclusion

                7.43               We think that receivables form such an important part of the assets of a business, and that debt factoring, block discounting and other transfers of receivables by way of assignment are so often closely akin to providing security for loans, that in principle these transactions should be registrable. In addition there is another reason for bringing assignment of receivables within the scheme. Under the present law, priority between competing assignments of receivables depends on the date of notice to the debtor. It is not practical for a factor, for example, to check with each debtor that the debt has not previously been assigned. Were the assignment to be registrable, priority would normally depend on the date of filing of the relevant financing statement. It would thus be easy for the factor or other assignee to see whether the debtor company has already made any arrangement to assign debts; and equally, if it has not, to file a financing statement itself and secure priority for the future. We would remind the reader that under the notice-filing system it would be possible for the factor or discount house to file a single financing statement for a series of transactions.[66]

                7.44               We are provisionally of the view that there should be an exception to the requirement to register when book debts are sold as part of a larger transaction (such as the overall sale of the business).[67] We also consider that there should be an exception in the case of negotiable instruments.[68]

                7.45               We ask whether consultees agree with our provisional views:

                7.46               A person can in principle create an effective equitable charge over chattels by declaring that he holds them in trust for a creditor by way of security for the payment of a specified debt.[69] A declaration of trust by way of security will therefore be a registrable charge where it is given over registrable charge property[70] or in substance constitutes a floating charge.

                7.47               The systems under the UCC, in Canada and in New Zealand all take a functional approach, generally expressly including interests created by trust deeds where they serve a security purpose.[71] The Australian Law Reform Commission recommended that the question of whether an interest in property arising under a declaration of trust or under some other equitable assignment was a security should be decided by taking a functional approach, but that it was not necessary to have any other special provision in respect of this.[72] It seems that this area is an example where our law already takes a functional approach.

are there any quasi-securities that should not be registrable?

                7.48               We provisionally proposed in Part V that a notice-filing system that applied only to charges should except some charges from registration.[73] While a notice-filing system taking a functional approach would obviously include more transactions than one simply applicable to charges, it should not include every transaction that falls within a broad definition of ‘security interest’. (We also noted in Part IV our provisional view that possessory securities and those arising by operation of law should be excluded; this would be so whether the notice-filing system applied only to charges or took a wider, functional approach.[74])

                7.49               There are several transactions that are expressly excluded from the scope of the overseas systems (either entirely or in respect of the notice-filing requirements). Some of these we have already noted in Part V, when we discussed charges that we consider should be exempt from registration. Examples include charges over shares and other investment securities, particularly in the light of the Draft Collateral Directive referred to in Part V.[75] In this Part we are discussing the functional equivalents to traditional security devices. Our provisional view is that where a quasi-security is functionally equivalent to a charge that should be excluded from being registrable, it should also be exempted.

‘Repos’ of shares and investment securities

                7.50               Thus in Part VI we described ‘repos’ (arrangements under which it is agreed that assets are sold for cash by one party to another, at a discounted price or at market price less a premium, with a provision for repurchase after a certain period of time or on demand) as frequently functionally equivalent to loans secured on a portfolio of shares that may continue to be traded. This might suggest that under a ‘functional’ approach to registration, ‘repos’ should be registrable. However, in Part V we proposed that even charges over shares and investment securities should not be registrable because in practice third parties will not have difficulty in finding out about them; either the share certificates will be deposited with the secured party or the secured party will be registered as legal owner. The same argument applies to ‘repos’; the shares will belong to the buyer (who functionally may be the secured party). There is thus no danger of third parties being misled and no need for registration of the ‘repo’.[76] It is our provisional conclusion that transfers of shares and investment securities under a ‘repo’ should not be registrable.

Contractual set-off arrangements

                7.51               Rights of set-off are expressly excluded from UCC Article 9 and from the registration requirements in the New Zealand system.[77] Contractual set-offs do not purport to create proprietary rights and we would propose to follow these examples.[78]

                7.52               We ask whether consultees agree with our provisional proposal that rights of set-off should be excluded from the need to register under a notice-filing system.

Special purpose trusts

                7.53               In Barclays Bank Ltd v Quistclose Investments Ltd[79]it was held that a loan to a company that was conditional on the sum being used for a particular purpose (in this case, the payment of a dividend) was held on a primary trust, and then on a secondary trust when that primary purpose failed. Whilst on a traditional trust analysis no question of security arises, it has been argued that from a functional point of view, a Quistclose payer is a secured creditor, if a Quistclose transaction is regarded as a two-step arrangement by which money is advanced outright, simultaneously coupled with a grant back by way of mortgage or charge.[80] However, even if this analysis is correct, we would regard this sort of transaction as one arising by operation of law, and hence outside the scope of our proposed system.[81] In any event, the beneficiary is unlikely to know that there is a trust, and so will not know to register any charge.

                7.54               We ask whether consultees agree with our provisional view that special purpose trusts should be outside the requirement to register (either because no security arises, or alternatively any security arises through operation of law).

Motor vehicles

                7.55               Security interests over motor vehicles might cause difficulties in a notice-filing system that took a functional approach to what security interest should be registrable, but do so only in relation to companies. Vehicles sold on conditional sale, or bailed under a hire-purchase agreement or a finance lease, would be subject to registrable security interests, and the additional rules on priorities and purchasers that we outlined earlier in this Consultation Paper would apply unless the issue were expressly addressed in some other way.[82]

                7.56               At first sight, there seems to be no compelling reason why a hire-purchase agreement or conditional sale in respect of a motor vehicle should not create a registrable security interest and be generally subject to the rules of any new system. Both the Crowther and Diamond reports thought that this should be so.[83] If the scheme of notice-filing of quasi-securities is to be extended to quasi-securities created by all debtors, we would agree. However, introducing a functional system that applies initially only to companies causes complications.

                7.57               The difficulties arise because of the way that questions of title for purchasers of vehicles that are subject to hire-purchase agreements or conditional sales are currently addressed by the law.

                7.58               Normally a purchaser who buys goods from a party who has them on hire-purchase will not get good title.[84] A purchaser from a conditional buyer sometimes will obtain title,[85] but not if the agreement is regulated by the Consumer Credit Act 1974.[86] However, under Part III of the Hire-Purchase Act 1964, provision is made for the passing of title on the sale of a motor vehicle that has been bailed under a hire-purchase agreement or sold on conditional sale, and which has been disposed of before the property has vested in the debtor.[87] A disposition to a private purchaser[88] without notice of the hire-purchase or conditional sale will pass good title to the purchaser.[89] Trade purchasers are not protected, the idea being that they can check in the HPI register to see if the vehicle is subject to an outstanding agreement.[90]

                7.59               Both the Crowther and Diamond reports suggested that such interests should be registrable, but that there should be particular rules in relation to purchasers of motor vehicles. The Crowther report suggested that rights of the type conferred by Part III of the Hire-Purchase Act 1964 should be restricted to the private buyer and should not apply to businesses.[91] On this point, the Diamond report took a different view, preferring that all purchasers should be protected except for motor traders and finance houses (as in Part III).[92]

                7.60               We initially considered whether, if motor vehicles were to be brought within a notice-filing system that would apply to companies, the rules we had outlined earlier in respect of purchasers of assets that were subject to a security interest would apply in the same way,[93] or whether they would have to be modified to reflect the different situation existing under Part III of the Hire-Purchase Act 1964. However, we soon realised that there would be problems in trying to bring purchasers of motor vehicles within such a system at all.

                7.61               A system that applied only to charges created by companies would result in confusion. Under the current system, protection is afforded to private purchasers regardless of the legal personality of the ‘rogue’ seller - that is, the person who had possession of the vehicle under a conditional sale or hire-purchase agreement and who sold it wrongfully. Under a notice-filing system that applied only to companies, if the rogue seller were a company, there could be rules in respect of innocent purchasers that might be similar to the protection offered by the Hire-Purchase Act 1964.[94] However, if the vendor were an individual, such a sale would be outside the operation of the system, since it would apply only to security interests created by companies. Consequently, Part III of the Hire-Purchase Act 1964 would have to remain in existence at least in part, in order to protect purchasers from non-corporate vendors. Having two different systems in respect of motor vehicles would mean that the purchaser having to be aware of the seller’s legal personality in order to know whether to conduct a search in the Company Charges Register or the HPI register.[95] This in turn might lead to problems if the legal personality was mistaken or misrepresented to the purchaser, who as a result did not search the relevant register.

                7.62               The situation becomes even more complicated where there is a chain. What if the innocent purchaser (say, a partnership) of a vehicle from the rogue seller (a company) goes on to sell it on conditional sale to a trade purchaser (say, a sole trader)? This would be a non-company selling to a non-company, but concerning one security interest that was registrable in the Company Charges Register (the original one created by the company) and another that was not (the conditional sale between the partnership and the sole trader). If, as is possible, trade purchasers were exempted from any protection under a notice-filing system as well as the Hire-Purchase Act 1964,[96] would they be expected to search the HPI register, the Company Charges Register, or both? If the Company Charges Register, how would the second purchaser be alerted to this? In order to cover themselves, they would have to search the Company Charges Register in every case. Moreover, in case there was no entry in the Company Charges Register, they would also have to search the HPI register as well as a matter of course. Such a situation does not seem to be sensible.

                7.63               In addition, we are not at all convinced that any provisional proposals we might suggest for the situation where the sale was by a company would often be applied: we suspect that the majority of sales that Part III of the Hire-Purchase Act 1964 was designed to catch are those where the rogue sale is undertaken by an individual or a small second-hand car dealership. If the latter is unincorporated, it will not come within the system, nor will individuals in any circumstances. Consequently, purchasers from sellers such as these will still have to be protected by the Hire-Purchase Act 1964.

                7.64               Given the existence of specific statutory protection that would still have to apply in the case of purchases from unincorporated businesses and individuals, we do not think that having two systems is sensible. Instead, we provisionally propose to exclude certain quasi-security interests from the notice-filing system for so long as the scheme for companies is not extended to security interests created by other debtors.[97] A quasi-security interest over a motor vehicle that takes the form of a conditional sale (including, we provisionally think, a consignment) or a hire-purchase agreement should be excluded, such situations being dealt with by Part III of the Hire-Purchase Act 1964 in its current form.

                7.65               We are uncertain as to whether the exception should be wider to cover other forms of vehicle financing by quasi-securities that are outside the protection offered by the Hire-Purchase Act 1964 (such as finance leasing). The finance lease may not fall within the protection offered by the Hire-Purchase Act 1964 for historic reasons, in that such a method of financing may not have been in common use for vehicle financing at that time. We suspect that the 1964 Act should be amended to bring finance leases and consignments with it, but we would welcome the views of consultees on this point.

                7.66               A charge over a motor vehicle - as opposed to a quasi-security - would be registrable, however, and subject to the rules in relation to purchasers that we have outlined earlier.[98]

Functional priority rules

                7.67               We noted in Part IV that all the overseas systems have a number of specific priority rules relating to particular situations which displace the residual ‘first to file’ rule.[99] We deferred consideration of some of those rules until this Part as they involve a change in approach from ‘form’ to ‘function’, and they apply particularly to quasi-securities. The rules relating to purchase-money security interests are of particular importance but there are also additional rules relating to accessions and commingled goods, as well as to purchasers of certain secured assets.

Purchase-money security interests

                7.68               In Part IV we discussed the purchase-money interest from the point of view of its application to security. There,[100] and subsequently at the beginning of this Part,[101] we noted that the treatment of purchase-money interests is of particular importance if quasi-securities are to be brought within a system of notice-filing.

                7.69               We explained the rules of the overseas systems, insofar as they were relevant to security, in Part IV. All those rules will of course apply to quasi-securities, insofar as they meet the definition of a purchase-money security interest set out in the relevant system.[102] What we said in Part IV is equally applicable in this Part. There is an additional point, that not having such a concept under a functional system would make it more difficult for a company to obtain vendor credit. Both the SPPSA and the NZPPSA have additional rules that are applicable in such cases.

                7.70               In Part IV we noted that, although the purchase-money interest would apply to security, the overseas systems have provisions that are more applicable to quasi-securities. More than one creditor may advance the funds that the debtor uses to purchase a single asset, and the debtor may grant each of them rights over it. As between competing purchase-money security holders, a seller, lessor or consignor[103] who takes a purchase-money security interest will gain priority over another holder if the seller, lessor or consignor perfects the interest at the time the debtor obtains possession (in the case of inventory) or not later than 15 days of the debtor obtaining possession (in the case of non-inventory collateral).[104] Priority of such interests not taken by a seller, lessor or consignor are determined by applying the residual rules set out in the overseas systems.[105]

Other forms of super-priority

                7.71               The priority given to purchase-money interests over earlier non-purchase-money interests is sometimes termed ‘super-priority’. As we noted earlier, it is justified in part by the argument that the secured party has enabled new assets to be brought into the company and that, without this priority scheme, it would be hard for companies to benefit from advantageous vendor-credit.

                7.72               However, purchase-money interests are defined as security over the assets purchased with the financing secured on the asset. It may be asked whether any other forms of super-priority should be given. It may be argued that any creditor who has provided fresh value (such as cash) in exchange for the security (as opposed to taking it to secure an existing debt) should also be given priority. However, as we noted in Part IV, the purchase-money creditor has provided an additional asset which does not harm earlier secured creditors.[106]

                7.73               In New Zealand, special priority rules enable debtors to use their accounts receivable (the equivalent of the term ‘book debt’) as an independent source of credit. Financiers who inject new value into a debtor’s business against a security interest in receivables enjoy priority over the other creditors who claim the same receivables.[107]

                7.74               We ask consultees whether secured parties who have given new value should, to the extent of that value, be given priority over existing perfected security interests.

Purchasers of investment securities and of receivables

                7.75               We have provisionally proposed that a purchaser of investment securities should take free of the security interest unless he knows of it and that sale would be in breach of the agreement.[108] For receivables we propose that a purchaser should be bound by a registered charge.[109] We suggest parallel rules should apply to the equivalent quasi-security interests (‘repos’[110] and purchases of receivables[111] respectively).

Summary

                7.76               In Part V we discussed what charges should be registrable under a notice-filing system. We provisionally proposed that all charges should be registrable save those on a list of exceptions. At the end of that Part we provided a summary of the principal kinds of charge that should, in effect, be registrable. If the system were to extend to take a functional approach, we think that any transaction that has a security function should be registrable unless, again, the transaction was excepted. In effect the principal ‘quasi-securities’ that would fall to be registered would be:

Other issues

Transitional issues for previously unregistrable charges and quasi-securities

                7.77               There would need to be transitional provisions in respect of quasi-securities, were a functional approach to be adopted.[112] Should there be a requirement for previously unregistrable charges or security interests to be registered within a certain time (as with the New Zealand system[113]) or otherwise become unperfected (and hence at risk of invalidity against third parties and loss of priority)? The alternative would be to provide that quasi-securities existing before the introduction of a notice-filing system should continue to be valid without the need to register.

                7.78               The difficulty with not having a requirement that such security interests be registered is that the notice-filing register will be inaccurate, and a person searching the register will not know whether there are existing security interests that might affect the company’s assets. For example, a hire-purchase agreement entered into after the commencement of any new notice-filing system would have to be entered on the register (if the functional approach is adopted), but if there were no requirement to register pre-commencement hire-purchase agreements, the register would be incomplete. However, a requirement to register existing security interests that were not previously registrable would clearly be prejudicial to companies or creditors who had already complied with the law when they entered the relevant transaction.

                7.79               We suspect that most of the security interests that would fall into the description of ‘quasi-security’ tend generally to be of relatively short duration (although there are always likely to be exceptions). If this be right, then the risk of the ‘invisibility’ of pre-existing unregistrable security interests will diminish within a reasonably short time following the introduction of a notice-filing system. It may therefore be necessary to accept that the introduction of a notice-filing system will be subject to the risk of invisible security interests for the early period of its existence, but that, over time, this risk will rapidly diminish (although previously unregistrable charges might last for a much longer period). As it is, under the current law such security interests (and currently unregistrable charges) will not be found on searching the Company Charges Register. It might be advisable for there to be a clear indication on the register that a charge or security interest that pre-dated the introduction of the system might be in existence, and that enquiry should be made of the debtor company. We think this approach might, on balance, be preferable to the prejudice caused by requiring all holders of unregistrable security interests to register them within a certain period, although we would welcome the views of consultees.

                7.80               We ask consultees whether they think that previous security interests (including quasi-security) that would be registrable under a notice-filing system, but which are currently not registrable ought to be registered within a certain period following the commencement of any new notice-filing system.

Quasi-securities and the company’s own register of charges

                7.81               We discussed in Part IV the question of whether the requirement under the Companies Act 1985 for a company to keep its own register of charges should be retained. We suggested that if the scope of the new register is widened to encompass more types of charge, as we have proposed, there is no clear case for continuing to require companies to keep their own registers.[114] If these are to be retained, however, an additional point needs to be considered. Under the current law, the obligation to keep a register arises in respect of all charges a company creates. If a functional approach is taken, so as to include more than charges, should the requirements on the company in respect of its own register change to reflect this? In other words, should there be a requirement to keep a register not just of charges, but of all security and functionally-equivalent transactions, so that quasi-securities such as retention of title agreements, conditional sales and finance leases should also be recorded?

                7.82               If the company’s own register is to continue, but the register at Companies House becomes functionally-based, it seems only sensible to provide that the company’s own register be on the same basis. The advantage would be to provide an additional source of information, given that the financing statement will contain little detail. The disadvantage of requiring this would be to increase the compliance workload on the part of the company involved (although it seems to us that such information would in all likelihood be kept in some form or other by a company in any event). We would welcome the views of consultees on this point.

Small transactions

                7.83               If a system of notice-filing is to be introduced, should it apply to all transactions that come within its scope, regardless of size, or should there be a minimum threshold? The Crowther report suggested that security interests for small amounts should not be registrable, in order to avoid cluttering up the register,[115] and the Halliday report also suggested such small transactions should be excluded.[116] However, the Diamond report suggested that there should be no exclusion for small transactions from the scope of the filing arrangements. The argument that the register should not be burdened with recording small advances was not accepted as accurate, given that filing should be voluntary and given that many small scale creditors would not bother to file in respect of one-off transactions where only a small amount was concerned. The decision whether or not to file would be taken for commercial reasons.[117]

                7.84               We have dealt with this topic in this Part, rather than Part IV, because with corporate debtors quasi-securities are much more likely to be small transactions than are charges. We are provisionally inclined to follow the suggestion of the Diamond report and not have an exclusion for small amounts. We are not convinced that there would be a clogging of the register with such financing statements, particularly given that the notice-filing system we are potentially considering would apply only to corporate debtors. It is unincorporated businesses and individuals whose debts, in very general terms, are likely to involve small transactions.

                7.85               We ask whether consultees agree with our provisional view that there should be no exclusion from the need to register in the case of small transactions.