The Law Commission

 


PART 1

INTRODUCTION

1.1      This consultative report sets out in detail our provisional recommendations for a scheme of electronic 'notice-filing' for mortgages and charges over the property of companies,^[1] and associated rules on priority. Notice-filing would replace the current scheme of paper registration of charges created by companies under Part XII of the Companies Act 1985. This is the second formal consultation document we have published as part of this project.^[2]
1.2      The title of this consultative report - Company Security Interests - reflects the fact that our provisional recommendations and draft legislation cover more than company charges. English law currently treats mortgages and charges in a different way from other transactions that have a security purpose, such as title-retention devices and the sale of expected income ('receivables'). If our recommendations were accepted in full, the scheme would apply also to these 'quasi-securities', and there would be a legislative statement of the rights and remedies of the parties to all transactions involving personal property that have a security purpose.
1.3      In addition, we recommend that the notice-filing scheme should be extended to cover security interests over personal property created by unincorporated businesses. It would replace the Bills of Sale Acts 1878 and 1882. This will require separate legislation.
1.4      The current law has been the subject of serious criticism for many years.^[3] It is claimed, for example, that the registration provisions for company charges are inefficient; those for other businesses are extremely complex and restrictive. Neither set of provisions gives a complete picture of which of a debtor's apparent assets are in fact encumbered by a security interest. The priority rules are complex, sometimes uncertain in their operation and frequently inappropriate to modern needs. The law on the remedies available is full of distinctions that make little functional sense.
1.5      The notice-filing scheme that we provisionally recommend is not our invention. It is a scheme whose essential features were devised in the United States over fifty years ago as Article 9 of the Uniform Commercial Code (UCC). Article 9 has been hailed as a great success.^[4] A similar scheme was adopted in Ontario in 1967 and Personal Property Security Acts (PPSAs) have now been enacted in all but one of the Canadian provinces. Most recently, New Zealand adopted a PPSA^[5] that follows the same model. Adoption is under active consideration in Australia^[6] and Singapore.^[7] Notice-filing also forms the basis of a Model Law promulgated by the European Bank for Reconstruction and Development.^[8] Legislation based on this model has been adopted in ten jurisdictions of Central and Eastern Europe. Not only have we been able to draw on these earlier legislative schemes, we are also able to draw on the years of experience of their operation in North America. We must not assume that what has worked well in North America will necessarily work as well here; but the fact that Article 9 and the PPSAs have been so successful means that they deserve very careful consideration.

The importance of credit and of security

1.6      Credit is vital to business, both to support the start-up or expansion of a business and to finance its operating costs in relation to staff, premises, equipment and the various stages of dealing with its products or services. Many of these costs will be incurred before the final products or services are sold in the marketplace, and even then the customer may delay payment, whether by agreement or otherwise. In order to cover these costs a business will frequently need to borrow funds or to delay payment to its own suppliers. As the Cork Committee put it, '[c]redit is the lifeblood of the modern industrialised economy'^[9] - words that are as true today as when they were written in 1982.
1.7      Those who lend or who supply goods or services on credit will often take steps to protect themselves against the risk of the business to whom they are supplying becoming insolvent before it has repaid what it owes. This protection can be achieved by taking security (usually in a non-possessory form, such as a mortgage or charge), or, when goods are supplied on credit, by the supplier retaining title to goods until payment is made, as with a conditional sale or a hire-purchase agreement. The fact that the loan or credit is effectively secured will usually mean that the charges for credit will be lower than if the credit were unsecured.^[10] Secured credit is thus seen as being of great importance to the economy. As Professor Goode has put it:

Security in personal property has become enormously important both within a country and in relation to cross-border transactions. Without an adequate legal regime for personal property security rights, it is almost impossible for a national economy to develop.^[11]

1.8      It is no doubt possible to exaggerate the importance of secured credit. We have been told that its importance varies from one sector to another. Many large, public companies are apparently able to borrow as cheaply on an unsecured basis as on a secured one, as lenders see the risk of the company defaulting as low. Small and medium-sized enterprises, however, present a higher degree of risk to a creditor. For them, the ability to offer security to the creditor may be vital to their survival and growth. Even public companies frequently make use of forms of security. Many large projects are now carried out through 'single (or 'special') purpose vehicles' (SPVs), companies that are set up, often jointly between a number of public companies, for the particular project. The public companies that finance the SPV will normally wish to take security over any physical assets bought or built by the SPV, as well as the stream of income from the ultimate client by whom the project was commissioned. Secured financing is also a crucial feature of financial markets.^[12]

Terms of reference

1.9      The reference for this project came from the Secretary of State for Trade and Industry, following a recommendation in the Final Report of the Company Law Review Steering Group.^[13] That Group developed a set of provisional proposals to establish a 'notice-filing' scheme, but had not had the time to discuss them widely.^[14] Our terms of reference require us to:

(1) examine the law on the registration, perfection and priority of company charges;

(2) consider the case for a new scheme of registration and priority of company charges, including charges created by

(a) companies having their registered office in England or Wales, wherever the assets charged are located; and

(b) oversea companies and companies having their registered office in Scotland, where the charge is subject to English law;

(3) consider whether such a scheme should apply both to security in the strict sense and to 'quasi-security' interests such as conditional sales, retention of title clauses, hire-purchase agreements and finance leases, including the extent to and means by which such interests should be made subject to the law governing securities;

(4) examine the law relating to the granting of security and 'quasi-security' interests by unincorporated businesses and individuals over property other than land, including the feasibility of extending any new scheme for company charges to such interests, and the extent to and means by which such 'quasi-security' interests should be made subject to the law governing securities; and

(5) make recommendations for reform.

The 2002 consultation paper

1.10      In July 2002 we published our consultation paper on Registration of Security Interests: Company Charges and Property other than Land (CP).^[15] The central provisional proposal of the CP was that a new scheme of 'notice-filing', and associated rules of priority, should replace both the current scheme of registration of charges created by companies under Part XII of the Companies Act 1985, and the scheme for charges created by non-corporate debtors over personal property under the Bills of Sale Acts. (In this consultative report we work on the basis that consultees will have read the CP or can refer to it.^[16])
1.11      In the CP we approached the matter in distinct tranches. We first examined how notice-filing for company charges could operate in general terms, and considered what charges should be registrable. We then asked whether a 'functional approach' should be taken, so that 'quasi-securities' would be included. We next considered whether the notice-filing system we proposed for companies should be extended to cover unincorporated businesses and individuals. Lastly we examined what degree of legislative statement of the law of security, if any, would be needed as part of any notice-filing reforms. (The alternative approach taken by the Company Law Review Steering Group, of making adjustments to the existing system, was dealt with in an Appendix to the CP.)
1.12      We received 68 responses to the CP, from a range of practitioners, academics and interested groups. The notice-filing scheme for the registration of company charges that we provisionally proposed, and its associated priority rules, received the broad support of all but a handful of consultees, though many consultees had particular reservations and some questions were raised about the effects of the scheme and its implementation. There was also broad support for our provisional proposal that the scheme should be extended to cover unincorporated businesses. The proposal to extend the scheme to include quasi-securities proved to be more controversial.^[17] Some consultees approved this proposal, others opposed it and the greatest number said that they wished to see how the scheme would operate in more detail before deciding whether it was justified. A particular question for many was whether the extension to quasi-securities should form part of the 'companies-only' scheme or should await extension of the scheme to unincorporated debtors.

Further consultation

1.13      The CP had been prepared and was published on the understanding that the best chance of implementing any legislative scheme was as part of the DTI's proposed wider reforms of company law arising from the Company Law Review process. This meant that the CP had to be produced in a shorter time than we would ordinarily have wished. As a result the scheme was not fully developed in the CP, and there was not time to meet with many interested groups before it was published. After the end of the formal consultation process we circulated a number of informal discussion papers and held meetings and seminars with interested groups, to help us to develop our policy.^[18]
1.14      Consultees have several times stressed that in order to be able to comment on our proposals in detail, they needed to know how our provisional proposals would actually be effected in legislative form. We agree. The purpose of this consultative report is therefore to explain how the scheme we provisionally recommend would operate and to seek comments, both on the overall scope of the scheme and on its detail, as set out in this consultative report and the accompanying draft legislation. Many of the issues dealt with in both the consultative report and the draft regulations are complex.
1.15      This further consultation has also had to be carried out within tight time constraints, in order to meet the DTI's timetable for wider company law reforms. It will not be possible for us to take into account comments received after the closing date for consultation, November 23, 2004. In order to maximise the time available to consultees, we are making this consultative report available on our website before printed copies can be made available.
1.16      Our terms of reference and the CP covered security interests created by debtors of all types. In this consultative report, however, we deal principally with security interests created by companies, and the draft legislation included in Appendix A is limited to companies and limited liability partnerships. Whilst we would prefer a scheme that would apply to at least all 'business' debtors (we have not at this stage reached any conclusions as to security interests created by consumer debtors), we have received clear advice not to insist on such an approach if there is to be any chance of implementation in even the medium-term. We are in any event of the view that the introduction of a scheme just for companies would have sufficient benefits to warrant adopting such a course, rather than insisting on an 'all or nothing' approach.
1.17      After analysis of responses to this consultative report, we plan to amend the draft regulations and publish a Final Report by the summer of 2005. That will set out our final recommendations on a scheme for security interests created by companies. Depending on the results of consultation, we expect that the Final Report will also address our final conclusions on the question of extending the scheme to non-corporate businesses (although it would probably not include any legislative provisions in this respect), and we hope that it may also be possible to make recommendations on security interests created by consumers.^[19]

Structure of this consultative report

1.18      In this Part we have set out a brief history of the project and developments since the publication of the CP. Below, we explain the derivation of the draft regulations and give a very short summary of the scheme we provisionally propose. In Part 2 we address what we consider to be the 'critical issues' raised by the new legislative scheme that we provisionally recommend, and we provide a brief overview of the main aspects of the scheme. In Part 3 we explain the central features in detail, and in Part 4 we deal with security interests over financial collateral, for which we recommend particular rules. In Part 5 we provisionally recommend the inclusion of a statement of the rights and obligations of the parties to a security agreement, which is aimed at clarifying and simplifying the law. Part 6 contains a list of our provisional recommendations and questions for consultation. We attach as Appendix A the draft regulations, with brief notes and cross-references to the text). We identify in Appendix B the changes that would have to be made to the legislation if a more limited scheme were to be introduced simply for 'traditional' securities and sales of receivables, rather than one that includes title-retention quasi-securities (as the draft legislation currently does).

The draft regulations^[20]

1.19      The draft legislation that accompanies this consultative report is in the form of regulations rather than a Bill. The work on this project has always been based on our understanding from the DTI that the most likely way of implementing any recommendations we make in this area would be by secondary legislation^[21] under a forthcoming Companies Bill.^[22]
1.20      In general terms, the draft regulations follow the equivalent legislation in force in all but one of the provinces of Canada. In the absence of an up-to-date version of the model Canadian statute, we have used the Saskatchewan Personal Property Security Act 1993 (SPPSA) as a model. The decision to use overseas legislation as a guide was taken partly due to constraints of time, and partly because we see no need to re-invent the wheel. Our draft regulations do, however, reflect policy variations and differences of English law and practice, which are sometimes significant. Moreover, in several areas covered by the draft regulations – particularly those concerned with financial collateral – the Canadian legislation is no longer up-to-date. The relevant law reform bodies in Canada have proposed amendments to the model PPSA law that follow Revised Articles 8 and 9 of the UCC, and we have broadly followed the same approach. In some places we have followed the provisions of the UCC more directly. We have also examined the New Zealand Personal Property Securities Act 1999 (NZPPSA). We are grateful for the work done by all those involved in the models upon which we have relied.
1.21      Unlike other schemes, our draft regulations are concerned only with security interests created by debtors who are registered companies, limited liability partnerships and, in some cases, companies incorporated outside England and Wales.^[23] However, this difference is reflected in only a few of the individual draft regulations, as in most cases the legislative wording would be identical regardless of legal personality.
1.22      There are some issues with which the draft regulations do not deal, such as the service of notices or the power of the Registrar to charge fees. These are better addressed in the Bill itself. However, the draft regulations contain some provisions that might ultimately be better placed in the Bill, but which we have included because of particular concerns of consultees that the issue should be addressed. An example is the meaning of 'knowledge';^[24] at a later stage it may be found to be equally applicable to other Parts of the legislation and be removed to the Bill. The draft regulations also contain a number of provisions that require something to be done within a certain time period. These time periods appear in square brackets in the draft regulations, to emphasise that as in many cases we have no strong view as to the appropriate length.^[25]

Summary of the scheme

1.23      The scheme that we provisionally recommend in this consultative report is in its essentials the same as that proposed in the CP. Some elements - particularly the proposals on security interests over financial collateral - are considerably more developed than they were at the earlier stage. Other topics - for example, the issue of security interests created by foreign companies - were touched on only briefly in the CP. Throughout there have been many refinements as the result of the responses to our formal and informal consultation and of further work.
1.24      In summary, the draft regulations apply to security interests created by companies registered in England and Wales (and, by consequential amendment, to limited liability partnerships). They also apply to security interests created by companies registered in Scotland or incorporated outside Great Britain over property in England and Wales (whether here at the time the security interest is created or when subsequently brought in) or to which the law of England and Wales would apply for the purposes of determining questions of perfection and priority.
1.25      The draft regulations define a 'security interest' in wide terms, to encompass interests in personal property that in substance secure payment or performance of an obligation. This will include not only what is treated by the current law as security (charges, mortgages and pledges), but also title-retention transactions that have a similar functional effect and various allied transactions, in particular sales of receivables – the so-called 'quasi-securities'.^[26]
1.26      The distinction between fixed and floating charges effectively disappears under the rules of the scheme. In effect the floating charge is replaced by a new form of security interest that has the same advantages to lender and borrower,^[27] but with fewer disadvantages to the lender.
1.27      The draft regulations set out when a security interest attaches and when and how it may be perfected (that is, what steps need to be taken to ensure as far as legally permissible, its effectiveness and priority against third parties). Perfection can be achieved in several ways, including by filing and possession. Special rules apply to 'investment property' (shares and other financial instruments) and bank accounts; with these, perfection can also be achieved by 'control'.^[28] Failure to perfect a security interest will result in loss of priority and ineffectiveness against the administrator, liquidator and other secured parties on insolvency.
1.28      A clear, detailed scheme of rules is established to determine the priority of conflicting security interests over the same 'collateral'. These include rules to give those who supply the funds for the acquisition of the relevant collateral priority over prior financiers (by way of the 'purchase-money security interest'), and for those who choose to perfect their security interest by a particular method.^[29] Rules are also included to determine the position of those who buy collateral that is subject to a security interest.
1.29      The draft regulations set out provisional recommendations on perfection of a security interest by filing. However, not all the detail is contained in the draft regulations. It is more appropriate that much of it should be covered by Rules to be made at a later stage, probably by the Registrar of Companies for England and Wales, under powers created by any enabling Companies Bill.
1.30      Given the significant changes that the draft regulations would bring about, there would need to be a period of time before they came into effect. In addition, the draft regulations include transitional provisions. We provisionally recommend that if quasi-securities are to be brought within the scheme, there should be a relatively long transitional period in order to avoid the need to register most existing quasi-securities.

Scotland

1.31      At the time we were first approached by the DTI about this project, it was wondered whether some form of joint project between the Law Commission and the Scottish Law Commission (SLC) might be possible. However, for various reasons a separate reference was made to the SLC, in more limited terms than our own. At the end of 2002 the SLC published its Discussion Paper on Registration of Rights in Security by Companies,^[30] in which it made provisional proposals which did not involve any form of 'notice-filing'. At the time of writing this consultative report the SLC has yet to publish its final recommendations.
1.32      At present the Companies Act 1985 imposes a similar registration regime, although the substantive law of security is different in the two jurisdictions. If a scheme along the lines of that provisionally proposed by the SLC were to be implemented, the registration schemes operating under Scots law and English law would be different, even were English law to remain unaltered. In Scots law, only floating charges would be registrable; the charge would have to be registered as a condition of its validity; and it is possible that the charge document itself might have to be registered.^[31] Were our proposals to be implemented the divergence would be greater still. Final policy in this area will depend on how, if at all, the provisions of the Companies Act 1985 are to be modified or replaced in relation to Scottish companies. If the provisional proposals by the SLC were to be enacted it seems likely that there would have to be changes to the present arrangements for 'cross-border charges', whether or not our proposals were implemented.

Consultation questions

1.33      In this consultative report we have followed our usual practice of highlighting in bold text our provisional recommendations and specific questions for consultees. However, we would welcome comments on any aspect of the scheme, whether or not it is the subject of a specific question, and on any of the accompanying draft regulations.
1.34      We would particularly welcome comments on the costs to which the scheme might give rise and the benefits that it might bring. This issue is addressed in Part 2 in particular but is one that we hope consultees will address on each point discussed in the consultative report.

Acknowledgements

1.35      A full list of acknowledgements will be published as part of our Final Report, but at this stage we express our thanks to the many people who have helped us since the publication of the CP, and acknowledge our debt to all of them. Professor Harry Sigman, Professor Sarah Worthington, Louise Gullifer and Professor Sir Roy Goode QC have acted as consultants. Kate Gibbons, Dr Dermot Turing, Andrew Dickinson, Malcolm Turner, William Glaister and Marisa Chan of Clifford Chance, and Graham McBain, have helped on several occasions and have given us valuable advice. We have met and been advised by various practitioners, including working groups from the Company Law Committee of the Law Society, the Banking Law sub-committee of the City of London Law Society, the British Bankers' Association, the Finance and Leasing Association, and the Factors and Discounters Association, as well as Martin Brassell and Professor Iwan Davies on behalf of HPI. Professor Ian Fletcher, Professor Robin Morse, Professor Jacob Ziegel, Dr Joanna Benjamin, Philip Wood and Dr Frédérique Dahan have also given us help and advice, as have the firm of SJ Berwin. We are also grateful for the help and advice given by members of the Insolvency Service and the Financial Services Authority. The contents of this consultative report are, of course, our responsibility and ours alone.
1.36      We are also grateful to the Society for Advanced Legal Studies, Norton Rose, Clifford Chance, Allen & Overy, Berwin Leighton Paisner and Freshfields Bruckhaus Deringer for their help in organising and hosting a series of seminars, and to all those who attended those seminars.
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Note 1    Mortgages and charges over land and various other assets for which there is a specialist register would be excluded: see below, para 2.20.    [Back]

Note 2    See below, para 1.10. We have, however, circulated on a limited basis a number of draft papers which have formed the basis of discussion at a number of seminars: see below, para 1.13.    [Back]

Note 3    Eg, Report of the Committee on Consumer Credit (1971) Cmnd 4596 (the ‘Crowther report’), Parts IV and V; A L Diamond, A Review of Security Interests in Property (1989) (the ‘Diamond report’). For details of the criticisms, see below, paras 2.3-2.5.    [Back]

Note 4    See further below, para 2.129.    [Back]

Note 5    Personal Property Securities Act 1999.    [Back]

Note 6    See CP para 1.44, and (2002) 14 Bond LR.    [Back]

Note 7    See G McCormack, “Reforming the Law of Security Interests: National and International Perspectives” [2003] Singapore JLS 1.    [Back]

Note 8    CP para 1.47.    [Back]

Note 9    Report of the Review Committee on Insolvency Law and Practice (1982) Cmnd 8558, para 10, quoted in the Diamond report, para 8.1.7.    [Back]

Note 10    There may be other reasons for taking security: see R Goode, Legal Problems of Credit and Security (3rd ed 2003) paras 1-01-1-02 (pp 1-3).    [Back]

Note 11    R Goode, “Security in Cross-Border Transactions” (1998) 33 Texas ILJ 47, referred to in I Davies, “The reform of English personal property security law: functionalism and Article 9 of the Uniform Commercial Code’’ (2004) 24 LS 295. Both authors note that this thinking has informed initiatives by the World Bank, the European Bank for Reconstruction and Development, UNCITRAL and UNIDROIT.     [Back]

Note 12    We are most grateful to Mr Philip Wood for graphic information on the use of secured lending.     [Back]

Note 13    Modern Company Law for a Competitive Economy: Final Report URN 01/942, ch 12.    [Back]

Note 14    See Registration of Security Interests: Company Charges and Property other than Land (2002) Consultation Paper No 164, paras 1.12-1.15.    [Back]

Note 15    Registration of Security Interests: Company Charges and Property other than Land (2002) Consultation Paper No 164.    [Back]

Note 16    The CP is available on the Law Commission’s website: http://www.lawcom.gov.uk.    [Back]

Note 17    The principal concerns are addressed in Part 2. We will note the views of consultees on other issues as they arise during the course of this consultative report.    [Back]

Note 18    Amongst these included seminars in September and October 2003 hosted by the Society for Advanced Legal Studies, Norton Rose, Clifford Chance, Allen & Overy and Berwin Leighton Paisner (the Law Commission was not in a position to proceed with a seminar planned to be held at Freshfields Bruckhaus Deringer).     [Back]

Note 19    We consulted on the question of including consumers in the CP, although we received fewer responses than for businesses, and we are continuing work on this area.    [Back]

Note 20    For convenience, although we use the term ‘draft regulations’, we will use the term ‘DR’ when referring to a particular numbered draft regulation contained in Appendix A.    [Back]

Note 21    We have been advised that even if the scheme were not, in the first instance, to be confined to companies it would be preferable to have a short Bill and the details of the scheme in secondary legislation.    [Back]

Note 22    As a result, instead of the approach generally taken by the PPSAs, of having the main provisions in primary legislation with detailed additional requirements introduced by secondary legislation, we are proposing that any Companies Bill which implements our draft regulations give the Registrar rule-making powers in certain areas (such as determining the exact detail of a financing statement): see below, para 1.29.    [Back]

Note 23    However, there are provisions relevant to non-corporate debtors where transfer of collateral between different types of debtor is concerned.     [Back]

Note 24    See DR 10.    [Back]

Note 25    We have also used the concept of ‘business days’, a term already used in the Civil Procedure Rules, but again we have no strong views on this issue.    [Back]

Note 26    Although the draft regulations apply to quasi-securities, we make clear that this is an issue open to consultation. In Appendix B we indicate the few provisions of the draft regulations that will need to be amended in order to allow for a scheme to be introduced that applied only to ‘traditional’ securities and sales of receivables.    [Back]

Note 27    Ie, enabling the debtor to continue to dispose of the property that is subject to the charge without the secured party’s consent for each disposition.    [Back]

Note 28    Perfection by control will bring priority benefits over perfection by another method.    [Back]

Note 29    Eg, by control rather than filing, in the case of investment property and bank accounts.    [Back]

Note 30    Discussion Paper on Registration of Rights in Security by Companies (2002) Discussion Paper No 121 (DP No 121).    [Back]

Note 31    DP No 121, in particular paras 2.11, 3.12, 4.12 and 5.11.    [Back]