The Law Commission

 


PART 3

THE SCHEME IN FULL

3.1     In Part 2 we explained the critical features of the legislative scheme we provisionally recommend. This Part contains a detailed discussion of the features of the scheme for registration (filing) and priority of SIs over personal property in general (where these have not been dealt with in Part 2), and is intended to indicate how we anticipate the scheme as a whole operating.
3.2     There are two significant aspects of the scheme that we do not deal with in any detail in this Part. One is how the scheme will operate in relation to financial collateral. This is a complicated area, often of specialist interest, and for reasons of clarity of exposition we have chosen to separate it out as a whole in Part 4 (although cross-references will be made to Part 4 when appropriate in this Part).^[1] The other is the statement of the rights and obligations of the parties and the remedies on default. This aspect is dealt with in Part 5.
3.3     In Part 2 we sought consultees' views on the question of whether the notice-filing system we provisionally recommended should include quasi-securities.^[2] In order for consultees better to assess this question, the explanation of the scheme in this Part deals with 'traditional' securities and 'quasi-securities' together, as do the draft regulations. In other words, we do not follow the approach we took in the CP of first establishing a scheme for company charges, and then considering how it could be extended to quasi-securities. Appendix B contains a list of those provisions of the draft regulations that would be removed or varied were the scheme to be introduced only for traditional securities. These are, in fact, few.

Structure of this Part

3.4     In this Part we begin by addressing the scope of the scheme we provisionally recommend, in terms of the persons and interests affected. We then deal with questions of attachment and perfection, and explain in detail the different methods of perfection over collateral other than financial collateral (which is dealt with separately in Part 4 due to the complexity of the issues involved). We then explain the scheme of priorities, the relationship of our scheme to the 'specialist registries'; how the scheme will apply to SIs created over assets outside the jurisdiction by companies registered here and to SIs created by companies registered in Scotland or incorporated outside Great Britain; and the transitional provisions envisaged for the scheme. An explanation of the rules forming part of the statement of the rights, duties and remedies of the parties will be dealt with in Part 5.
3.5     In this Part -and others- we highlight in bold text our provisional recommendations and also questions on which we would particularly welcome assistance from consultees. We would welcome views on any aspect of the scheme or the draft regulations.

Scope of the scheme

3.6     In essence the scheme applies to SIs over personal property created or provided for by companies (and which will by consequential amendment extend to LLPs, as do the current company charge registration provisions). We take each of these elements in turn, dealing with 'companies' and 'personal property' in this section and 'security interests' in the next.

Companies

3.7     The effect of the draft regulations is that they apply to SIs created or provided for by a debtor who is one of the following persons:^[3]

(1) a company registered in England and Wales (as defined under the Companies Act 1985 or its successor),

(2) an LLP,^[4] or

(3) a company registered in Scotland or a company that is incorporated outside Great Britain, if the relevant assets are in England and Wales (or to which the law of England and Wales would apply, for example a bank account that is governed by English law).^[5]

For the remainder of this Part we shall refer to such persons collectively simply as 'companies'.

Unregistered companies

3.8     The draft regulations have been drawn up to apply only to registered companies. In the CP we provisionally proposed that unregistered companies should be included within the scheme,^[6] and there was broad support from those who addressed this issue. On further consideration it seems to us that the issue of including companies which have not been registered is quite wide, and is really a question relating to which bodies corporate should be included. Bodies corporate can take several forms, for example, those incorporated by Act of Parliament or by Royal Charter, or public benefit corporations such as NHS foundation trusts; these can be subject to their own specific rules. In the case of industrial and providential societies, for example, there are additional requirements to register charges with the Financial Services Authority.^[7] We would welcome views on whether the scheme we provisionally propose should be limited to registered companies and LLPs, or should apply also to other corporate bodies; and if so, as to which corporate bodies should be included.

The person creating the SI and the 'debtor'

3.9     It is important to note that the scheme is one that applies to SIs created or provided for by registered companies (and LLPs). It is the legal personality of the person creating the SI that is critical to the application of the draft regulations. The secured party can have any form of legal personality.^[8] Likewise, buyers and other persons who may be affected by the operation of the draft regulations need not be companies.
3.10     For the most part the scheme will apply to SIs when the debt or obligation secured is owed by a company, but this will not always be the case. A person may create an SI in order to secure a debt or other obligation owed by a third party. If the person creating the SI is a company, the scheme will apply, whether or not the person who owes the debt or obligation is also a company.^[9] In the converse case in which an individual creates an SI to secure a debt owed by a company, the 'companies-only' scheme described in this Part will not apply.^[10]
3.11     This is linked to the definition of 'debtor'. In the majority of cases the party creating the SI and the person owing the obligation secured will be one and the same. However, 'debtor' is defined as a person who owes payment or who is liable to perform the obligation secured, whether or not that person owns or has rights in the collateral;^[11] and 'debtor' can, according to the context, either refer only to the person who has the interest in the collateral, or to the person who owes the obligation secured even though it does not have rights in the collateral, or to both.^[12] This follows the PPSA model. We recognise that it is a bit cumbersome. However the approach of UCC Article 9, which designates the party who creates the security as the debtor and the party who owes the debt or other obligation as an 'obligor',^[13] seems to us even more awkward. It seems counter-intuitive to refer to the person who does not owe the debt as the 'debtor', and we find the use of 'obligor' (and by implication, obligee) confusing – quite simply, it is very easy to muddle who owes and who is owed the obligation. We have therefore kept to the PPSA model.
3.12     The situations covered by the scheme may involve a third type of debtor. Where security is taken over a company's accounts receivable, for instance, there are two 'debtors': the company and the party who is liable on the receivable. We use the term 'account debtor' when referring to a person who is obligated under an account.^[14]
3.13     The definition of debtor also covers expressly those persons who create 'deemed' SIs, which do not secure payment or performance of an obligation: for example, the outright sale of an account receivable. We deal with this point in more detail later in this Part.^[15]
3.14     We would welcome advice on whether we should continue to use a definition of 'debtor' that may refer to either the party creating the SI or the party whose obligation is secured, where they are not the same person, or both.^[16] If not, should we refer to the first as 'the debtor' and the second as 'the obligor', as does the UCC; or do consultees have other suggestions?

Agents and trustees

3.15     The scheme set out in the draft regulations applies not only to parties that act on their own behalf but also to those who act as agents or trustees for others. Thus a company that creates an SI may be the title holder for assets of a group of companies which the group as a whole seeks to use to raise money. In such a case there may be questions as to whether the company is the 'debtor' in both of the senses above or whether each of the companies in the group is separately liable for its share of the obligation secured.
3.16     Equally, a secured party may hold an SI for its own benefit or for the benefit of others. The definition of 'secured party' covers a person who holds an SI beneficially and one who holds an SI for the benefit of others including, where the SI is embodied in a security trust deed, the trustee for the holders of debt obligations.^[17]

Personal property

3.17     In the draft regulations we use the term 'collateral' to refer to personal property that is subject to an SI. Personal property can comprise different types of asset, including goods, documents of title, instruments, accounts, money, investment property, bank accounts and intangibles. Each of these categories is defined in the draft regulations.

Goods

3.18     Goods are defined as tangible personal property^[18] other than documents of title, instruments, money and certain tangible forms of investment property.^[19] A company can hold goods either as inventory or equipment. The definition of inventory is wide: it includes goods which are held for sale or lease, furnished under a contract of service, raw materials or work in progress, or materials used or consumed in a business. 'Equipment' is defined simply as goods that are not held as inventory.^[20]
3.19     Many types of goods now incorporate software without which the goods cannot be used. To date English law does not have specific rules on this; the software is treated as goods, at least where it is already embedded in the goods or comes on a disk or other tangible medium.^[21] We do not think it necessary that the scheme should follow the UCC approach of expressly including 'embedded software' within the definition of goods.^[22]

Instruments and documents of title

3.20     'Instrument' refers to negotiable instruments. The definitions of instruments and documents of title are limited to paper documents although for other purposes, a document can be in electronic format.

Accounts

3.21     An 'account' is defined as being a monetary obligation (whether or not earned by performance), and will cover book debts and other receivables.^[23] Monetary obligations evidenced by an instrument are excluded from the definition, as are investment property and bank accounts. Certain rights to payment for money or funds advanced or sold are also excluded, as with the UCC. This exclusion exists to prevent loans being classed as accounts (for example, where a lending bank credits its borrower's bank account for the amount of the loan, this advance of funds is not a transaction which gives rise to an account). It also effectively excludes from the definition of accounts the sale of loan participation (that is, where the original lender sells part of the loan, and the security given with respect to it, to a third party). The sale of loan participation will fall entirely outside our scheme.^[24]

Intangibles and money

3.22     'Intangibles' form a residual category defined on an exclusionary basis: it is personal property that is not goods, a document of title, an instrument, investment property, an account, a bank account or money. Licences are expressly included.
3.23     'Money' means coins and notes in valid currency.^[25]
3.24     The definitions of investment property and bank accounts are dealt with in Part

'Chattel paper'

3.25     Unlike the UCC and PPSAs, our provisionally recommended definition of personal property does not refer to 'chattel paper', nor does our scheme have special rules for it. Parties who have disposed of inventory by way of conditional sale, hire-purchase or finance lease may use the income stream as a form of collateral as under a block discount arrangement. In North America it appears that the transaction is often effected by a physical transfer of the document recording the agreement; the effect of the North American legislation is that physical transfer of the chattel paper to the secured party transfers both (a) the right to the payments due and (b) the transferor's right (by virtue of its retained ownership) to repossess the goods on default.^[26] This transfer of 'chattel paper' is subject to special rules of priority under the UCC and PPSA schemes. We have consulted experts in the finance industry who tell us that there is no equivalent practice in the UK of handing over the physical document or of always transferring the right to repossess to the assignee of the debt that is due under the agreement. Therefore no special rules for chattel paper are required. The right to payment may be transferred by assignment like any other account; if necessary, the right to repossess can equally be assigned to the transferee of the account.

Security interests

3.26     The concept of the 'security interest' is fundamental to the scheme. The definition in the draft regulations is wide enough to capture both those interests that are currently regarded by the law as being security and interests that are not so regarded, but which have a security purpose. As we noted in Part 2, the question of whether the term should include quasi-securities divided consultees; quasi-securities have been included in the draft regulations so that consultees may evaluate the scheme properly.^[27]
3.27     The definition is intended to be sufficiently flexible to accommodate the emergence of new forms of transaction that have a security purpose, and therefore does not simply comprise a closed list of particular transactions or devices currently used by business. Commentators sometimes refer to those interests that have a security purpose (whether comprising what would currently be 'traditional' security or quasi-securities) as 'in-substance' SIs.
3.28     The definition of an SI in the draft regulations also includes sales of accounts and promissory notes, as well as those commercial consignments and leases for a term of more than one year that do not have a security purpose. These are sometimes referred to by commentators as 'deemed' SIs (although neither the term 'in-substance' nor 'deemed' appears in the draft regulations). The distinction between 'in-substance' SIs and 'deemed' SIs is important in relation to the application of the scheme's rules relating to the rights and remedies of the parties on default under the security agreement. As we discuss later, these provisions apply only to 'in-substance' SIs and not 'deemed' SIs.^[28]
3.29     For the purposes of discussing our proposed definition of 'security interest', we consider the position of 'in-substance' SIs and 'deemed' SIs in turn.

'In-substance' SIs

3.30     As drafted for the purposes of consultation, the definition of an SI means 'an interest in personal property which secures payment or performance of an obligation'.^[29] This is without regard to the form of the transaction which creates or provides for the interest or to the person who has title to the collateral. This definition is thus wide enough to encompass those devices currently regarded by English law as security, such as mortgages, charges and pledges, and title-retention devices such as conditional sales, hire-purchase agreements and finance leases, as they can be said to have a security purpose.
3.31     For the avoidance of doubt, DR 3(2) sets out in paragraph (a) those transactions that clearly have a security purpose and in paragraph (b) those that may or may not. For example, a lease may have a security purpose if it is what is commonly termed a finance lease, but an 'operating' lease does not have a security purpose.^[30]
3.32     Whether the interest secures payment or performance of an obligation is not a question of the intention of the parties or merely of interpretation; it is one of characterisation of the transaction to which they have agreed.^[31] Thus whether a lease has a security purpose (and so is what we refer to as a 'finance' lease) or not (and so is what we term an 'operating' lease) will depend on factors such as whether the lessee is required to pay the bulk of the capital cost of the equipment; whether after that period the lessee has the right to continue to use the equipment for a reduced payment; whether if the equipment is not required by the lessee it is to be returned to the lessor or sold by the lessee as agent for the lessor; how the proceeds of any disposition are to be divided between the lessee and lessor; and who bears responsibility for maintenance of and repairs to the equipment during the currency of the lease.^[32] We have not thought it necessary to list these factors in the draft regulations, but it would be possible to do so if consultees think that would be desirable.^[33]
3.33     On the assumption that the scheme should apply to quasi-securities, we provisionally recommend that the definition of 'security interest' should encompass all those transactions that have a security purpose, irrespective of the form of the transaction or who has title to the collateral.

'Deemed' SIs

3.34     In addition to providing the 'in-substance' test for an SI, the definition in the draft regulations also provides that the following are SIs:

(1) sales of accounts and promissory notes;

(2) leases for a term of more than one year that do not secure payment or performance of an obligation, and

(3) commercial consignments that do not secure payment or performance of an obligation.

The common feature is that none of the above transactions secures payment or performance of an obligation. They would fail the 'in-substance' test, and unless they were expressly brought within the definition, they would not be SIs.^[34] Thus they are informally said to be 'deemed' rather than 'in-substance' SIs.

3.35     This means that a transfer of accounts receivable, for example, is a 'security interest' within the meaning of the scheme whether it is a transfer by way of charge (when it will be an 'in substance' SI) or an outright sale of the accounts (when it will be a 'deemed' SI). However, it is very important to note that although these 'deemed' SIs will be subject to the rules of the scheme in relation to attachment, perfection and priority, they fall outside the rules on surplus and the scheme of remedies that we discuss and provisionally recommend in Part 5. Thus if the lessee (the debtor) under an operating lease defaults, the remedies of the lessor (the secured party) will be those provided by the lease agreement and even if the re-possessed equipment is worth more than the outstanding debt, there will be no question of the lessor having to pay any surplus to the lessee. For the avoidance of doubt, we have made this point plain on the face of the draft regulation dealing with the meaning of SI.^[35]
3.36     The reason for including these types of interest within the scheme for perfection and priorities is that first, they are difficult to distinguish from transactions that give rise to an interest that has a security purpose; and, secondly, if they are not given 'publicity', they may be equally misleading to third parties, including other secured parties and buyers, who may not realise that the asset in question is not the property of the company. All the overseas schemes include provisions relating to sales of accounts and commercial consignments, but they vary over leases. We take leases first.

Leases that do not have a security purpose

3.37     The UCC Article 9 does not apply to leases that do not have a security purpose, but we are told that in practice leasing companies find it easier to register all leases of any length, since it costs little and can do no harm.^[36] Virtually all of the Canadian and New Zealand schemes build on this practice by requiring that operating leases be registered unless they are of less than a year's duration (to avoid catching short-term rentals of such things as vehicles or plant-hire).^[37] Thus it is only in the small minority of cases in which there is a default that it will become necessary to determine whether a lease of goods, for instance, was a finance lease or an operating lease.^[38] In the CP we asked whether all leases should be registrable (if over a certain minimum period), or only those that have a security function.^[39] The majority of those who responded favoured the first option.
3.38     We provisionally recommend that leases for over one year that do not have a security purpose should be brought within the definition of 'security interest' for the purposes of perfection and priority.
3.39     The definition in the draft regulations of 'lease for a term of more than one year' includes not just the obvious lease of goods for a term of more than one year, but also leases for an indefinite term; leases for one year or less where the lessee, with the lessor's consent, actually remains in possession of the goods for more than a year,^[40] and a series of short, renewable leases that together add up to more than one year.^[41] It should be noted that, in common with the PPSAs, the definition of 'lease for a term of more than one year' only applies where the lessor is regularly engaged in the business of leasing goods.^[42]
3.40     We have said that leases (and consignments) that do not have a security purpose fall outside the scheme of remedies. Moreover, some of the other non-default based rules will only apply to 'in-substance' SIs, such as the right of the debtor to demand certain information from the secured party.^[43] Of course leases of whatever length (and consignments) may have a security purpose, and hence may fall within the 'in-substance' definition of an SI; and when they do so the normal provisions, including the remedies for default, will apply. We ask whether consultees agree with the way 'lease for a term of more than one year' has been defined in the draft regulations.

Commercial consignments that do not have a security purpose

3.41     The issues relating to consignments are parallel to those for leases. As we noted in the CP,^[44] a consignment may be for a financing purpose or some other commercial purpose. For example, 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. We asked whether a consignment should be registrable only if it secures payment or performance of an obligation, or whether it should be registrable whatever its purpose. Again a majority favoured registration whatever the purpose.
3.42     A commercial consignment is, in effect, one where both the consignor and consignee in the ordinary course of their businesses deal with goods that are delivered for sale, lease or other disposition by way of consignment.^[45] Therefore there is no need to file for the occasional consignment for sale. The delivery of goods for auction is also excluded.
3.43     We provisionally recommend that commercial consignments that do not secure payment or performance of an obligation should nonetheless be 'deemed' to be SIs.

Sales of accounts and promissory notes

3.44     We have explained in Part 2^[46] the reasons for bringing outright sales of accounts within the scheme, and have noted that the provisional proposal in the CP that all sales of receivables (for example under a factoring or block discounting agreement or a securitisation) should be registrable received^[47] widespread support, even among some who were opposed to bringing other forms of quasi-security within the scheme. Receivables now come within our provisionally proposed definition of 'accounts' in the draft regulations; an 'account' is defined in the draft regulations as meaning a monetary obligation other than investment property, bank accounts or monetary obligations evidenced by an instrument and certain rights to the payment for money advanced.^[48]
3.45     We have already noted that some transactions involving accounts have a security purpose. A charge over book debts, for example, would satisfy the 'in-substance' test of an SI. In contrast, a true sale of accounts does not have a security purpose, and would fall outside the 'in-substance' test described earlier. It will fall within the overall definition of an SI and be subject to the perfection requirements (that is, it will need to be filed) and to the rules of priority.^[49] The 'surplus' and 'remedies' provisions do not apply. In the CP we pointed out that the rules on default remedies, for example, accountability to the seller for a surplus, should not apply to outright assignments of accounts (receivables).^[50] If, for example, accounts are assigned outright on a non-notification basis under a block discount agreement and, because the assignor has become insolvent, the assignee notifies the account debtors and recovers the sums due, there should be no question of the discounter having to account for any 'surplus' to the assignor. There was general agreement with this. Thus the 'surplus' rule and the remedies for default set out in Part 5 will apply only if the assignment was by way of charge (that is, an 'in-substance' SI).^[51]
3.46     For the purposes of consultation we also include sales of promissory notes within the 'deemed' SIs. It is not even necessary to file in order to perfect such a sale (they are 'automatically perfected'^[52]) but they are subjected to the rules of priority of the scheme. This is an extension found in UCC Revised Article 9. We understand that it was made at the specific request of banks involved in securitisations.^[53] Promissory notes are apparently often sold as part of a securitisation but may not actually be handed over to the Special Purpose Vehicle.^[54] Apparently sales of promissory notes were included within Revised Article 9 to put it beyond question that the sale is effective against the trustee in bankruptcy. We would welcome advice as to whether the draft regulations should retain a similar provision.
3.47     If promissory notes are to be included, we would welcome views as to whether sales of bills of exchange should be similarly treated. For the present, we have not included such sales within the definition of an SI.^[55]
3.48     We provisionally recommend that sales of accounts should be treated as SIs for the purposes of perfection and priority.
3.49     We ask consultees whether, for the purposes of priority, sales of promissory notes should also be treated as SIs that are automatically perfected. We also ask consultees whether sales of bills of exchange should be treated as SIs in the same way as sales of promissory notes.

'Deemed' SIs and the definition of 'debtor'

3.50     The definition of 'debtor' in the draft regulations reflects our provisional recommendation that certain interests should be treated as ('deemed') SIs even though they do not secure payment or performance of an obligation. 'Debtor' includes a person who receives goods under a commercial consignment, a lessee under a lease for a term of more than one year, and the seller of an account or promissory note.^[56]

SIs in 'supporting obligations'

3.51     Although it is hard to find clear authority, we understand the current law to be that, if a right to payment is guaranteed or supported by an indemnity or letter of credit, and the right is assigned, the assignee is entitled to the benefit of the guarantee or indemnity, or to the proceeds of the letter of credit, without showing a separate assignment of the 'supporting obligation'.^[57] Even if it is not the current law, it seems a sensible rule; there seems very little point in requiring a separate assignment of the supporting obligation.^[58]
3.52     Such a rule has been included in Revised Article 9 of the UCC through the concept of the 'supporting obligation.' In essence, the UCC provides that if a monetary obligation such as an account is supported by a guarantee or indemnity from a third party, or by a letter of credit from a bank, then an SI created over the monetary obligation should of itself also create one over the 'supporting obligation'. There is no need for a separate assignment of rights over the guarantee or under the letter of credit, nor of separate filing or other means of perfection. Under the UCC there are specific rules on attachment, 'automatic' perfection and priority for supporting obligations.
3.53     For purposes of consultation we have included equivalent provisions within our scheme. The term 'supporting obligation' is defined in the draft regulations.^[59] It covers the right to proceeds of a letter of credit^[60] as well as guarantees or indemnities in respect of the non-performance of the principal obligation.^[61] However, a supporting obligation falls within the definition only if the principal obligation that it supports consists of an account, a document, an intangible, an instrument, or investment property.
3.54     Where an SI attaches in collateral, an SI attaches automatically in a supporting obligation for the collateral.^[62] Perfection of an SI in collateral also perfects an SI in a supporting obligation.^[63]
3.55     The draft regulations also provide that for the purposes of the 'residual' priority rules (which we explain below,^[64] but which essentially give priority to the first secured party to file or perfect its SI), the time of filing or perfection as to an SI in collateral supported by a supporting obligation is also the time of filing or perfection as to an SI in the supporting obligation.^[65] Like the UCC, we have provided that an SI in a supporting obligation has the same priority as an SI in the collateral which it supports.^[66] We have also included specific perfection and priority rules relating to control over the right to proceeds of a letter of credit. We deal with this aspect in more detail in Part 4, when we address the issue of financial collateral more generally.^[67]
3.56     Since we did not raise this issue in the CP or, in any detail, the subsequent informal seminars, we would particularly welcome the views of consultees. Before responding on this point they may wish to read the last section of Part 4, which deals with 'control' over the proceeds of letters of credit.^[68] This may be important if the assignment of the principal obligation were not perfected, or were the principal obligation to be assigned to two assignees.
3.57     We provisionally recommend that:

(1) where an SI attaches to a monetary obligation an SI attaches automatically to any supporting obligation for the collateral;

(2) perfection of an SI in the collateral also perfects an SI in the supporting obligation.

Partial and total exclusions from the overall scheme

3.58     The draft regulations exclude some interests from the application of the scheme, even though they would, or might arguably, fall within the wide definition of SI. All the overseas schemes have a similar list of excluded interests.^[69]
3.59     Some of these exclusions, for example, of interests over land, are total. Others are partial, in that the scheme applies only to the extent that it gives priority to such interests over conflicting SIs that are wholly within the scheme.
3.60     The complete exclusions are made for a number of reasons. Some are excluded for the avoidance of doubt even though, for example, we think there is no question of a proprietary interest arising; another group because they do not really have a 'financing purpose'; and the last group because SIs over the type of asset, or at least some SIs over them, are registrable in a specialist registry.
3.61     The interests that are partially excluded comprise:

(1) Interests arising through operation of law, such as liens. A common feature of all the overseas schemes we have looked at is that they apply to consensually-created SIs. We suggested having this exclusion in the CP.^[70] Consultees who addressed the question were unanimous that security created by operation of law should be excluded.^[71]) An issue that this exclusion does not settle is whether a special purpose trust - a Quistclose trust - is a consensual SI. We provisionally suggested in the CP that special purpose trusts should be 'outside the requirement to register', either because no security arises, or alternatively because any security arises through operation of law.^[72] A clear majority of those who addressed the question agreed with our provisional proposal, although there was disagreement amongst consultees as to the nature of a special purpose trust. This issue has been the subject of debate,^[73] and on further reflection we do not think our draft regulations should seek to determine the issue one way or the other. It should be left to the courts to determine the issue if and when it should arise in litigation. As the 'secured party' will in any event be able to preserve its position by filing a financing statement 'just in case' it is held to be a consensual SI,^[74] we do not think our position on this will cause significant problems.

(2) Rights of set-off. In the CP we proposed to exclude these because they do not purport to create proprietary rights.^[75] Almost all those who responded on the point agreed.^[76] The concept of set-off is referred to in relation to bank accounts.^[77]

3.62     Interests that are wholly excluded because the transactions do not have a 'financing purpose' are:

(1) Interests created or provided for by the transfer of an unearned right to payment under a contract to a person who is to perform the transferor's obligations.^[78] A further reason for this exclusion is that there is no risk of misleading third parties that the transferor retains rights under the contract.^[79]

(2) The assignment of accounts or promissory notes solely to facilitate collection on behalf of the person making the assignment.

(3) The assignment of a single account or promissory note to an assignee in full or partial satisfaction of a pre-existing indebtedness.^[80]

(4) The sale of accounts or promissory notes as part of the sale of a business.

3.63     Interests that are excluded because there is a specialist register are:

(1) The creation or transfer of any interests in land, including a lease.^[81] However, it is important to note that transfers of rights to payment arising in connection with an interest in land are not excluded, so that where, for example, the debt secured by a mortgage over land is factored by the land mortgagee, an SI would exist over that receivable which would fall within our scheme.^[82]

(2) Interests in ships, where the ship has been registered in the UK or abroad.^[83]

(3) Interests in aircraft, where the aircraft has been registered in the UK or abroad.

(4) Interests in intellectual property, where the intellectual property has been registered in the UK or abroad.

3.64     Lastly, there will be an exclusion for interests arising from the three categories of trust deed that underwriting corporate members of Lloyd's are required to enter in support of their underwriting business. In the CP we provisionally proposed that these should be exempted from the need to file because no potential creditor of the member would think that the member owned the assets outright.^[84] The majority of those who responded to this question agreed. We provisionally recommend that these trust deeds should be excluded from the scheme as a whole. We have not finalised the drafting of this exclusion in the draft regulations.
3.65     There are several exclusions found in the PPSAs which we have not sought to follow.^[85] Thus SIs over interests in insurance policies are included in our scheme: there was considerable support amongst consultees for our provisional proposal to this effect in the CP.^[86] Similarly we have not followed the PPSAs in excluding SIs over a right to damages in tort. We understand that in some situations these can be a significant asset, and there seems no real reason to exclude them. They are included in the UCC (although we have not sought to include any of the further specific rules that the UCC has in this respect^[87]).^[88]
3.66     We ask consultees whether there are there other interests that should be wholly or partially excluded from the application of the draft regulations.
3.67     We provisionally recommend that the interests listed in DR 12 should be excluded from the scheme. We provisionally recommend that SIs over insurance policies and tort claims should be within the scheme.

Effectiveness of a security agreement, attachment and perfection

3.68     Under current law an agreement for an SI such as a charge may have various effects according to what has been agreed and the circumstances.

(1) There may simply be an agreement that a security will be granted in favour of the creditor at some future date. This will give the creditor no more than a personal right against the debtor.

(2) There may be an agreement for a 'present' SI to cover property that the debtor acquires in the future. Obviously this cannot give the creditor the right to any piece of property until the debtor has acquired it; but it is more than a merely contractual right. Thus in Re Lind^[89] the debtor granted the creditor a mortgage over his expectant share in his mother's estate. The debtor then became bankrupt and was discharged. The discharge had the effect of releasing him from existing contractual obligations. Later he acquired the share. The Court of Appeal held that the mortgagee was entitled to the property; its rights were not affected by the discharge in bankruptcy.

(3) Where the debtor has the relevant collateral at the time of the security agreement, or has subsequently acquired it, and the creditor has given value, the creditor may have a right, as against the debtor and some third parties such as judgment creditors, to satisfy its claim from the collateral. This depends on whether the charge has attached to the collateral. A fixed charge will attach when the conditions just stated are satisfied; a floating charge will attach only when the charge crystallises, for example on the appointment of a receiver.

(4) However, where the debtor is a company, the creditor's rights may be invalidated as against a liquidator or adminstrator if the creditor has not 'perfected' the charge by registering it within the statutory period. Equally a charge that has not been duly registered will be ineffective against another creditor claiming the same piece of collateral. However, the first creditor's rights over the collateral are only ineffective to the extent provided by legislation. If the debtor defaults and the creditor enforces its rights without the debtor becoming insolvent or a second creditor acquiring enforceable rights to the same collateral, the creditor's actions are perfectly proper since it had an otherwise valid interest.

(5) Even a charge that has attached and that was properly perfected may of course not have priority.

3.69     As we explained in Part 2, the introduction of a notice-filing scheme would change these rules to some extent. Thus the distinction between a fixed charge and a floating charge would for practical purposes disappear, and the rules of priority would be altered. In other respects, however, the scheme would replicate the current position. In particular, a security agreement would be effective to give the secured party not just a contractual right against the debtor but rights that can be enforced against third parties, except to the extent that the scheme provides otherwise – for example, because the SI has not attached to the collateral or has not been perfected.

Effectiveness of security agreement

3.70     DR 14(1) states explicitly that a security agreement is effective according to its terms as between the parties, against purchasers of the collateral and other creditors and as against an administrator or liquidator, except as the draft regulations provide.

Attachment of SIs

3.71     For the secured party to have a right to any particular piece of collateral, it is necessary for the SI to 'attach'. We have explained that though this concept is used by some lawyers in England and Wales, consultation revealed that it was not a familiar concept. We provisionally recommend that it (and perfection) should be defined in the draft regulations.^[90]
3.72     Attachment is the point at which the secured party acquires a proprietary right in the collateral, and is a necessary step for perfection to occur. For clarity, the provision dealing with attachment is drafted so that three conditions have to be fulfilled; they can occur in any order.^[91] The first condition is that there has to be a security agreement that either of itself, or as the result of subsequent appropriation under it, sufficiently identifies the collateral. For example, if the agreement specifies no more than that the debtor will give an SI over equipment to be specified, and later the parties agree on specific items, or some items are delivered into the secured party's possession, the SI would attach to the items concerned.^[92] The second condition is that value is given, and the third is that the debtor has rights in the collateral or the power to transfer rights to a secured party.^[93] (Special rules relating to financial collateral are dealt with in Part 4.)
3.73     We have noted in Part 2 that under our scheme an SI may attach despite the fact that the debtor is given licence to dispose of the collateral free of the SI. This effects a change to what is currently the 'floating' charge.^[94]
3.74     It is perfectly possible under our scheme for the parties to agree that attachment will occur at a later time, for example, only in the conditions under which a floating charge would crystallise under current law. It is not clear, however, that it would be in either party's interest to do so. For the avoidance of doubt the draft regulation makes it clear that simply referring to a 'floating charge' in the security agreement does not amount to an agreement to defer the time of attachment.

Should the security agreement have to be in writing?

3.75     There is one significant difference between our provisional recommendations and the UCC and PPSA schemes. Those schemes require that before an SI can attach, either the debtor must have signed a written security agreement^[95] or the secured party must take possession of the collateral.^[96] In other words, an agreement is effective as a contract, and as an inchoate property right,^[97] between the parties whatever form it takes, but it will not give the secured party any right to a particular item of collateral unless the conditions just stated are met, along with the other requirements for attachment.^[98] We do not see the need to require that the security agreement be in writing.
3.76     Present law does not require writing for every kind of non-possessory security agreement. In the CP we provisionally proposed that a written security agreement signed by the debtor^[99] should be necessary for any non-possessory SI.^[100] There was unanimous support for this from those who commented. Further consideration, however, has led us to doubt our original proposal. It seems to us that it would be very difficult to define what must be in the writing, while the requirement of writing would be of very little value to any of the parties.
3.77     If a signed writing were to be required, we do not think it would be necessary that all the terms of the security agreement be included in it.^[101] It should however show that the parties have made 'a security agreement.' This is defined by the PPSAs as a writing which is or which evidences an agreement that creates or provides for an SI, either immediately or at some future date.^[102] It should also give some indication of the collateral. In the CP we proposed that the writing should give a sufficient description of the property so that it can be determined what assets fall within it.^[103] Consultees agreed, one questioning whether it is necessary to state something so obvious. Further study and reflection makes us think that actually the point is not so obvious, and has led us to question the need for any writing at all.
3.78     The Saskatchewan and New Zealand PPSAs differ in their requirements on this point, but have this in common: neither requires precise identification of the collateral. Commentators say:

The … description requirement is intended only to provide evidence consistent with a claim that a security interest has been taken in particular collateral. Extrinsic evidence may be necessary to identify individual items of collateral.^[104]

3.79     We can see the argument that an SI should not fail when it is quite clear that it was agreed and what it covered, but the written description of the collateral was only in general terms. However it is hard to see what useful purpose is served by this attenuated writing requirement. The secured party will have to prove that there was a security agreement that covered the particular item of collateral that it claims. If it can do that by using parol evidence, why should it matter that there is no writing signed by the debtor, when the debtor will be personally liable in any event, and when third parties will not be relying on the existence of a writing that in practice they will never see? In practice the secured party will file a financing statement or take possession or control; the fact that it has done one of those things and that the debtor has not objected seems to provide evidence of the existence of a security agreement of some kind. To require in addition a signed writing that does not have to identify the collateral precisely adds very little. It is just as likely that the formal requirement might – like so many formal requirements – work to defeat meritorious claims. We think that it is better not to include any formal requirement for security agreements created by companies but, when we consider the extension of the scheme to other debtors, to reconsider whether we need formal requirements that will protect the debtor from personal liability as well as affecting the position of third parties.
3.80     The Law of Property Act 1925, section 53(1)(c) does require a signed writing for the disposition of an equitable interest. As we will see in Part 4, this has already been disapplied in financial collateral arrangements, though 'writing' is required. We see no reason to retain section 53(1)(c) for SIs over other forms of property. That would merely perpetuate a distinction between legal and equitable interests when one of the aims of our scheme is to reduce the differences. This will not affect requirements for writing made by other legislative provisions, such as for the assignment or mortgage of certain sorts of intellectual property (where it comes within the scheme).^[105]
3.81     We provisionally recommend that for a non-possessory SI to attach there should be no requirement that a security agreement should be, or be evidenced, in writing (whether signed or not), and that the Law of Property Act 1925, section 53(1)(c) should, so far as it would otherwise apply, cease to apply to SIs under our scheme.^[106]
3.82     The draft regulations have also not replicated the provision in the SPPSA that obliges the secured party, where a security agreement is in writing, to deliver a copy of it to the debtor within 10 days after its execution. The NZPPSA does not have any such requirement though there is an equivalent one under the Credit Contracts Act 1981. In England and Wales there are requirements for agreements regulated by the Consumer Credit Act 1974; we see no need for further provisions.

Returned and repossessed goods: reattachment

3.83     As we will explain later, there are circumstances where a buyer or lessee of goods will take free of an SI in the goods.^[107] However, it may sometimes happen that the goods subsequently come back into the hands of the seller or lessor, for example, if they are returned because they are faulty, or if they were sold subject to a further SI and were repossessed on the buyer's default. There seems no good reason why the original SI should not then reattach to the goods. The PPSAs contain a provision that where goods have been sold or leased in circumstances in which the buyer or lessee takes free of the SI, and they have been returned to, seized or repossessed by the debtor, the SI will reattach to the goods if the obligation remains unpaid or unperformed.^[108] For the purposes of consultation, we have included a similar provision.^[109]
3.84     However, we understand that a similar provision to that contained in the PPSAs was originally included in former Article 9 of the UCC, but no longer forms a specific section of Revised Article 9.^[110] We are told that this was because the circumstances that gave rise to the operation of the section arose infrequently, and that the parties were usually able to resolve matters satisfactorily, without the need for legislative intervention.^[111] We would therefore welcome the view of consultees as to whether we should continue to include such a provision.
3.85     We ask whether the scheme should contain a provision dealing with the reattachment of an SI to goods which have been returned or repossessed.

Perfection of SIs

3.86     An SI will be perfected when it has attached and all the steps (if any^[112]) required for perfection by one of the methods allowed for in the draft regulations have been taken.^[113] It could be said that perfection means completing the steps to secure, so far as legally permissible and necessary, the effectiveness and priority of an SI as against third persons. However, it is important to note the caveat contained in that last sentence: 'so far as legally permissible'. Whilst perfecting an SI is necessary to take advantage of most of the rules of priority as against other SIs, perfection does not guarantee that an SI has priority over all other competing SIs: the draft regulations contain a series of priority rules which determine this issue, and in some cases a perfected SI may still 'lose' to a subsequent perfected SI (for example, a subsequent PMSI generally has priority over an earlier non-PMSI) or to a buyer.^[114]
3.87     Some commentators have remarked that in the overseas systems the word 'perfection' is used in two senses: (1) the steps that need to be taken in order to perfect an SI (for example, making a registration/filing, taking possession etc.) and (2) the status that is thereby achieved ('a perfected SI').^[115] This is correct, but the double sense does not appear to have caused practical difficulty in any of the systems. We have therefore - at least for this consultation - retained this familiar terminology in our draft regulations.
3.88     The draft regulations provide several ways in which an SI may be perfected. We have listed these in a single draft regulation,^[116] although each method has its own detailed individual provisions. The most significant methods of perfecting an attached SI are by taking the following steps:

(1) filing, or

(2) possession, or

(3) for financial collateral only, delivery or control.

3.89     There are a few cases in which an SI is treated as being perfected as soon as it attaches; in other words the secured party need take no further steps to perfect.^[117] This is sometimes referred to as 'automatic' perfection. Examples are the sale of a promissory note and SIs in supporting obligations.^[118] The only others relate to financial collateral.^[119] There are also special rules for goods in the possession of a bailee.^[120]
3.90     In certain situations an SI that has been perfected may continue to be treated as perfected for a short 'grace period' after the perfection has ceased, provided that the SI is re-perfected or perfected by another method within that period. An example is where a documentary intangible is released from the secured party's possession and handed to the debtor for certain limited purposes.^[121] This is referred to as 'temporary perfection'.
3.91     It is possible that an SI may be perfected initially by one method and subsequently by another – for example, a secured party might take possession of collateral and later file and hand the collateral back to the debtor. For priority purposes, provided that the SI has not been unperfected at any time, the SI is regarded as having been 'continuously' perfected, so that priority dates back to the start of the first form of perfection.^[122] There are additional provisions with regards to proceeds, which we will deal with below.^[123]

Methods of perfection in detail

3.92     In this section we go through the steps that can be taken to perfect an SI over collateral in general: in particular, possession and filing. (We refer to 'filing' rather than 'registration' to signal a clear break from the transaction registration approach currently used in relation to company charges. Some of the overseas schemes refer to one, some the other.) The forms of perfection applicable only to financial collateral are dealt with in Part 4.
3.93     It should be borne in mind that an SI achieves the status of a 'perfected SI' only when it has both attached and the steps necessary to perfect it in one of the ways detailed below have been taken.^[124] However attachment can occur before or after the steps below have been taken. This is an important point insofar as the priority system is concerned, as we shall explain later in this Part.^[125]

Perfection by filing

3.94     Following our general recommendations in Part 2, we provisionally recommend that the filing of a financing statement should be capable of perfecting an SI that has attached (whether before or after filing) over any type of collateral.^[126] We discuss the filing process in detail later in this Part, after we have explained the other methods of perfection.^[127]

Temporary perfection

3.95     The draft regulations contain several provisions under which an SI, having been perfected, will remain perfected for a short period of time despite the occurrence of events that would otherwise result in it becoming unperfected (or for which there is a short period of 'grace'). At the end of that period of time the SI will indeed become unperfected unless it has been perfected in the meantime. This is usually referred to as 'temporary' perfection (although some of the overseas schemes are not consistent in their usage of this term^[128]). One of the main examples is in relation to goods that have been in the possession of the secured party, but which are returned to the debtor for sale or preparation for sale.^[129] Others instances of temporary perfection involve proceeds, PMSIs in collateral other than inventory, and goods being brought into the country.^[130] We discuss each instance later in this Part.

Automatic perfection

3.96     In a limited number of cases in the draft regulations an SI is perfected without any particular step such as possession or filing having to be taken. Apart from sales of promissory notes and SIs over supporting obligations, which we discussed earlier,^[131] the other instances of automatic perfection relate to financial collateral, and we discuss these in Part 4.^[132]
3.97     There is one instance of automatic perfection which is found in the UCC but on which we have not for the present included in our draft regulations. The UCC provides that an assignment of accounts 'which does not by itself or in conjunction with other assignments to the same assignee transfer a significant part of the assignor's outstanding accounts…' is perfected when it attaches (in other words, is automatically perfected).^[133] The Official Comments note that the purpose of this provision 'is to save from ex post facto invalidation casual or isolated assignments – assignments which no one would think of filing'.^[134] The assignment will have priority over assignments that are filed later, but be subject to any that have been filed already. Although such a provision should not be relied on as a reason not to file, it may serve a useful purpose in preventing inadvertent non-perfection, and we would welcome the views of consultees as to whether our draft regulations should contain an equivalent provision.
3.98     Should the scheme provide that an assignment which does not by itself or in conjunction with other assignments to the same assignee transfer a significant part of the assignor's outstanding accounts will be automatically perfected on attachment?

Perfection by possession and goods in possession of bailees

3.99     In the CP we provisionally proposed that possessory securities should be left 'out of the scope of the notice-filing system', in the sense that filing would not be needed, save where the creditor's possession was constructive and resulted from the debtor attorning to the creditor.^[135] It was proposed that the scheme should deal with the relative priority of possessory and non-possessory SIs.
3.100     The vast majority of consultees who responded on this point agreed that registration should not be required for possessory securities. Those who disagreed argued that requiring filing would make the register more complete, and that creditors might lend on the basis of the known existence of the asset in question without checking that it was in the debtor's possession. We do not think that taking such a risk would be reasonable and we therefore recommend that possessory SIs should not be registrable; or, to put it in the terms used in the other schemes, possession should be an alternative method of perfection to filing. We provisionally recommend that actual possession of collateral by the secured party (or its agent) should perfect an SI in goods, an instrument, a negotiable document of title or money.^[136]
3.101     The draft regulations do not provide a definition of 'possession', but there are specific provisions dealing with certain forms of what might be said to constitute constructive possession.

Possession by a debtor who has attorned to secured party

3.102     In the CP we pointed out that where the collateral is in the possession of the debtor or debtor's agent, an attornment by the debtor will not suffice to perfect the SI: at least if it is in writing, it will require registration under the Companies Act 1985, section 396(1).^[137] We provisionally proposed that such attornments should have to be registrable under the notice-filing scheme. Consultees agreed. We provisionally recommend that where the goods are in the possession of the debtor or its agent, attornment to the secured party will not amount to possession by the secured party.^[138]

Possession of goods by bailees

3.103     We also provisionally proposed in the CP that where the goods are in the possession of a third party who attorns to the secured party, that should be treated as possession by the secured party. There was no dissent from this but on further reflection we think it is better to provide separately for such cases, so that, for the purposes of perfection, goods that are in the possession of a bailee are not regarded as being in the possession of the secured party.^[139]
3.104     We provisionally recommend that, where the goods are in the possession of a bailee other than the debtor, the SI may be perfected in three ways:

(1) by the bailee attorning to the secured party;

(2) by the bailee issuing a document of title in the name of the secured party; or

(3) by the secured party perfecting an SI in a negotiable document of title to the goods, where the bailee has issued one.^[140]

3.105     An SI can also be perfected by filing a financing statement, in accordance with the relevant rules.

Seized or repossessed goods

3.106     The PPSA schemes exclude from 'perfection by possession' the situation where the secured party comes into possession of the collateral as a result of seizure or repossession, typically after the debtor's default.^[141] The reason is to avoid a creditor who cannot produce a signed security agreement from seizing and repossessing the collateral and arguing that the 'possession' it obtained as a result is sufficient to fulfil the requirements of those schemes for attachment (that is, possession or a signed writing^[142]). We do not have such a requirement for attachment and, if the SI has attached, we see no reason to say that a secured party who failed to file but who has subsequently seized or repossessed the collateral has not thereby perfected its interest. Its SI would be subordinate to any other that had been perfected before it perfected.^[143]
3.107     We provisionally recommend that a secured party who has not perfected its SI by filing but who has seized or repossessed the goods should not be excluded from having possession of them for the purposes of perfection.

Trust receipts and temporary perfection

3.108     A pledgee of goods or documents of title may release them to the pledgor (the debtor) for a limited purpose, such as for sale as agent of the creditor, without losing its proprietary rights over the goods; the debtor signs a trust receipt agreeing to hold the proceeds for the pledgee. This is currently regarded as a method of securing the continuance of the pledge rather than as an independent security device, and trust receipts are not registrable under the current company charges registration scheme.
3.109     The treatment of this situation under the comparable schemes is rather different. They normally contain a specific rule that applies where there is an SI over an instrument that was perfected by possession, or over goods that were in the possession of a bailee who issued a negotiable document of title or attorned to the secured party. If the collateral is then returned to the debtor for specified purposes, the SI remains perfected for a limited period of time (for example, 15 days) but thereafter will become unperfected unless steps are taken to perfect it before the end of that period. (In practice, this will mean filing a financing statement, which can be done before the goods are returned.) As we have noted, the effect of temporary perfection is that the SI will maintain its priority against other SIs over the same collateral and will be effective in the event of the debtor's insolvency.^[144] Buyers of the goods or transferees of the document of title will take free of the temporarily perfected SI unless they actually know of it.^[145]
3.110     In the CP we asked whether we should adopt a similar rule.^[146] The question was not as well phrased as it could have been; the majority were opposed to the suggestion but for divergent reasons, some thinking that the idea was right but the period too short, others that filing should be required immediately. (None appeared to think that filing should not be required however long the collateral remained in the debtor's hands.) Some consultees^[147] argued that the idea was sound but that it would be unduly burdensome to require filing in a shorter period than the normal trade cycle of 90 days. However, as far as priority over competing SIs is concerned, we think 90 days is too long a period. True, it is unlikely that unsecured creditors (who are the ones affected by the effectiveness of the SI in insolvency) will change their position in reliance on the debtor's apparent possession of the goods in less than 90 days, but we are concerned that other secured parties might lend on the apparent security of the goods. Given that the secured party to protect itself only needs to file, which will be simple and cost little in time and money,^[148] we suggest that the SI should remain temporarily perfected for a period of 15 business days. The draft regulations provide accordingly.^[149]
3.111     This provision applies to instruments and certificated securities, negotiable documents of title, or goods held by a bailee that are not covered by a negotiable document of title, that are made available to the debtor to enable the debtor to sell or exchange them or, in the case of instruments or certificated securities, for enforcement and registration.^[150]
3.112     We provisionally recommend that where an SI over instruments or certificated securities has been perfected by possession, or one over goods in the possession of a bailee has been perfected by the bailee issuing a negotiable document of title or otherwise, if the collateral or document of title is returned for specified purposes, the SI should remain perfected for a limited time thereafter. We ask whether 15 business days is an appropriate period.

Filing

3.113     Perfection by filing is likely to be the most common form of perfecting an SI over collateral other than financial collateral.^[151] As we noted in Part 2, we think it necessary that the filing system should operate on a wholly electronic basis (although this does not appear as a requirement in the draft regulations). In brief, a filing will be made through the submission of an on-screen 'financing statement', which will contain the name and the registered number (if any) of the debtor; the name and address of the secured party or its agent; brief details of the collateral (including, where appropriate, the unique serial number of the goods if the secured party so wishes); the duration of the filing (which may be fixed or unlimited); and any other matter prescribed by the Rules to be made by the Registrar. These features are broadly in line with the provisional proposals in the CP.^[152]
3.114     There was almost unanimous support for the introduction of wholly electronic filing.^[153] There was broad agreement also on the content of the financing statement; particular suggestions will be noted as we deal with each item below.^[154]
3.115     It should be noted that the draft regulations set out the framework for the filing system, but do not set out every detail. We think that many of the details would be more appropriate for the Rules to be made by the Registrar under the power given in the enabling clauses under any Companies Bill. The Rules are likely to reflect the sort of detail contained in the subordinate legislation of the overseas PPSA schemes. In any event, the precise nature of the filing system cannot be determined or provided for until the system is commissioned and the necessary software is created. However, we anticipate the system operating very much along the lines of the wholly electronic register introduced under the NZPPSA. Contact between Companies House (or whoever is to run the registry) and some of the existing overseas registries that have an electronic capability would no doubt be a sensible step.^[155]
3.116     It may help to give a brief description of the filing process for those filing via the internet (large volume users would have a slightly different system that we outline below), under the draft regulations and the Rules that we anticipate being made:

(1) Someone wishing to file a financing statement (in practice, the secured party) would first have to register as a 'user' with the registry, which would probably include registering a payment method (such as establishing a direct debit facility or entering credit card details). The user would then be given an identification number and password that could be used to gain access to the system for this and future filings. (This process would be all on-line.)

(2) In order to register a financing statement, the user would enter data onto a series of 'screens'. Once the information has been transmitted and received by the system, a financing statement registration number would be generated by the system, as would a 'debtor personal identification number' (PIN). These numbers would appear on the 'verification statement', which would be sent automatically to the secured party, and a copy of which would be sent by the secured party to the debtor.^[156]

(3) In addition to these two numbers, a 'financing statement PIN' would also be generated. This would be sent to the secured party separately; it should be kept private by the secured party. The financing statement PIN would be used to access the system to make changes to the financing statement.^[157]

3.117     For regular users who may wish to file large numbers of financing statements, such as finance houses or firms that regularly supply goods subject to a retention of title clause, we anticipate that Companies House would develop a system akin to the New Zealand Government's G2B^[158] system. This allows direct linkage between the user's data recording system and the personal property security register (PPSR), so that data on the user's files can be transmitted to the PPSR at a keystroke. Thus once a finance house has entered details of a finance lease and the lessee onto its own system, it need not input the data a second time but can simply have the relevant information transferred direct to the PPSR.

Financing Statement

3.118     A financing statement is defined in the draft regulations as meaning the data which is transmitted to the Registry in accordance with the Rules to effect a filing.^[159] The draft regulations set out the minimum information that the financing statement is to include, and provide that the Registrar may prescribe further information that must be supplied.

Debtor's name and registration number

3.119     The financing statement has to contain the name of the debtor and, where it has one, its Companies House registration number. The name and the number will both be searchable fields. From discussions we have had with Companies House, we understand that it should be possible for the system to check automatically that the name and number entered match the number recorded for that company on their existing records, and that a warning could be given, or the system could reply that it will not accept the filing, if the name and number did not match. This should go some considerable way to reducing the risk of making a mistake in recording the details of the debtor.
3.120     We will see below that, as drafted, the scheme will apply to SIs created by companies incorporated outside England and Wales where the SI is over assets here (or to which English law applies).^[160] Thus there will be instances where a debtor, within the meaning of the draft regulations, will not have a Companies House registration number. In such a case automatic checking of a name/number match will not be possible. This has implications for the search tools that should be made available.^[161]
3.121     In the CP we provisionally proposed that where the debtor is acting as a trustee, this should be recorded, and our provisional proposal to this effect^[162] was supported by a very high proportion of those who responded to this question. Many thought that where the trustee was a bare trustee, the beneficiary should also be identified. We can see the value in this suggestion but hesitate to require it because the more information that is required the greater the scope for errors that might accidentally render ineffective the entire filing.^[163] We would welcome views on whether the financing statement should record that the debtor is a trustee and, if so, whether the beneficiary of a bare trust should also be identified.

Name and address of the secured party

3.122     Although a few consultees thought it was unnecessary to include details of the secured party, the majority thought that the name and address of the secured party, and of its agent, if any, should be required in the financing statement. Even though these are not searchable fields, it was thought to be essential that enquirers should know who the secured party is in order to know whom to approach for further information.^[164] Moreover, in order to obtain PMSI status over inventory there is an obligation to notify other secured parties who have filed a financing statement over the same collateral, so these details are needed for this purpose.^[165] Thus the draft regulations provide that the financing statement should contain this information. However, if the secured party has appointed an agent to deal with the SI, it will be the agent to whom enquiries need to be directed and thus whose name is important. The draft regulations therefore require the name of the secured party or its agent. We understand that there is concern that lenders to companies conducting scientific research or business in what some consider to be 'controversial' areas may themselves be subject to intimidation. The ability of a lender or supplier to use an agent's name rather than its own might be considered useful in such circumstances.
3.123     The financing statement will not be ineffective if the information relating to the secured party is wrong or not up-to-date. That would be unnecessary given that the debtor can supply the information if need be. However, as we noted above, it is in the secured party's interest to ensure these details are accurate, as in some cases information has to be sent to the secured party using the details recorded.^[166]

A description of the collateral

3.124     The financing statement must also contain 'a description of the collateral'. A large majority of consultees agreed with the provisional proposal that the description should be 'brief'.^[167] Two concerns were clearly expressed. On the one hand, the assets subject to the SI should be clearly identified in the financing statement, but, on the other, the description should also be as brief as possible to make filing quick and simple.
3.125     The draft regulations require the financing statement to contain 'a description' of the collateral. 'Description' is not defined further in the draft regulations;^[168] it is something to be dealt with in more detail in the Rules. However, we recommend that the description should be brief, with a word limit on the amount of information that can be provided (to prevent what we understand to be the current practice of just 'cutting and pasting' large amounts of the charge document onto form 395). It would probably be sensible to provide 'tick-boxes' for common and easily identifiable categories.

'Sufficient' collateral descriptions

3.126     Revised Article 9 of the UCC attempts to give some guidance as to what will suffice by way of a collateral description. In other words, the description does not have to comply with what is set down in the UCC provision but, if it does, the validity of the filing cannot be challenged on the basis of inadequate description. This is termed a 'safe harbor' approach.^[169] Article 9 provides that the description may be 'specific'; by 'category'; with a few exceptions, by any of the collateral types referred to in Article 9 (for example, 'goods, 'equipment' or 'inventory'); by any method 'if the identity of the collateral is objectively determinable'; or as 'all assets' or 'all personal property'.^[170] We doubt the value of such general guidance and have not replicated this provision in our scheme.
3.127     What we think is important to get across is that a financing statement will be effective to perfect the SI even if the collateral description is broader than the underlying security agreement. Thus a security agreement over photocopiers may be perfected by a filing that refers to 'office equipment' – though of course the filing will not give the secured party the right to any office equipment other than the photocopiers covered by the security agreement. As we shall see, the debtor will be able to require that the financing statement be changed to reflect the security agreement;^[171] but the filing will be effective.

Collateral type as a searchable field

3.128     The New Zealand scheme requires the collateral to be put into one of a number of collateral types that are, in conjunction with the name, then made searchable fields. Consultees from New Zealand pointed out that this can very easily lead to errors that prevent the financing statement being discoverable.^[172] If the collateral is mistakenly put into the wrong category (for example, were an SI over a farmer's livestock mistakenly entered not as 'goods-livestock' but as 'goods – other', these being two of the search categories in the New Zealand system) a search using the debtor's name and the correct collateral type would not reveal the SI. We do not recommend following this approach. We think that 'check boxes' may be useful as a way of entering the description of the collateral but the register should not be searchable by collateral type.
3.129     The draft regulations provide that where collateral is of the type that has a 'unique identifying number' (at this stage, principally motor vehicles), that number can be included on the financing statement and a search can be made by unique number. We deal with this in more detail below.^[173]

Duration of the filing

3.130     The financing statement will also state the intended duration of the filing. On the issue of maximum duration, there is no common approach taken by all the overseas systems. The UCC provides generally for a period of validity of five years after date of filing, renewable by the filing of a continuation statement within six months before the expiration of the five-year period. On the expiration of the period, an SI becomes unperfected.^[174] The NZPPSA also has a general five-year validity period (unless a shorter time is specified).^[175] The SPPSA provides that registration is effective for the period indicated on the financing statement.^[176]
3.131     In the CP we argued that a fixed period would create too great a risk that creditors would lose by an inadvertent failure to register, and provisionally proposed that the filing be effective for the period indicated on the financing statement.^[177] A large majority of consultees agreed that it should be possible to file for the SI to last indefinitely; most considered it appropriate to permit filings for a fixed duration as an alternative. We note that the Saskatchewan system seeks to prevent the register becoming cluttered with 'indefinite' filings that may become out of date by charging a significantly higher fee for such filings; the same system might be adopted here should this prove to be a problem.
3.132     Thus we provisionally recommend that a filing (unless discharged) should be effective either indefinitely or for such period as has been indicated on the financing statement.^[178]

Other matters

3.133     A small number of consultees argued that the amount secured, or the maximum amount, should have to be stated on the financing statement; and some that the financing statement should state whether or not an SI has actually been created. We have already explained our reasons for rejecting these suggestions.^[179]
3.134     We provisionally recommend that the financing statement should contain:

(1) the name of the debtor and its registered number (if any);

(2) the name and address of the secured party or its agent;

(3) a description of the collateral;

(4) whether the filing is to continue indefinitely or for a specified period; and

(5) such other matters as may be prescribed by the Rules.

We ask consultees to identify any additional information that they consider should be provided or any information that should not be required.

3.135     We note at this stage that we have drawn up the draft regulations in such a way that it should be clear that, subject to one qualification, the Registrar should have no 'discretion' to decide whether or not to accept for filing a financing statement that contains information in the required fields. There is no requirement for the Registrar to check the information supplied as part of the filing, nor any power to reject a purported filing on the ground that it is not believed, for example, that the information is accurate. Accuracy or otherwise of the information supplied goes to the effectiveness of the filing to perfect the SI or determine its priority, rather than to whether the filing should be accepted by the system in the first place. (As we shall see, the Registrar will have power to correct or discharge an incorrect financing statement at the debtor's demand; that is a different issue.^[180])
3.136     The one qualification is that we have included a provision that is intended to enable the removal of filings on the Registrar's own initiative where they are libellous, vexatious or similarly improper. We understand from the staff at Companies House that false or libellous statements contained in information sent to them is a real issue at present, and so we have sought to address it in the draft regulations.^[181]

Who files?

3.137     There is no restriction on who may file. In practice we think it will invariably be the secured party who files: it is the secured party who will lose from the SI being unperfected. Unlike with the Companies Act 1985, there will no obligation on the debtor to send anything for registration, nor any criminal sanctions for not filing.^[182] We provisionally recommend that any person should be able to file a financing statement.

Filing for future SIs

3.138     The notice-filing scheme is not transaction-based. In other words, it does not operate on the basis of a filing being made for each SI after it has come into existence. Although, as we explain below, the consent of the debtor is needed as part of the filing process, it will be possible for the actual or potential secured party to file before the security agreement is entered into, either for a single SI or for any number of future SIs between the same parties. Providing that the information contained on the financing statement – particularly the collateral description – is sufficient to cover the future SIs, there will be no need for a new filing whenever a new SI is created. This will be of benefit to secured parties such as suppliers who conduct regular business with the same customer under separate transactions: where goods are supplied on retention of title terms, for example, one filing at the beginning of the business relationship may be sufficient to cover all future supplies to the same customer.
3.139     We have noted that our proposal to permit advance filing provoked some debate; in particular many consultees were concerned that the register might become cluttered with unwanted filings. We have already explained our reasons for concluding that this is not a serious risk and for recommending that filing may be made before or after the SI has been created.^[183] We provisionally recommend that it should be possible to file before or after a security agreement has been made.

Consent of the debtor to filing

3.140     The draft regulations provide that a filing of a financing statement or a financing change statement which either adds collateral or a debtor to a filing is ineffective unless the debtor consents to the filing.^[184] (Consultees overwhelmingly agreed that the debtor should not be required to sign or authenticate the financing statement.^[185]) A debtor who has entered into a security agreement is deemed to have consented to an appropriate filing. The requirement of consent is aimed at filings in advance of creation of the SI,^[186] and we think that it may be a helpful check on speculative or vexatious filings: filing without the necessary consent could result in the person filing being liable for loss or damage caused.^[187] It should be noted that even if at the time of filing the debtor had not consented or there was no security agreement in existence, the filing will be validated retrospectively if the debtor later gives consent or enters into a security agreement. We provisionally recommend that a financing statement that is filed before a security agreement is made should be ineffective if it is made without the debtor's consent (whether before or after the filing).
3.141     We do not anticipate that unauthorised filings will be a problem in a companies-only scheme.^[188] In case this does turn out to be a problem, it would be possible to have a provision empowering the Registrar to require that each filer indicate that a security agreement exists or the debtor has consented to the filing being made, with criminal liability for false declarations. However, such a requirement or power does not yet feature in our draft regulations, although we note that the Company Law Review recommended that it should be an offence knowingly or recklessly to deliver false information to the Registrar.^[189] If such a provision were to be a part of any Bill enabling the introduction of our provisionally proposed scheme, consultees might consider that this, together with the need for the person filing to register with the system, the verification statement process, and the process for altering or removing incorrect filings, to be sufficient safeguard against wrongful or erroneous filings. We ask consultees whether they think a power should be taken to impose a criminal sanction on those who file without the debtor's consent when there is no security agreement in existence.

'Last-minute' filing

3.142     A large majority of those who responded agreed with our provisional proposal in the CP that – unlike the current '21-day' rule for company charges - there should be no requirement to file a financing statement within a certain time after creation of the SI.^[190]
3.143     However, we noted that the Insolvency Act 1986, section 245 provides for the partial or entire avoidance of floating charges given in various situations, including where the charge was given within the last two years to a 'connected person' who did not give 'new value' and where the charge was given to anyone else within the last 12 months before insolvency, unless new value was given or the company was solvent at the time. We pointed out that the Company Law Review Steering Group thought that in general there was no need to invalidate charges that were registered only a short time before insolvency, and that we saw no reason to disagree (although the question was raised for consultation). However, we thought that 'connected persons', and in particular directors, should be prevented from last-minute filing. Directors are particularly likely to know that a company is approaching insolvency and might be tempted to take a charge at that point. Therefore we provisionally proposed that there should be a provision to prevent last-minute filing by connected persons.^[191] A small majority were in favour of the scheme containing provision to prevent last-minute filing, although it is clear from the responses of some of those who were against having such a provision that they were not against preventing last-minute filing as such, but thought that it should be done through insolvency law (as it currently is by the Insolvency Act 1986, section 245) rather than through a rule of our scheme.
3.144     Section 245 is confined to floating charges for two reasons: because these normally cover the whole, or substantially the whole, of a company's assets and because, despite this broad reach, they allow the company to continue trading. If the first of these reasons is thought to be the critical one, the equivalent avoidance provisions under our proposed scheme might be confined to 'general' SIs, that is, those that cover the whole, or substantially the whole, of the company's assets. (Like section 245, the provisions should not apply if the chargee gave 'new value'.)
3.145     However, we see no particular reason to confine any such provision to 'general' charges, nor to ones that contain a licence to deal. It seems to us that any 'last minute' charge that does not represent 'new value' given to the company may create the same mischief as a floating charge.
3.146     We provisionally recommend that, when our scheme is introduced, section 245 of the Insolvency Act 1986 be amended to apply to any SI in favour of the persons mentioned in that section that is filed within the times stated before the onset of insolvency, save when new value is given or the company is not insolvent at the time, as provided in section 245(3) and (4).

Verification statement

3.147     A large majority of respondents agreed with the CP proposal that there should be a mechanism to ensure that that the debtor is aware of the filing after it has been made.^[192] The question is how this should be achieved: should the debtor be notified directly by the 'system' or should the secured party be required to notify the debtor?
3.148     Some argued that the notice should be sent by the Registrar, but that has its difficulties. First, although all filing will be electronic, so that each filer – the secured party or its agent – will presumably be required to give an e-mail address to which Companies House can send confirmation of the filing, and although Companies House will have an address for each debtor that is a registered company, not all companies have e-mail addresses recorded with Companies House. It would therefore be necessary to send notification to at least some debtors by post. Companies House have expressed reservations about taking on responsibility for sending notices that a filing has been made to the debtor. Secondly, later in this consultative report we provisionally recommend that SIs created by overseas companies over assets in England and Wales should be brought within the scheme.^[193] Companies House can hardly be expected to check the address details of a company incorporated outside Great Britain and not registered here. Therefore we conclude that we may have to follow the other schemes in placing responsibility on the secured party to inform the debtor that a filing has been made.
3.149     Thus, once a financing statement has been filed, the Registrar should send a 'verification statement' to the person making the filing. The draft regulations provide that the verification statement must contain the date and time of filing, the financing statement number assigned by the Registrar, and the information contained in the financing statement, together with any other prescribed data required by the Rules. We anticipate that the verification statement will be sent electronically (it would presumably be an automated action).^[194] The secured party (or person named as secured party in, or the agent responsible for, the financing statement) will be under an obligation to send a copy of the verification statement to the debtor within 10 business days of receiving the statement, unless the debtor has waived in writing the right to receive a copy.^[195] Failure to comply with this obligation will render the secured party potentially liable for reasonably foreseeable loss or damage under the general damages provision contained in the draft regulations, where such loss can be proved.^[196]
3.150     We provisionally recommend that, when a financing statement has been filed, the Registrar must send the secured party a verification statement. The secured party must then send a copy of the statement to the debtor within 10 business days, unless the debtor has waived the right to receive a copy.

Effect of failure to file or perfect by other means

3.151     Except for financial collateral,^[197] supporting obligations or sales of promissory notes,^[198] a non-possessory SI can only be perfected by filing. In this section we discuss the consequences of failing to file or perfect by other means, for example, by taking possession. It should be remembered that even if one of the steps we have discussed in this section, such as filing or taking possession, has been taken, the SI will still be unperfected for so long as the SI has not attached.
3.152     Consultees were almost unanimous in agreeing with our provisional proposal in the CP^[199] that there should be no criminal sanction for failing to file. Thus the decision whether to perfect in this or any other way will be a commercial one for the secured party. The vast majority agreed also that the consequences of failure to file (or perfect in some other way) should be invalidity (ineffectiveness) against an administrator and liquidator, and a loss of priority against a subsequent secured creditor who files first.^[200]
3.153     Thus we provisionally recommend that it should not be compulsory to perfect an SI by filing or any other means; but that an unperfected SI should be:

(1) at risk of losing priority to one that has been perfected;

(2) ineffective against a liquidator or administrator on insolvency and other secured parties;

(3) ineffective against an execution creditor who completes execution before the SI is perfected;

(4) ineffective against some purchasers (whether a buyer or subsequent secured party) in certain circumstances.

We will return to these points in more detail during the course of this Part.^[201]

(a) Financing change statements

3.154     Amendments to an existing filing are made through filing a financing change statement. A financing change statement is defined in the draft regulations as the data transmitted to the registry in accordance with the draft regulations and the Rules to amend a financing statement or discharge a filing.^[202]
3.155     As we noted above, we anticipate that the Rules will establish a system whereby the 'original' filing will generate a financing statement number, a debtor PIN and a financing statement PIN. The financing statement number and financing statement PIN will be necessary for making changes to the filing. The system should automatically allocate a number to the financing change statement that is linked to that of the financing statement. Thus the financing statement and any financing change statements will form a 'family' and a search that is appropriate to reveal one of them will reveal the others.
3.156     The draft regulations provide that an amendment or renewal of a filing may be done by filing a financing change statement any time before the filing expires.^[203] This means that the secured party can make amendments to a filed financing statement at any time. The debtor will not be able to make amendments (providing the secured party has kept the financing statement PIN private) except under the procedures described below.

Correction of errors and removal of unwanted filings

3.157     In the CP we provisionally proposed that there should be provisions allowing the debtor to demand that a change to an inaccurate financing statement be made, or an outdated financing statement be removed, by the secured party within a certain period, failing which the debtor may make the change.^[204] The overwhelming majority of consultees agreed.
3.158     To enable the debtor to demand formally - and if necessary enforce – the removal of unwanted filings or changes to incorrect or out of date information on the register, the draft regulations provide that the debtor (or any person with an interest in property that falls within the collateral description) may require the secured party to file a financing change statement. This applies where the obligations under the security agreement have been discharged or no security agreement exists; where the secured party has agreed to release some of the collateral described in the financing statement; or where the description of the collateral is too extensive.^[205]
3.159     The draft regulations enable the debtor, or any person with an interest in the property described on the financing statement, to issue a 'requirement notice', requiring that the necessary changes be made by a financing change statement. The secured party must then either make the changes or commence proceedings for a court order^[206] to maintain the filing (and notify the Registrar and the person making the demand) within 15 business days after the notice was issued. The Registrar, on receiving such a notification, is required to place an indication on the register that the financing statement in question is disputed. This should warn third parties that further investigation is needed. If no order is received within 90 days after the indication that proceedings have been commenced, then the party making the request can make the changes itself.^[207] We would welcome views on this.
3.160     The 'mechanics' of how the requirement notice be served, and how if necessary the debtor may make any change, will be left to the Rules. One way it could operate would be to follow the New Zealand approach (as we understand it). A formal demand for a financing change statement can be made electronically, through the debtor accessing the system and entering on the system a 'financing change demand' (in the New Zealand terminology), using the financing statement number and debtor PIN. This would indicate the changes demanded to the financing statement. The entry of this demand will generate an automatic notice to the secured party that the changes demanded will take effect to alter or discharge the filing at the end of 15 days, unless a court order (this is required in the New Zealand system; we would substitute an indication of commencement of proceedings) to maintain the filing is received by the Registrar. If no such indication is received, the changes are automatically incorporated into the financing statement and take effect to amend or discharge it.

Transfer of secured party's interest

3.161     Consultees agreed with our provisional proposal in the CP that it should be possible to amend the financing statement when the creditor's interest has been transferred to another creditor, but that this should not be necessary in order to maintain the effectiveness or priority of the SI.^[208]
3.162     We provisionally recommend that the creditor should be able to make amendments to the financing statement by means of a financing change statement. The debtor should be able to demand that an incorrect or out of date financing statement is, as appropriate, corrected or removed.

Errors in the financing statement

3.163     The proposals in the CP on the effects of errors in filing were, with hindsight, not formulated clearly and consultees found it difficult to provide straightforward answers. However, there seemed to be a general consensus that the system should be broadly that of the other schemes. This is that an SI is not perfected in respect of a particular piece of collateral unless the item is covered by the collateral description in the financing statement, but that an error in the description will not prevent the financing statement perfecting SIs over collateral that is properly described. A filing will only be ineffective as a whole if there is a mistake in a searchable field,^[209] such that a properly conducted search will not reveal the existence of the SI. In practice, except where motor vehicles and similarly serially-numbered goods are concerned, this will occur only when the name or company registration number (if any) entered for the debtor is wrong. (Motor vehicles are dealt with below.^[210])
3.164     We think the scope for errors in the name and number of the debtor will be limited. While the scheme is limited to registered companies, LLPs and some overseas companies, most debtors will have a registered name and number. We understand that Companies House would be able to cross-check the name and number entered as part of the financing statement. The system might be set up so that it would not accept a filing unless either the name and number of the debtor company correspond (and each is complete and correct), or the filing party acknowledges that it is filing against an overseas company that is not registered at Companies House. Thus when a filing is to be made against a company (or LLP) registered in England and Wales the risk the company's name is entered incorrectly should be eliminated. The chief risk will be that the filing is made against the wrong company entirely, for example, against another company that has a similar name because it is in the same group. A careful check of the number should prevent this. In any event, when the company is notified of the incorrect filing it is likely to demand a change.
3.165     In practice a searcher^[211] might not have to use the full company name and number as a search term. We envisage that the system might be set up so that a search by the principal names of the company (for example, 'Smith Jones Robinson') would produce a list of all the companies containing those three names - for example, all those in a group using those names with different suffixes. The searcher could then ask for details of the particular company in which it is interested. This is a point for the Rules. However, the operation of the search tools will matter when the name of an overseas company is entered incorrectly - an obvious risk with foreign company names. A filing under the wrong name will be ineffective if a reasonable search would not reveal the financing statement. A system that enabled a searcher who is not sure of the exact name of the company (for example, an oversea company) to search for any 'similar' names will reduce the scope for argument that an incorrect filing is ineffective. It is not feasible to legislate for this; for example, the outcome might depend on how many 'near misses' would be shown and how serious the errors are. The issue must be left to the court's decision as to what was reasonable, in the light of the search tools made available by the Registrar under the Rules and the facts of the case.
3.166     It is immaterial, however, whether a search has actually been carried out. The question is what a searcher would have found had a reasonable search been made. The majority of consultees agreed with this 'objective' approach.^[212]
3.167     An error in describing the collateral so that it purports to cover more than is actually covered by the security agreement will not prevent the SI being perfected but it will not, of course, give the secured party additional rights. The remedy here would lie in the debtor making a financing change demand to correct the error, as explained above.
3.168     We provisionally recommend that the effectiveness of a filing should not be affected by a defect, irregularity, omission or error in the financing statement unless it would have the result that a reasonable search, conducted in accordance with the requirements of the draft regulations and the Rules relating to searches, would not reveal the financing statement.^[213] An error in the collateral description will result in the SI remaining unperfected in relation to collateral that was omitted but will not affect it as regards other collateral that is described in the financing statement.^[214]

Effect of unauthorised or accidental discharge

3.169     We noted earlier that a financing statement will be effective either indefinitely or for such shorter period as is indicated on the financing statement. Given that specific periods of effectiveness are permissible, it is possible that a filing will lapse through inadvertent failure to renew it. It is also possible – although less likely – that a filing could be discharged either inadvertently by the secured party or by the secured party's agent without the secured party's authorisation.^[215] It seems sensible to permit the re-activation of the filing provided that other secured parties or buyers are not prejudiced and that it is done within a short enough time that it is unlikely that unsecured parties will have relied on the apparent discharge of the SI.
3.170     We provisionally recommend that where there has been mistaken or unauthorised lapse or discharge of a financing statement, the secured party should be able to re-activate the financing statement within 30 days of the lapse or discharge. Where this is done, the lapse or discharge should not affect the priority ranking of the SI as against those SIs which, prior to the lapse or discharge, were subordinate in priority to it. However, this should not be the case as against SIs that are perfected by filing after the lapse or discharge but before the financing statement was re-activated, nor to the extent that the competing SI secures advances made or contracted for in that period.^[216] The Rules should deal with the procedure for re-activation of the financing statement.

Searching

3.171     We have explained the information that has to be contained on the financing statement.^[217] Not all of this information can be used to conduct a search. The draft regulations provide that the register will have to be organised so as to allow searching by one or more listed criteria. The criteria are the company name; the company registered number (where it has one – overseas companies may not be registered at Companies House); the financing statement number (the number allocated by the registry on filing); and the unique identifying number (for collateral prescribed in the Rules as having a unique serial number, for example, motor vehicles^[218]). The draft regulation also allows for the possibility that the Rules might introduce additional search criteria.
3.172     It will be possible to search by company name or company number. The searcher will then have to check the search result to ensure that it has 'found' the correct company. Alternatively the searcher may enter both. Companies House tell us that they should be able to configure the system so that when a name and number is entered an automatic check is run to ensure that the name and number tally with each other according to the records that they hold on registered companies. If they do not, some form of warning will appear on-screen to this effect, perhaps offering alternatives. It seems to us that this would go far to reducing the risks of identifying the wrong debtor. We have already pointed out that where a company is incorporated outside Great Britain,^[219] this check will not be possible. We suggested that the Rules should make it possible for searchers who are not confident that they have the name 100% correct to search for 'near misses'. This should also reduce the risk that a financing statement will not be revealed.
3.173     The NZPPSA has provisions linked to New Zealand's Privacy Act 1993, and there is a requirement that a person searching the register make a declaration that the search is being made in accordance with that legislation.^[220] We do not think similar issues arise for our system. Any requirements relating to data protection or freedom of information that Companies House is, or may become, subject to will continue to apply.
3.174     We provisionally recommend that it should be possible to search the register on-line by the company name; the company registered number (where it has one – overseas companies may not be registered at Companies House); the financing statement number (the number allocated by the registry on filing); and (for collateral prescribed in the Rules) the unique identifying number.

System failure

3.175     We think the risk of major loss being caused by a system failure is rather low: if the system 'goes down' it will be evident to both filers and searchers, so that they will know that they must wait and try again. This would certainly cause inconvenience but it is unlikely to cause serious loss unless the secured party is unwise enough to advance the funds before filing, in which case it has only itself to blame.^[221] There is a slight danger that a defect in the software might prevent a properly conducted search from revealing a registered SI; and perhaps a greater danger from hackers deliberately interfering with the system. We suggest that income from filing and searching fees be used to establish a fund from which compensation may be paid on a 'no-fault' basis, up to (fairly low) pre-determined limits, although provisions to effect this do not form part of the draft regulations. We also suggest that there should be statutory, fault-based liability on Companies House for loss caused by errors in the system. The provisions in the draft regulations relating to damages are intended to cover this position.^[222] We ask consultees whether there should be a statutory, no-fault compensation fund for system failures; and fault-based liability for loss caused by errors in the system.

SIs over vehicles

3.176     At this point it is appropriate to deal with SIs over vehicles and other types of goods that have unique serial numbers (the vehicle identification number or VIN, and/or the registration number). We explained in Part 2 the advantages that would result from permitting these to be filed using the unique serial number (or numbers – whether it is just the VIN or also the registration number is a matter for the Rules).
3.177     If collateral is of this type (that is, motor vehicles and other types of serial-numbered collateral to be identified in the Rules), then the number may be included in the financing statement. There is no obligation to include it, so that someone financing, say, a fleet of vehicles could perfect its SI by describing the collateral as 'motor vehicles' rather than recording each individual serial number, but consequences may follow from not using the serial number. A filing that is made without using the serial number, where one could have been recorded, will preserve the effectiveness of the SI as against the administrator or liquidator. In other cases the consequences will depend on whether the goods are held by the debtor as equipment or as inventory.
3.178     Where the goods are equipment, a buyer or lessee of them will take free of any SI perfected by filing, if they were serial numbered goods and the serial number was not used in the collateral description as part of the filing.^[223] In addition, such a 'general' filing will not be sufficient to preserve priority as against other perfected SIs.^[224]
3.179     Where the goods are held as inventory, a buyer or lessee of the goods will normally take free of any SI created over them by the seller or lessor, as the disposition will in most cases be authorised.^[225] Even if it is not, it will normally be made in the ordinary course of the seller's business, so that the buyer or lessee will take free of the SI under the 'buyer' rules.^[226] This means that it would be unreasonable to expect the secured party to file the serial numbers of the individual vehicles or other assets held as inventory. In turn, however, the secured party's priority against other SIs taken over the same inventory should be preserved even though the secured party has filed only in general terms. Thus the rule subordinating a 'general filing' SI over serial-numbered goods to a subsequent SI applies only where the goods are equipment, not when they are inventory.
3.180     We provisionally recommend that where goods are of a type that is designated by the Rules as having a unique serial number, the financing statement may include that serial number. If it does not, a buyer of the goods who does not know of the SI will normally take free of it, and, where the goods are equipment, the SI will not be treated as perfected for the purposes of priority as against other SIs over the same goods.
3.181     Where the uniquely identifiable number has purportedly been included, but there is an error in it, a search by using the number would not reveal the existence of any SI over the collateral. In this case, there is a question: should the filing be treated as ineffective, even though the debtor's name was entered correctly; or should it be effective provided there was an adequate description of the collateral in general terms (for example, as a vehicle of a particular make, model and year)?^[227] There may also be the converse question, whether a correct serial number can 'save' a filing that was made against the wrong debtor. These issues are not clearly settled by the Canadian legislation and have troubled the Canadian courts.^[228] In our view,

(1) The fact that the serial number was correct should not 'save' a filing that stated the debtor's name incorrectly, except where, as previously suggested, the system would in fact reveal the filing as a 'near miss'. It would be unreasonable to expect those who are concerned with whether there are SIs over the company's property as a whole to search against individual vehicles. It is true that this might occasionally mean that an SI over a vehicle will be unperfected when a person searching on the vehicle number alone could in fact discover it; but this will rarely cause a windfall to the searcher. This is because the most usual searcher will be an intending buyer of the vehicle and, if the buyer conducts the search and discovers that there is an SI over it, the buyer will have knowledge of the SI and will not take free of it.

(2) Where the name of the debtor is correct but the serial number is incorrect, the financing statement should be treated as if it did not contain the serial number.^[229] The advantages of the scheme as regards vehicles would not be fully realised unless a potential buyer of the vehicle or (where the vehicle is not inventory) a subsequent secured party can rely on a search by serial number alone. In practice there will be adequate safeguards against the secured party making a mistake. We anticipate that most SIs over vehicles will be entered by one of the existing registration organisations as agent for the secured party. Those organisations are able to check that the various items of data submitted tally - most obviously, that the registration number and VIN match, but also that these match any other details of the vehicle supplied by secured party.

Proceeds

Definition of proceeds

3.182     The concept of proceeds is an important and difficult one. Under the schemes we have examined and under our draft regulations, 'proceeds' refers to three different situations. The first is where the debtor receives income from the collateral (for example, dividends or interest from financial collateral) or collects on it (thus, the sums received from payment of a book debt). The second is when proceeds arise from a disposition of the collateral by the debtor. The SI will normally continue into such proceeds. The third is where the debtor has a claim arising out of damage to or interference with the collateral.^[230]

Right to proceeds of disposition

3.183     The CP dealt only with proceeds in the second sense. A large majority of consultees agreed with the provisional proposals made as to the perfection of proceeds in the CP.^[231] Our provisional recommendations, which we set out below, follow these with some amendments. We provisionally recommend that where collateral is disposed of by the debtor, unless the secured party has authorised the dealing free of the SI or the case is one in which the buyer will take free of the SI, the SI should continue in the collateral and attach to the proceeds.^[232]
3.184     If a disposition of the collateral was authorised (whether by the security agreement or by a subsequent authorisation from the secured party) or, though unauthorised, it was made in circumstances in which the buyer^[233] will take free of the SI,^[234] the secured party will have rights to the proceeds of the collateral. In contrast, if the transferee takes subject to the SI, the secured party should have rights to both the original collateral and the proceeds of disposition. Where the secured party would be able to claim both the original collateral and the proceeds, the SPPSA (but not Article 9) contains a provision to prevent the effect being to swell the value of the collateral that is subject to the SI: where the secured party enforces an SI against both the collateral and the proceeds, the amount secured by the SI in the collateral and the proceeds is limited to the market value of the collateral at the date of the dealing.^[235] We have included this for the purposes of consultation only. It may be seen as a consumer protection measure and less suitable to the more limited scope of our scheme than to the PPSAs. We ask consultees whether the scheme should include a provision to limit the secured party's recovery from original collateral and proceeds to the market value of the collateral.
3.185     Whether something will be proceeds will depend on it being identifiable and traceable. We do not think this should depend on there being a fiduciary relationship between whoever has the SI in the proceeds and a person having rights in, or who has dealt with, the collateral. We provisionally recommend that whether proceeds are identifiable and traceable should not depend on the presence of a fiduciary relationship. We have accordingly included a provision to that effect in the draft regulations.^[236]

Perfection of right over proceeds

3.186     The rules just stated apply to 'proceeds' that arise on disposition of the collateral by the debtor. We consider that, as in the other schemes, it is appropriate to apply the general rules that we are about to describe to the other types of proceeds also.
3.187     At this point we are concerned with perfection of any SI in the proceeds. On this we confirm the proposal in the CP. We provisionally recommend that an SI in proceeds should be continuously perfected if the SI in the original collateral is perfected by filing, and

(1) the financing statement contains a description of the proceeds that would be sufficient to perfect an SI in original collateral of the same kind; or

(2) the financing statement covers the original collateral, if the proceeds are of a kind within the description of the original collateral; or

(3) the proceeds consist of money, cheques, deposits in or money credited to a bank account or insurance payments.^[237]

In other cases, the secured party should have a short period in which to perfect against the proceeds.^[238]

Obtaining additional information about the SI

3.188     The filing scheme introduced by the draft regulations is intended to supply a warning that an SI may exist over the debtor's apparent property.^[239] A party contemplating supplying assets or funds to a debtor may want to find out more by contacting either the debtor or any secured party revealed by a search of the register – in particular, to find out what property is covered by the financing statement (which may contain only a broad description of the collateral) and how much is owed to the secured party. In most cases, we anticipate that the position may be much as we understand it to be at present, with such information as is commercially appropriate being supplied on a voluntary basis. Nothing prevents the debtor - or anyone else - seeking any information from the secured party. Consultees were divided on our provisional proposal in the CP that in certain circumstances the debtor and anyone with an interest in the company's property should be entitled to obtain further information about the security agreement: just over half of those who responded agreed with us.^[240] Consultees did in general agree with our suggestion in the CP that the company's own register of charges fulfilled no useful function in this context, and was not worth maintaining.
3.189     To cover the case where the secured party is reluctant to release information on a voluntary basis, we have included in the draft regulations, for the purposes of consultation, provisions enabling a debtor to make a written request to its secured party to be provided with certain information in relation to a security agreement. If the secured party receiving such a request does not comply with the requirements of the draft regulation, or if it supplies inaccurate information, it could face potentially serious consequences.^[241] (This right to be supplied with information is not limited just to SIs perfected by filing.)
3.190     One important issue is who should be entitled to make a request (thereby putting the secured party at risk of penalty for non-compliance). In the CP we suggested that anyone with an existing interest in the company's property should be entitled to make a request for further information.^[242] This is the approach generally taken in the PPSAs. In contrast, the UCC takes the approach that the debtor, but no one else, can require the secured party to send specified information to him or a named third person.
3.191     A number of consultees expressed concerns about confidentiality issues that would be involved in allowing persons other than the debtor (for example, competing secured parties) the right to demand information without the express consent of the debtor. Balanced against this is the question of how judgment creditors can be expected to find out which of the debtor's assets are subject to an SI. Potential lenders can expect the debtor to provide the information or get it sent to them by the secured party. However judgment creditors may need information to identify what property they can safely seize. Where the debtor is nearing insolvency, it may have no incentive to respond to a request for information from a judgment creditor. In our view, however, this is a lesser concern than the confidentiality issue. There is no way at present by which judgment creditors can readily discover which of a debtor's inventory is subject to a retention of title clause, or which of its equipment is subject to a finance lease. Under our scheme, even if they are not entitled to obtain further details from the secured party, their position will be improved since they may discover the possible existence of such agreements from the register and may seize any goods that are subjected to an unperfected SI.
3.192     Therefore we provisionally recommend that, if the scheme is to contain a provision dealing with the obtaining of further information, only the debtor should be permitted to make an 'information request. We have drawn up the draft regulations accordingly. However, it should be noted that the right to obtain information is limited to 'in-substance' SIs; it does not apply if the SI is a 'deemed' one. This is because a potential secured party will be less interested in 'deemed SIs', as there is no question of the debtor having a right to a difference between the value of the collateral and the sums outstanding.
3.193     Adopting such an approach would mean that those interested in lending to or dealing with the debtor will have to direct their enquiries through the debtor, who can request that the information be sent directly by the secured party to a third party at a specified address. This will enable the third person to rely on the information as coming from the secured party; and if the third person does so rely, the secured party will be estopped from claiming that it was in fact owed more, or was entitled to more collateral, than it stated in the information it gave.^[243]
3.194     The debtor will be able to ask how much it still owes, or ask the secured party to confirm the debtor's estimate; and to ask the secured party to confirm which personal property is subject to an SI. The debtor can be expected to have a copy of the security agreement, so this item has not been included in the list.
3.195     We think that having a provision enabling the debtor to request information in the way outlined above would be useful, but we recognise that this goes beyond what we understand the current position to be. Given that more than half of consultees who responded to the CP proposal were in favour of the wider approach that we provisionally recommended at that stage (allowing both the debtor and those with an interest in the company's property to make a demand), we think we would be justified in making a provisional recommendation that the scheme contain such a provision. However, given that this issue is controversial, we leave the matter open and seek the views of consultees.
3.196     Where, without reasonable excuse, the secured party does not comply with the information request within 10 business days of receiving it, the draft regulation provides that the debtor can apply to court for an order requiring the secured party to comply.^[244] Where the court makes such an order, it may also impose sanctions for non-compliance with the order of the court, including the extinguishing of the SI.^[245] We are not wholly convinced of the need for these additional sanctions, but have included them for consultation: the question is whether the awarding of actual damages for breach of a duty or obligation under the draft regulations would be a sufficient sanction, or whether there should also be a possible sanction of extinguishing the SI.^[246] We would welcome the views of consultees.
3.197     We conclude from the point of view of obtaining information about security that there is little point in maintaining the company's own register of charges. We ask whether the scheme should contain a provision enabling the debtor to require the secured party to supply information relating to the amount owing and the collateral subject to the SI. In particular, we seek views on whether:

(1) only the debtor should be entitled to make an 'information request',

(2) the secured party should be obliged, at the debtor's request, to supply the information to a named third party,

(3) the court should be able to order the sanctions set out in DR 18, including extinguishing the SI.

Priority between competing SIs

3.198     The establishment of a clear set of priority rules is a fundamental feature of the overall scheme we are provisionally recommending. The CP made provisional proposals or asked questions on a number of specific issues relating to priority, but did not contain a set of detailed proposals or questions on the general rules. However, the topic was the subject of a subsequent informal discussion paper, presented at one of our seminars.^[247] That seminar revealed a very broad measure of agreement over the general rules; disagreements were on specific points that we will discuss as we come to them.
3.199     In this section we deal with questions of priority as between competing SIs. The rules dealing with buyers and similar transferees are for the most part treated separately,^[248] though there are some rules that apply to both buyers and competing secured parties (often referred to generically as 'purchasers').^[249]
3.200     The draft regulations dealing with the priority of conflicting SIs take the form of a set of rules that apply in specific situations and 'residual' rules that apply otherwise. There are several specific (and important) rules that apply only to financial collateral; these are dealt with in Part 4. We start with the general, 'residual' rules.

'Residual' priority rules

3.201     There was broad agreement on the 'residual' rules that should apply in the absence of a more specific priority provision. We provisionally recommend the following residual rules:

(1) Perfected SIs take priority over unperfected ones.

(2) As between secured parties with perfected SIs, priority is determined by whoever was first to file or perfect.

(3) As between unperfected SIs, priority is determined by date of attachment.^[250]

(4) The priority that an SI has under the rules above applies to all advances, including future ones (whether or not made under an obligation).^[251]

3.202     The rule that, as between conflicting perfected SIs, priority is determined by the 'first to file or perfect' means that where the conflict is between two SIs that have both been perfected by filing, priority will go to the secured party who filed a financing statement first, regardless of the date that the SIs came into existence or attached. Thus if SP1 files its financing statement on 1 February and its SI attaches on 10 February, and SP2 files its financing statement on 2 February, which is also the date on which its SI attaches, as of 10 February SP1 will have priority. If SP2 had perfected by taking possession on 2 February the same result would follow.^[252]
3.203     As we noted above, if collateral is of a type prescribed in the Rules as having a 'unique identifying number', this number can be included on the financing statement. If it is not included in the filing, and the collateral is equipment, whilst the SI will be perfected and effective against the administrator or liquidator, the 'residual' priority rules provide that this will not be sufficient to preserve priority as against other perfected SIs.^[253]

Specific priority rules

Purchase-money SIs

3.204     The most important specific rule is that giving priority to purchase-money SIs (PMSIs). In essence, a PMSI is an SI taken either by a seller to secure payment of the purchase price of the collateral, or by a lender to secure repayment of funds it has provided to enable the debtor to acquire rights in the collateral, for example, where a bank lends a sum of money to a company to buy a particular asset, securing the loan on that asset. In the CP we repeated the argument made by the Crowther committee that it would be unfair to allow the security for this additional loan to be subordinate in priority to the earlier SI:

In this case, it is [the later creditor's] money that has led to the increase in the dealer's inventory, and it would be quite wrong that this increase should become a windfall added to the security of the original party … simply because he had filed a prior financing statement.^[254]

3.205     The great majority of consultees agreed that PMSIs should, subject to certain conditions to be discussed later,^[255] have priority over previously perfected SIs.^[256]

Definition of PMSI

3.206     Under the draft regulations, a PMSI is an SI in collateral^[257] to the extent that it secures all or part of the collateral's purchase price;^[258] or an SI taken by a person who gives value for the purpose of enabling the debtor to acquire rights in the collateral, to the extent that the value is applied to acquire those rights.^[259] The first limb will cover 'vendor-credit', for example where the seller seeks to secure payment for the asset by including a retention of title clause in the sale agreement, or where a hire-purchase agreement is used. The second covers 'lender-credit'.
3.207     The definition of PMSI also expressly includes the interest of a lessor of goods for a term of more than one year and the interest of a consignor who delivers goods to a consignee under a commercial consignment.^[260] These are expressly included because, although they may come within the definition of an SI, in the circumstances there may be no security purpose. Thus they would otherwise fall outside the vendor- or lender-type situations discussed above and so be outside the definition of PMSI and suffer in priority as a consequence.^[261]
3.208     Subject to a number of conditions to be explained below, we provisionally recommend that an SI in collateral, to the extent that it secures all or part of the collateral's purchase price, and an SI taken by a person who gives value for the purpose of enabling the debtor to acquire rights in the collateral, to the extent that the value is applied to acquire those rights, should have priority over any other SI given by the debtor in the same collateral. Interests of lessors and consignors of goods should have the same priority.
3.209     The UCC provides for PMSI status only in relation to goods.^[262] In the Canadian and New Zealand schemes a PMSI may exist in any form of 'collateral' other than investment property; so there can be a PMSI over a licence to use a patent, for example, if the secured party has provided the funds that were used by the licensee to acquire the licence.^[263] We understand that Article 9 takes the narrower approach simply because PMSI status is regarded as exceptional and there seemed to be no demand for it other than in relation to goods. For the purposes of consultation the draft regulations follow the wider approach. We ask consultees whether our scheme should limit PMSIs to SIs over goods or whether it should include an SI over any type of collateral other than investment property.
3.210     We have included in the definition of PMSI an element contained in the UCC, but not the PPSAs, to the effect that a PMSI does not lose its status as such even if the obligation has been renewed, refinanced, consolidated or restructured.^[264] This seems to us to be a useful clarification. We have not thought it necessary to include all the other provisions of the UCC on PMSIs, such as the 'application' (appropriation) of payments, where PMSI status depends on this.

Conditions for PMSI status

3.211     The CP dealt only rather briefly with the question of the conditions that must be fulfilled for an SI to achieve and retain PMSI status. Several consultees responded that they could not comment without more detail. We set out our provisional recommendations below.
3.212     When collateral is supplied subject to a PMSI, the UCC and the PPSAs draw a distinction between inventory and other collateral. In each case PMSI status will apply only if certain steps are taken, but the steps differ according to the type of collateral.

Inventory

3.213     When inventory is supplied to a company it is quite likely that other secured parties (existing or prospective) may rely on the inventory as collateral. There are, for example, stock financiers who on a regular basis advance funds on the security of the debtor's inventory, and who therefore check the value of the inventory regularly. It seems right that if such a lender has already perfected its SI by filing, it should be warned before it makes any further advances that the debtor may be receiving inventory that will be subject to a PMSI. Therefore the UCC and the PPSA require that, for an SI in inventory to have PMSI 'super-priority', as it is sometimes termed, the PMSI must be perfected and other secured parties who have filed to perfect SIs over inventory should be given notice, before the inventory is delivered.^[265] We think that the notice requirement serves a useful function and we recommend adoption of the same rule.
3.214     We provisionally recommend that for an SI over inventory to have PMSI status, it must be perfected, and a notice must have been given to any other secured party who has filed a financing statement covering the same type of collateral, before the debtor (or another person on its behalf, if earlier) obtains possession of the collateral. The notice must state that the person giving the notice expects to acquire an SI in inventory, and describe the inventory by item or kind. ^[266]

Non-inventory collateral

3.215     Where the PMSI is over collateral that is equipment rather than inventory it is much less likely that other secured parties whose SIs would include the equipment will advance funds on the security of the new equipment within a short period; and they can be expected to search before doing so. Therefore the other schemes do not require notice, and there is a 'grace' period for filing of 10-15 days after delivery of the equipment.
3.216     Incorporating a period of 'invisibility' into the scheme might at first be thought to be problematical. However, we do not think in practice that this period will cause significant problems, for the following reasons. First, the PMSI priority rules only operate to give priority as against other secured parties. A buyer of the collateral during the period before which a filing is made to perfect the PMSI will be subject to the 'usual' rules of buyers and unperfected SIs: it will take free providing it bought the collateral without knowledge of the SI.^[267] Secondly, as against other secured parties, the invisibility period only exists for collateral that is not inventory. Secured parties relying on such collateral can do as they can at present and withhold funds until the grace period has passed.
3.217     We had wondered whether the 'grace' period was appropriate in the case of a wholly electronic filing system, but we understand that it has proved useful in the overseas systems where a business handles its filings centrally rather than in each of its individual offices or shops: time is needed for the dealer to inform the head office that an SI has arisen. Consequently, we see benefit in retaining the grace period.
3.218     As we explained earlier, in the draft scheme it is possible to have a PMSI over intangible property such as a licence. With intangible property the grace period could not run from the date of delivery; it therefore runs from the date the SI attaches.
3.219     We provisionally recommend that a PMSI over goods that are not inventory should have priority over any other conflicting SI provided that it is perfected not later than 10 days after the debtor obtains possession of the collateral. In the case of a PMSI over intangibles, the 10 day period should date from attachment.

Cross-collateralisation

3.220     The current law allows a retention of title supplier under an 'all-monies' or similar clause, if the buyer defaults in paying, to repossess any original goods supplied under retention of title, even if the particular goods seized have already been paid for. This is sometimes referred to as 'cross-collateralisation'. In practice it will be possible only if the SI has PMSI status even over the goods that have been paid for. Revised Article 9 defines a PMSI so that it applies to cross-collateral. We think this is a valuable provision; without it, there would be great practical difficulties in establishing which of several batches of identical goods all supplied by a single supplier have been paid for, and which not. We provisionally recommend that PMSI status in one piece of inventory should extend to other inventory supplied by the same supplier, even if the particular item claimed has been paid for.^[268]

Conflicting PMSIs

3.221     A debtor may have financed the purchase of collateral partly by credit from the vendor and partly by borrowing from another secured lender. Each will have a PMSI. It seems useful to have a rule to deal with the conflict in priority. We provisionally recommend that where two PMSIs in goods or proceeds conflict, a PMSI taken by a seller, lessor or consignor has priority over any other PMSI, providing that it is perfected, in the case of non-inventory, within 10 days of the debtor obtaining possession of the collateral or, in the case of inventory, at the time the debtor obtains possession of the collateral.^[269]

PMSIs over proceeds and conflicting SIs

3.222     An important issue arises in respect of PMSI inventory claimants and receivables financiers. If inventory that is subject to a PMSI is sold to produce receivables, those receivables will amount to proceeds of the PMSI and the PMSI will accordingly continue over them. However, before entering into the PMSI arrangement, the debtor may also have created an SI over its receivables, for example by factoring them. The factor would want to claim the PMSI receivables as its original collateral. Who should have priority? Under the rules outlined above for inventory, the PMSI claimant would have priority. However, if the PMSI in inventory were permitted to continue into the proceeds without more, then it would be difficult for receivables financiers to secure priority over receivables arising from the sale of inventory.^[270] Consequently, some of the North American systems contain specific provisions giving priority to an accounts receivable financier if it has given new value and has perfected its SI by filing prior to the supplier perfecting or filing in respect of its PMSI.^[271] In contrast, the Ontario PPSA gives priority to the PMSI inventory proceeds claimant, as did, until very recently, the NZPPSA.^[272] Although the Ontario rule has staunch defenders, the rule has been criticised. ^[273]
3.223     Policy in this area needs to reflect the relative commercial importance of receivables financing as against supplier-financing (for example, by sale on retention of title clause). Receivables financing is a very significant method of raising finance within the UK economy^[274] and appears to be a more established and efficient method of financing than supply of inventory on credit under a retention of title clause.^[275] To prefer the receivables financier would also better replicate the current situation: retention of title suppliers that seek proceeds are usually held to have unregistered floating charges and would thus generally lose to factors. Moreover, the factor is likely to give notice to the account debtor first and thus obtain priority under the rule in Dearle v Hall.^[276] We provisionally recommend that a secured party claiming an account as original collateral should have priority over a secured party claiming the account as the proceeds of a PMSI, provided that the receivables financier perfected its SI by filing before the PMSI secured party supplied the goods in question or filed in respect of its SI.^[277]

Priority rules for farming?

3.224     Some of the other schemes contain additional PMSI provisions relating to the farming industry. For the purposes of this consultation, we have not replicated these in the draft regulations, but we would welcome the advice of consultees as to whether equivalent provisions would be appropriate for our scheme.
3.225     The first issue concerns livestock. It may be hard to determine whether livestock should be treated as 'equipment' or as 'inventory' for the purposes of the PMSI priority rules. The UCC treats a PMSI in livestock in the same way as it does a PMSI in inventory, requiring notice to be given to other holders of conflicting SIs within a certain time before the debtor receives possession of the livestock.^[278] We would welcome views on whether we should replicate this provision.
3.226     For the purposes of the priority rules, should the scheme provide that a PMSI in livestock be treated in the same way as a PMSI in inventory?
3.227     The second issue relates to those who finance the production of crops, for example by supplying fertiliser on credit. The SPPSA contains a provision that a perfected SI in crops or their proceeds that is given for value to enable the debtor to produce the crops, and that is given while the crops are growing or within the six months prior to their planting, has priority over any other SI in the same collateral.^[279] In the US, a 'model' section of the UCC contains a similar rule in relation to such 'production-money' SIs.^[280] Again, we would welcome views on whether our scheme should contain similar provisions.
3.228     We ask whether the scheme should provide that an SI taken by a secured party who effectively enables a crop to be produced should have priority over competing SIs in the resulting crop or its proceeds. If so, should there be time limits or notice requirements in relation to this?

Protection of transferees of 'negotiable' collateral

3.229     In the CP we made the provisional proposal that the priority rules of a notice-filing system should not disturb the protection currently given to a holder in due course.^[281] Those consultees who addressed the question agreed unanimously.
3.230     This is a matter that affects any transferee of a negotiable instrument, whether a buyer or a person who takes an SI over it. The draft regulations deal with several situations involving negotiable collateral together in one provision. At this point it is important to note the way in which the terms 'buyer' and 'purchaser' are used in the draft regulations. The definition of 'purchaser' is drawn widely – it includes someone who takes by sale, lease, discount, assignment, mortgage, pledge and gift. The term will thus cover both a buyer and other secured parties, and any provision in the draft regulations that applies to 'purchasers' will apply to both these types of person, whereas some of the provisions are expressly limited to 'buyers' (or lessees).^[282] The rules discussed the following paragraphs apply to 'purchasers' or, where another form of outright transfer is in question, 'holders' or 'transferees'.
3.231     We provisionally recommend that a purchaser of an instrument for value, without knowledge of the SI, and who takes possession of the instrument should have priority over any SI in the instrument, whether or not the SI was perfected, unless the purchaser not only knew of the SI but knew that the transaction would violate the terms of the security agreement.^[283] Where the purchaser acquired the instrument in the ordinary course of the transferor's business, the purchaser only has 'knowledge' if it knew that the transaction violates the terms of the security agreement. 'Instrument' is a defined term.^[284]

Transferees of money

3.232     Transferees of money should also be protected, as should those who receive payment in some other form.^[285]
3.233     Where a creditor has received payment of a debt owing by the debtor through an electronic funds transfer or certain types of written payment mechanisms (via a 'debtor-initiated payment'), it will take priority over an SI in the funds paid, the intangible which was the source or the instrument used to effect the payment, whether or not it knew of the SI at the time of payment.^[286] We did not deal specifically with this provision in the CP, but it is an important one for the purposes of businesses being able to trade and raise funds. Commentators on some of the equivalent provisions in the overseas schemes have noted that the importance of this provision lies in its being the equivalent of the 'old' power of the debtor to pay creditors where the debtor's assets were subject to a floating charge. Without such a provision, it would be difficult to carry on business where a general SI - the 'replacement' to the old floating charge - had been given.^[287]
3.234     We think that, for holders of money, protection should extend to a holder who either receives the money without knowledge of the SI or who, though knowing of it, gives value.
3.235     We provisionally recommend that:

(1) holders of money (that is, notes and coins in any currency^[288]) which is subject to an SI, whether perfected or not, should have priority over that SI if the holder acquired the money without knowledge that it was subject to an SI, or is a holder for value, whether or not the holder acquires the money without knowledge of the SI;^[289]

(2) a creditor who has received payment of a debt owing to it by the debtor other than by payment in cash,^[290] should have priority over an SI in the funds, intangible or instrument used to effect the payment, whether or not it knew of the SI at the time of payment.^[291]

Transferees of negotiable documents of title

3.236     We provisionally recommend that a holder to whom a negotiable document of title is negotiated, and who gave value, should have priority over an SI in the document of title, whether or not the SI was perfected, unless the holder not only knew of the SI but knew that the transaction would violate its terms.^[292]

Priority in transferred collateral

Transfers by the secured party

3.237     An SI may be assigned by the secured party to a new secured party. We have said that, if the SI was perfected by filing, no new filing will be required.^[293] However the new secured party may wish to change the register to reflect its interest, in particular so that any notices are sent to it rather than to the old secured party (such as the notice needed to secure PMSI status over inventory, as discussed earlier). It will be possible to achieve this by filing a financing change statement.

(a) Transfer by the debtor

3.238     In contrast, if the debtor company transfers the collateral, the SI will continue in the collateral unless the transfer is authorised or the situation is one in which the buyer will take free.^[294] There may be implications for perfection and priority of the SI.
3.239     One question of priority arises where, for example, the debtor receiving the transfer (the transferee) has already created a general SI over all its present and future assets, or subsequently creates one. The other systems have a series of priority rules relating to this scenario, which we think we will have to address. The difficulty is that the three schemes we have looked at differ in substance and in drafting.
3.240     Let us assume that Company A has created an SI over a machine in favour of SP1, and Company B either has created one or (before SP1 has filed against Company B or taken possession of the collateral) creates one over collateral of the same type (or a broader description, for example, all goods) in favour of SP2. Company A transfers the machine to Company B, without SP1's authority and not in the ordinary course of business (that is, it does not normally sell machines of that kind^[295]), so that Company B takes subject to SP1's SI.
3.241     Another priority issue arises if Company B subsequently creates an SI over its property. Parties who carry out a search to find out what of the transferee's property may be subject to SIs will not discover the SI over the property that was transferred because the relevant financing statement will have been filed against the transferor.
3.242     The UCC rule is simple: provided SP1's interest was perfected at the time of transfer and has remained so, SP2's interest is subordinate, so SP1 has priority over SP2. This is so whether SP2's interest was created or filed before or after SP1's.^[296]
3.243     The SPPSA and NZPPSA take a different approach. In essence, once SP1 knows that the machine has been transferred to SP2, it has a limited period of time in which to file against SP2. If it does not do so within the time, its SI will lose its priority as against any SI subsequently created by SP2 and perfected first.
3.244     The PPSAs have a further provision dealing with advances made by SP2 under an already perfected SI.^[297] SP1 will lose its priority against further advances being made or contracted for under the existing SI, unless within 15 days it acts to protect its priority. Once it knows of the transfer and who the transferee is, it has 15 days in which to file or take possession. It will have priority over any advance that is made or contracted for within the 15-day period. After that period has expired, it will have priority only if it takes possession or files against the transferee before the advance is made or contracted for.
3.245     Consultees expressed a wide variety of views on this question, some of which did not take into account the nature of the notice-filing system. We think that SP1's interest should have priority when it did not know of the transfer; that is common to all the schemes and seems incontestable. The policy question is whether SP1 should always retain priority over SP2's SI, whenever filed (as in the UCC), or should it lose priority to SIs perfected after it knows and has had 15 days in which to file against Company B but does not do so (as in the PPSAs)? After further consideration we provisionally recommend the UCC's approach. It seems an unnecessary burden on the secured party to have to file a second time. The PPSA rule does not offer SP2 much greater practical protection. Since SP2 will be bound by SP1's interest if SP2 did not know of the transfer, SP2 will, before it takes a new SI over a used machine, have to check its provenance and search against prior owners in any event.^[298] This should safeguard it. To adopt the PPSA rule, qualifying SP1's rights when it knew, seems to us to invite litigation over whether or not, or at what point in time, SP1 had notice of the transfer.
3.246     We provisionally recommend that if collateral is transferred by the debtor to a party who takes subject to the SI, then provided the secured party's interest was perfected at the time of transfer and has remained so, it should have priority over any SI created by the transferee. This is so whether the SI created by the transferee was created or filed before or after the SI created by the transferor.^[299]

Changes in the debtor's name

3.247     There are also issues if the debtor company changes its name. Under the current provisions of the Companies Act 1985 a company can change its name by special resolution. However, the change of name does not have effect until the Registrar has entered the new name on the register and issued an altered certificate of incorporation.^[300]
3.248     Some of the other systems have rules relating to the priority position of SIs when the debtor changes its name.^[301] In our system however (at this stage at least), we are dealing solely with corporate debtors. We think it should be possible for Companies House to amend automatically the registry entry once it received notification of the name change from the company in the usual way. Presumably it would be possible for the software to recognise when a search by a previous name was being used and to bring up a 'warning box' with the new name. (This could be coupled with Companies House notifying any secured parties who had filed of the change in debtor name.) There would need to be a more detailed rule were our proposed system to apply to all debtors, when there would be a certainty of name changes outside the knowledge of Companies House, but this is something that can be developed at a later stage. However, we recognise that even at this stage there might be problems where an overseas company - one that Companies House has no existing record of - changes its name. It may be necessary for the draft regulations to include provisions addressing this issue, although they do not at the moment.

Liens

3.249     Although interests arising by operation of law, such as liens, are generally excluded from the scope of the draft regulations,^[302] there may be a conflict between a lien and an SI over the collateral that is the subject of the lien. We provisionally recommend that where a person in the ordinary course of business supplies materials or services with respect to goods which are subject to an SI, a lien that that person has with respect to those services and materials has priority over the SI (unless the lien is a statutory lien which expressly provides otherwise).^[303]

Priority as against execution creditors

3.250     The 'residual' rules discussed above also contain provisions concerning the priority advances as against execution creditors. In essence an execution creditor will be subject to any SI that is perfected when the creditor attempts execution.^[304] We have explained that this will be a change from the present situation under a floating charge. Whereas in principle^[305] an execution creditor takes free of a floating charge if it has completed execution before crystallisation of the charge, under our scheme SIs will normally have attached to collateral that has been acquired by the debtor. The execution creditor will not have priority over the SI unless the SI has not been perfected.^[306]
3.251     However, we think that the secured party should not have priority in respect of further advances made after it knows that the execution creditor has acquired an interest in the goods, unless the secured party was under an obligation to make the advance.
3.252     We provisionally recommend that execution creditors should have priority over unperfected SIs^[307] and over a perfected SI in respect of further advances made after the secured party knows of the execution creditor's interest, unless the secured party was under an obligation to make the advance.^[308]

Priority as against buyers or lessees

3.253     Earlier, we noted that if collateral is disposed of by the debtor, the SI continues in the collateral unless either the dealing was authorised by the secured party, in the agreement or otherwise, or the case is one in which the scheme provides that the transferee of the collateral takes free of the SI.^[309] The scheme contains a number of rules about when a buyer or lessee of other collateral will take free of an SI, even where the dealing was unauthorised.
3.254     It should be recalled that the scheme distinguishes between buyers and purchasers: the latter includes both buyers and those who merely take an SI in the collateral.^[310] In this section we deal with the separate provisions affecting only buyers and similar disponees of the collateral.

Unperfected SIs

3.255     In the CP we provisionally proposed that an unperfected SI should be ineffective against any person who for value acquires an interest in or right over property subject to the charge even if the buyer had actual knowledge of the SI.^[311] Although a large proportion of consultees agreed with this, we have since reconsidered it in part. We think that a buyer who has actual knowledge of an SI should take subject to it even if it was unperfected. As a number of consultees have pointed out, the rule we proposed in the CP would give opportunities for fraud: for example, a director of a company might buy equipment from the company knowing that it was subject to an unperfected SI. We therefore provisionally recommend that a buyer of collateral subject to an unperfected SI will take free of it, providing value is given and the buyer was without knowledge of the SI.^[312] As with the other rules, we would apply the same approach to a disposition by way of lease.
3.256     We provisionally recommend that a buyer or lessee of collateral should take free of an unperfected SI unless it had knowledge of the existence of the SI.

Sales of goods in the ordinary course of business

3.257     A buyer or lessee who deals with a company whose normal business is selling or leasing the kind of goods in question should not be expected to search to see if the seller or lessor has created an SI over the goods. The other schemes provide that where goods are sold or leased in the ordinary course of business, a buyer or lessee will take free of any perfected or unperfected SI unless it knew not just of the existence of the SI but that the sale or lease constituted a breach of the security agreement under which the SI was created. In the CP we explained that, in this context, 'ordinary course of business' must be interpreted more narrowly than, for example, under current law in relation to dispositions under a floating charge or even under the Sale of Goods Act 1979. In those contexts it seems to mean no more than that the sale must not be 'suspect' in some way; whereas under the UCC and PPSAs it means that the sale is one of goods of a type that the seller normally sells. Thus a buyer who buys a stock item from a dealer will take free of any SI created by the seller, and therefore does not need to search; but the person who buys, say, a used press from a printing company will be bound by any perfected SI over the press and thus should search the register before agreeing to purchase it.
3.258     In response to the CP, consultees expressed a wide variety of views on this proposal.^[313] In subsequent discussion, however, a consensus seemed to emerge that this is an appropriate rule. Therefore the provision in the draft regulations is worded so that it is different from the current English law on sales in the ordinary course of business. Under the draft regulations, the rule applies if the sale is both in 'the ordinary course of business' and the seller's business normally involves selling goods (or the lessor's business normally involves leasing goods) of the type in question. This will normally be confined to sales of inventory, though it may occasionally include goods that at one time were equipment, for example if company regularly sells off its stock of equipment.^[314]
3.259     It should be noted that under this rule the buyer will only take free of SIs created by the immediate seller. If the goods are second-hand it is possible that they may be subject to an SI created by a previous seller, for example, if the previous seller held them under a hire-purchase agreement that has not been paid off. Under the general rules, if the earlier SI was perfected it will be binding on the buyer. (We have already noted the special rules for uniquely numbered goods such as motor vehicles^[315]). In the CP we provisionally proposed, as had the Crowther and Diamond reports, that a person who buys from a dealer should take free of all SIs, since there would be no way for the buyer to discover the SI.^[316] A small majority of consultees supported the proposal but the minority who disagreed made a telling point: this would constitute a major inroad into the principle that a seller cannot transfer a title it does not have, and one that is not necessary to our scheme.^[317] Moreover it would have a considerable impact on those who supply equipment on retention of title terms. It should not be adopted without a full review of the law of transfer of title. We have therefore abandoned this proposal as a general rule.
3.260     We provisionally recommend that a buyer of goods from a seller who normally sells goods of that kind, or a lessee from a lessor who normally leases goods of that kind, should take free of any perfected SI created by the seller or lessor unless the buyer or lessee knows that the sale or lease is in violation of the security agreement.^[318]

Low price goods bought for private purposes

3.261     In the CP we also asked whether a person who buys goods for private purposes, whether buying from a dealer or someone else, should take free of all SIs. This question divided consultees. Most of the other schemes have a similar provision, applicable to goods bought for less than a modest sum such as $1000. In other words, private buyers of low value second-hand equipment^[319] need not search or worry about SIs over the equipment. We think it might be useful to include such a provision and for the purposes of consultation have included one in the draft regulations.
3.262     We ask consultees whether a person who

(1) buys goods for a purchase price of, say, £1000 or less (or leases them where they have that market value),

(2) does so primarily for personal, family or household purposes,

(3) and does not know that the goods are subject to an SI,

should take free of any perfected or unperfected SI in the goods. If so, is the figure of £1000 appropriate?

Motor vehicles and other serial-numbered goods

3.263     We noted earlier that where the collateral consists of what are prescribed by the rules to be uniquely identifiable goods, it is possible for the unique number to be included on the financing statement.^[320] A buyer or lessee without knowledge of the SI will take goods that are equipment free of any SI that has been perfected by filing where the goods are uniquely identifiable but where the unique number was omitted from the filing.^[321]

Other priority situations

3.264     There are several other areas where the UCC and PPSAs have rules addressing specific priority situations. In a number of cases we have decided not to replicate these.

Fixtures

3.265     Interests over land are excluded from the application of the draft regulations, as they generally are from the UCC and PPSAs.^[322] However, on the related question of fixtures, the North American schemes have complex provisions dealing with questions of priority as between the secured party and those with interests in the land. These seem to reflect a different background in terms of the rules about fixtures. The NZPPSA does not include such rules. We think that we also can avoid complex rules on the continuation of an SI over goods that become fixtures and its priority.
3.266     Under our proposals, an SI covering the goods that ultimately become fixtures would be within the scheme, until the point that they become fixtures.^[323] The SI will continue in the collateral even if it becomes a fixture, but the secured party will have no right to enforce its rights against the landowner unless the landowner has consented to the removal of the fixture (for example, by agreeing to a right of re-entry on default).
3.267     In order for the secured party to protect itself against purchasers of the land to which the goods have become affixed, it will have to take steps to register the right of entry at the Land Registry, as under the current law. Should the goods later be detached from the land, the SI in them will in revive. Whether it will be effective will depend on the usual rules of perfection. We have not thought it necessary to include specific provisions this effect.
3.268     We ask whether consultees agree that specific rules dealing with fixtures are not needed.

Crops

3.269     We have also included provisions to deal with growing crops. We would welcome the views of consultees on whether the approach we provisionally propose is an appropriate one.
3.270     We think that an SI over growing crops should fall within the scope of our proposed scheme, so that the crop can be secured separately from the land on which it is growing. However, under current land law, a mortgagee in possession could also claim growing crops within the scope of its mortgage over the farmland. The draft regulations therefore include a priority rule designed to address this potential conflict, by providing that a perfected SI in crops growing on land has priority over a conflicting interest in the land, if the debtor has an interest in or is in occupation of the land.^[324] This approach is similar to that taken in the UCC. It is simpler than that taken in the PPSAs, which make priority dependent upon registration of an interest in the local Land Registry Office.
3.271     This rule seems appropriate both to crops that have been planted (that is, what are sometimes referred to as fructus industriales: for example, a cereal crop) and to those naturally grown (fructus naturales: for example, fruit growing on trees). The definition however excludes trees other than crops forming part of trees, so that growing trees are neither crops nor goods, and interests over a growing stock of trees would fall outside our scheme. On this the overseas schemes vary, and we would welcome advice, particularly where the trees were planted as a crop.
3.272     We provisionally recommend that a perfected SI in growing crops (whether planted or natural) should have priority over a conflicting interest in the land, if the debtor has an interest in or is in occupation of the land.
3.273     We ask consultees whether growing trees should be treated like other crops or should be left outside the scheme.

Accessions and commingled/processed goods

3.274     The draft regulations - as with the PPSAs - provide that an SI can continue into the proceeds of goods.^[325] However, where accessions and processed/commingled goods are concerned, these may not fall within the definition of 'proceeds'. The North American and New Zealand schemes include specific provisions dealing with accessions and processed/commingled goods (particularly as to priority). In the CP we asked whether any 'restatement' should set out rules on accessions and processed/commingled goods.^[326] We had only five responses to this question, but all were in favour of having such rules, principally because it would help to avoid confusion. Since the consultation process we have had the opportunity to consider this area in further detail. In the light of further comments we have received, we have come to the conclusion that the draft regulations do not need to contain specific provisions dealing with these issues; they will be covered by the general provisions of the scheme.

Accessions

3.275     When a supplier retains an SI in components that it has delivered to a buyer, a question may arise whether the supplier's interest in a component continues after it has been installed in or fixed to other goods. Under the current law, where an article is added to another article but is easily removable, without serious injury or destruction to the whole that has been formed, the proprietary rights of the supplier are unaffected.^[327] If it is not easily removable, and the other article is the 'dominant chattel', the supplier's interest disappears by 'accession' to the dominant chattel. Another supplier may have an SI in the dominant chattel. The value of this interest would be increased by the value of the accession.
3.276     This is different from the rule laid down in the other schemes, which we understand represent pre-UCC law, at least in the US. These permit the secured party to remove any item that has become an accession provided that it compensates the owner of the dominant article for the damage caused (other than the mere loss in value to the dominant article). The right to remove an accession is formally unlimited; but in practice it is limited by a cost-benefit test, in that a secured party will not seek to remove an accession if the accession is worth less than the damage that will be caused. We think that this difference in the pre-scheme law explains, at least in part, why the North American treat accessions in the way that they do.
3.277     When we discussed this in one of our informal seminars, those who spoke saw no reason to adopt this approach, nor to provide that a secured party whose goods have become an accession to other, dominant goods should have an automatic SI in the dominant goods. It suffices that it is possible - as we explain below - for the supplier and the buyer to agree that the supplier should have an SI in the goods to which the component has become an accession. Therefore the draft regulations do not contain a definition of 'accessions'; this question is left to the existing law. Nor do the draft regulations set out specific rules dealing with the priority of SIs over accessions as against SIs over the dominant goods. We provisionally recommend that specific rules on accessions are not needed.

Commingled goods

3.278     At common law, where goods belonging to one party are mixed with similar goods belonging to another (for example, if two parcels of loose grain are stored in a single silo), the two become co-owners of the bulk. Thus if two creditors each had an SI in one of the two parcels, they would each continue to have an SI over the owner's share of the bulk. The goods have not changed in their nature, so no new filing is needed; and any SI over the share in the commingled goods will have the same priority that it had before the goods were mixed. If, for example, grain that is subject to a PMSI is mixed into a mass of other grain that is subject to an 'all assets' SI in favour of a bank, the SI over the proportion that represents the 'PMSI' grain will continue to have PMSI status as against the general SI over the mass. We provisionally recommend that there is no need for our scheme to include special rules to deal with commingled goods.

'Processed' goods

3.279     Where goods of different natures are combined into a new article, for example resin and wood chips are combined into chipboard, it seems that any SI in the ingredients would disappear along with the identity of the ingredient.^[328] The UCC and the PPSAs expressly provide that an SI continues into the new goods, and that the secured party does not need to file a new financing statement: perfection of the SI over the original goods being treated as perfection over the product or mass.^[329] There are then complex rules dealing with the priority of the various competing claims, both as against each other and as against any SI over the goods as a whole.
3.280     Again, at the informal session the general view was that we should not change the common law rule that when the new product is made, the original goods and any SI over them disappear. It should be for the parties to agree expressly that the secured party should have an SI in the new goods as well as the original goods supplied.^[330] This comes close to replicating the current law, save that in practice the supplier is unlikely to have an effective SI over the new goods under current law. It would be a floating charge and it is most unlikely that the supplier will register it as such. If such an arrangement were to be agreed under our proposed scheme, the SI over the new goods could be perfected by an appropriate filing, which could of course be made in advance of the transaction. No special provisions are required to achieve this result.^[331]
3.281     Nor do we consider it necessary to have special priority rules for competing SIs that continue into the product; this can be left to the general priority rules. In what is probably the most common case – where several suppliers each have an SI over different ingredients and each secured party also takes an SI over the 'new goods', but the goods will have to be sold at an insolvency sale and fetch less than the unpaid prices of the ingredients – the secured parties would have priority according to the order of filing.
3.282     It should be noted that while the supplier will have a PMSI over the goods in their original state (assuming it has fulfilled the necessary conditions as to notice and filing^[332]), under our proposals any SI over the 'new' goods will not be a PMSI. It will therefore be subordinate to any previously filed or perfected SI over the new goods, such as an SI in favour of a 'stock' financier or a general SI in favour of the debtor's bank. The same would be true of any claim to the proceeds of sale or disposition of the new goods; but we have already proposed that, to protect receivables financing, the relative priority of a PMSI claim to receivables as proceeds and of an SI over them as original collateral should be governed by the order of filing.^[333] We provisionally recommend that there is no need for our scheme to include specific provisions on processed goods.

Liability in damages

3.283     In the CP we asked whether there should be a provision to the effect that a person failing to discharge any duty or obligation imposed by the system should be liable for reasonably foreseeable loss caused to those who could reasonably be expected to rely on performance of that duty or obligation.^[334] This type of provision features in the overseas schemes, although the schemes vary as to whether this is limited to the person to whom the duty/obligation was owed, or whether it is also extended to any other person who can reasonably be expected to rely on performance of it. Of those who commented, a bare majority were in favour of having such a provision, although several thought that it would be necessary to see the nature of the scheme in more detail before deciding whether such a provision was necessary. The draft regulations contain a provision that extends liability to any person who can reasonably be expected to rely on performance of the duty. We would welcome views on it.^[335]
3.284     There are several provisions in the draft regulations non-compliance with which might lead to an award of damages. These include:

(1) DR 17 (secured party's obligation to use reasonable care in the custody and preservation of collateral in its possession);

(2) DR 18 (secured party's obligation to send information about a security agreement to the debtor or someone named by the debtor);

(3) DR 47 (filing a financing statement without the debtor's consent);^[336]

(4) Part 5 (secured party's obligations relating to the giving of notices, disposal and distribution of the proceeds of disposal of collateral following default).

3.285     However, unlike some of the overseas schemes, there are no provisions awarding fixed-sum damages ('statutory damages') for breach of particular provisions. The damages provisions are also expressly without limitation to or effect on any other liability which may exist.
3.286     Do consultees agree with the approach we have set out in DR 71 of permitting damages for reasonably foreseeable loss? If not, what sanctions should exist for failing to carry out any obligation imposed by the draft regulations? Should the availability of damages be limited to those to whom the duty or obligation is owed? If damages are an appropriate sanction, should there be provision for fixed-sum awards for breach of particular provisions?
3.287     We would welcome views on whether the draft regulations should contain an equivalent to a provision found in the UCC, which in effect expressly provides that a secured party does not owe a duty based on its status as secured party:

(1) to a debtor, unless the secured party knows:

(a) that the person is a debtor,

(b) the identity of the person, and

(c) how to communicate with the person; or

(2) to another secured party that has filed a financing statement, unless the secured party knows:

(a) that the person is a debtor, and

(b) the identity of the person.

3.288     Should there be a provision effectively limiting any duty of a secured party towards debtors and other secured parties unless the secured party knows that the person is a debtor or secured party as appropriate, and their identities?

SIs and the 'specialist' registries

3.289     Under current law there are statutory provisions for the registration of certain assets at what are sometimes called 'specialist registries'. The assets concerned are land, ships, aircraft and certain forms of intellectual property, and the relevant legislative schemes allow for registration of an asset itself and, in some cases, of an interest affecting that asset (such as a charge, mortgage or assignment). A charge created by a company over such an asset must also be registered at Companies House, regardless of any other registration provisions relating to the specialist registry. Failure to comply with the company charge registration requirements will render the charge invalid against third parties on insolvency, even if the specialist registry registration provisions have been complied with.^[337] Thus a charge may need to be registered in two places. The priority of securities registered in the specialist register will depend on the rules of the particular scheme; it will not necessarily be affected by any 'constructive notice' of an earlier charge registered only at Companies House.
3.290     In the CP we noted that the Company Law Review Steering Group had proposed that neither the validity nor the priority of charges over land should depend on registration in the Companies Register, though it suggested that there should still be a penalty if the charge were not registered there, in order to ensure that the register gave a more accurate position. We suggested that the latter was unnecessary since the existence of a charge that is on a specialist register is readily discoverable from that register. We therefore made the provisional proposal that the validity and priority of charges over land, and over other assets if the charge is registrable in a specialist register, should not depend on filing a financing statement at Companies House.^[338] We suggested that it would be useful, however, if the specialist registry could forward information about registered charges to Companies House so that it would also appear on the Companies House register.^[339]
3.291     The responses from consultees fell into three groups. Some, including the Land Registry, welcomed the proposal without reservation. A small group were wholly opposed, on the ground that it was important that the Companies Register should have complete information about charges over the company's property. Much the largest group agreed with the proposal that validity and priority should not depend on registration at Companies House on condition that information from the specialist registry were forwarded to Companies House and included on the register for information purposes. There was particular concern about this in relation to charges over land.
3.292     Since the CP we have developed our proposals in more detail. We have considered the relationship between the Companies Register and the specialist registers, in particular the ship and aircraft registers, if the scheme is to be extended to include quasi-securities. This aspect has caused us to rethink the policy issues, because it became apparent that simply to exclude charges that had been registered in the specialist registry from a scheme that includes quasi-securities would cause difficulties. There would be the confusing possibility of some SIs dropping in and out of the scheme, or interests over the asset being covered by two different schemes.^[340] Consequently, as we go on to explain, our policy now is not just to exclude charges that are registered in a specialist register but to exclude any form of SI (whether charge or quasi-security) over an asset for which there is a specialist charges register.^[341]
3.293     We have approached the question of aircraft, ships and intellectual property – for which there are, in most cases, specialist registries and mortgage registration provisions – on the basis that if a lender is really serious about taking security over such an asset, as opposed to just 'sweeping it up' together with the rest of the company's assets in general, it will ensure that all the necessary steps are taken to comply with any specialised 'asset' registration or mortgage registration requirements.^[342] We have been told that this is the case by those involved in specialised finance in some of these areas.
3.294     Although our general policy approach to the specialist registers is similar there are differences, so we deal with each in turn. We deal first with land, and then turn to the specialist registers involving personal property.

Land

3.295     We continue to think that our scheme should exclude the creation or transfer of an interest in land, including a lease, from its scope, whether the land is registered or unregistered.^[343] Neither the validity nor the priority of charges over land would depend on registration at Companies House. Matters of attachment, perfection and priority of such interests should be governed solely by land law. However we think that arrangements should be made to enable a search of the Companies Register to show registered charges over land.
3.296     We think there are two reasons for requiring all charges over a company's land to be registered at Companies House. One is to avoid the need to search two registers. The other is that the land register might not reveal every SI.
3.297     Under current law, a search at Companies House will reveal a charge over land. The land registry will not register the charge without a certificate of registration from Companies House, though a notice or caution may be entered. The exclusion of the creation or transfer of interests in land, without more, would mean that a search of the 'notice-filing' register at Companies House would no longer have this effect. A potential lender contemplating taking security from a company over its land would need to search at the Land Registry rather than at Companies House. If it were proposing to take security over both personal property and land it would have to search both registers.
3.298     We have been told by practitioners that it is common practice to search only the Companies Register, on the basis that the absence of any entry there of a charge over land will invalidate the charge against third parties on insolvency.^[344] If it were no longer possible to search in this manner, additional work would need to be done by the lender to establish whether land was subject to a charge.
3.299     Moreover, the absence of a Companies House registration might mean that an equitable interest over land that had not been registered at the Land Registry would not be revealed at all. We have also been told that sometimes where fixed charges are taken over a portfolio of real property, those charges are only registered at Companies House and not at the Land Registry. We understand that they are not registered at the Land Registry for commercial reasons, to avoid complications where it is anticipated that the property might be sold. We do not know how common this practice is, nor whether it relates to registered land, unregistered land or both. But they raise the question, how serious a risk is presented by charges that have not been registered at the Land Registry? How many parties dealing with companies might be put at risk if the link with Companies House were broken?
3.300     If the land is unregistered, a puisne mortgage or a general equitable charge will be void as against a purchaser of the land charged with it, or of any interest in such land, unless the land charge is registered in the appropriate register before the completion of the purchase.^[345] Priority of registered land charges is dealt with by the Law of Property Act 1925. Section 97 provides that that '[every] mortgage affecting a legal estate in land…whether legal or equitable…shall rank according to its date of registration as a land charge pursuant to the Land Charges Act'.^[346] Therefore purchasers of unregistered land will not be affected by charges that have been registered only at Companies House and removing a requirement to register there will not affect them. It would affect principally unsecured creditors, because, if it were no longer necessary to register there, wholly unregistered charges would no longer be void as against the liquidator.
3.301     If the land is registered, a legal charge is registrable at the Land Registry. Equitable interests can be protected by notice (under the old Land Registration Act 1925, as a 'minor interest' by notice or caution), but such a notice does not affect their priority, this being determined by the first in time to create, rather than being linked to any date of notice being entered. Failure to protect by notice does not affect priority. Consequently, under current law, an equitable mortgage created by a non-corporate person that has not been protected by notice or caution can have priority over a second equitable mortgage,^[347] even though the second mortgagee could not find out about the existence of the first.^[348] In the case of such a charge created by a company, even if a notice is not entered at the Land Registry, the current requirement to register the equitable mortgage at Companies House will mean its existence is discoverable. Removing this requirement would, without more, result in the priority position of equitable mortgages created by companies being the same as for individuals (that is, a potentially undiscoverable interest might have priority). Unsecured creditors would face the same problems as with unregistered land.
3.302     However, we think that the dangers of 'invisible' equitable mortgages over registered land may soon be over. The Land Registration Act 2002 contains a provision allowing rules to be made allowing for electronic conveyancing, whereby the disposition of a registered estate or charge, or an interest which is the subject of a notice in the register (or a contract for such disposition) will only have effect if it is made by means of a document in electronic form and it is electronically communicated to the registrar.^[349] At present, the Land Registry is consulting on proposals for the introduction of 'e-conveyancing'.^[350] Assuming that provisions along the lines of those anticipated in the Land Registration Act 2002 are introduced, the result should be that all mortgages or charges over registered land will have to be registered electronically in order to have effect. We consider it likely that any e-conveyancing proposals will be implemented before our system is operational, and that consequently the risk of 'invisibility' caused by our 'de-linking' the land register from the company charges register will no longer be a problem in respect of registered land.
3.303     E-conveyancing would solve the problem of invisible mortgages over registered land. With unregistered land there remains a risk for unsecured creditors, but we wonder how serious the risk is. First, we do not have information that many lenders rely on charges over unregistered land that are not registered under the Land Charges Act 1972. Secondly, the 'risk' faced by unsecured creditors depends not just on whether the charge is valid but on whether they can find out about it. This relates to the next point to be discussed.
3.304     In the CP we asked whether the specialist registry should forward information about charges created by a company to Companies House 'for public notice'. Most consultees who responded on the issue seemed to favour establishing some form of electronic link, and some even made support for notice-filing conditional on there being a link between the registries. It would clearly remove the need for dual searching, and would thus reduce the risk to unsecured creditors in particular, if the land registry could forward information to Companies House and the latter could display it on, or make it available through, the register of SIs.
3.305     For so long as the system of land law permits unregistered equitable interests to have priority over subsequent equitable interests, the usefulness of forwarding information to Companies House would be limited, in that it would reveal those charges and mortgages that had been registered, but not those that had not; and there would be no reason to register an equitable mortgage in order to preserve its priority.^[351] Once e-conveyancing is introduced, with the effect that all charges and mortgages will now have to appear at the Land Registry in order to be effective, a link between the registries would be more effective, as all charges and mortgages over registered land should appear. There may be some unregistered charges over unregistered land but we suspect they would be few.
3.306     There are two ways in which information that is on the land registers could be made available to those searching the Companies House register.

(1) One would be by the Land Registry forwarding information to Companies House for display on the register. Under the Land Registration Act 2002 the Lord Chancellor already has power to make rules to provide for this.^[352]

(2) The other would be by establishing a 'hyper-link' between the on-screen information presented by Companies House and the electronic register of the Land Registry. This would depend on the Land Registry's e-conveyancing register being searchable by company name rather than the identity of the land, but we see no reason why this should not be technically possible.^[353] It would also depend on the Land Registry marking in some electronic fashion charges over land, so that the hyperlink would give access only to charges and not to all entries (for example, holdings of land that are not subject to a charge) in a company's name. We are sure that if this is not done already it would be possible.^[354]

Which system should be used seems to be a purely technical question.

3.307     We therefore think that the combination of e-conveyancing and establishing a link between two electronic registries will be sufficient to overcome the potential problems of removing the need to file charges over land at Companies House.
3.308     It is possible that, theoretically at least, another consequence of excluding the creation or transfer of interests over land would be that a floating charge over land would continue to be governed by the existing law rather than our scheme. However, we understand that it is far more usual to take fixed charges over land and floating charges over any property not covered by such fixed charges. We have not heard of problems arising in the PPSA schemes because of this theoretical possibility. ^[355]
3.309     We provisionally recommend that the creation and transfer of interests in land should be excluded from the scope of the draft regulations. Arrangements should be made to make available on or via the Companies House register information about charges over a company's land that are registered at the Land Registry.

Rights to payment arising in connection with land

3.310     Although the creation or transfer of interests in land are excluded from the scope of a personal property security scheme, it is very important to note that there is a distinction between interests in land and interests in any debt that that interest itself creates. The former is outside the scheme, the latter inside it. Thus if A grants a mortgage over Blackacre to B, the mortgage will be outside our scheme, and will be subject to the rules of land law relating to matters such as validity, registration and priority. However, if B then factors the income stream due to it as repayments under that mortgage to C, or otherwise creates a charge over its receivables, that arrangement between B and C will fall within our scheme.
3.311     We make this point because some of the PPSAs, in addition to excluding the creation or transfer of interests over land, also exclude transfers of rights to payment arising in connection with an interest in land, unless evidenced by a security or an instrument.^[356] We prefer the approach of the UCC and the Ontario PPSA, which do not have such an exclusion.^[357] Otherwise factors would have to operate under two different regimes, as would those taking security by way of a general SI (which under current law would be a floating charge).
3.312     We provisionally recommend that interests over rights to payment arising from an interest in land should not be excluded from the scheme.

Aircraft

3.313     As a general rule, an aircraft cannot fly in or over the UK unless it is registered in some part of the Commonwealth (which includes the UK^[358]), a 'Contracting State' (one that is party to the 1944 Chicago Convention), or any other country with which the UK has an agreement which makes provision for the flight over the UK of aircraft registered in that country.^[359] (There are some exceptions to the general rule, although they are unlikely to be of great significance in relation to company SIs.^[360]) The practical effect of the legislation is that virtually all commercially-flown aircraft operated by companies in the UK will have to be registered.^[361]
3.314     The UK Register of Civil Aircraft is administered by the Civil Aviation Authority (CAA) and is governed by the provisions of the Air Navigation Order 2000, as amended.^[362] The legislation contains detailed registration requirements which we do not discuss here. The registration and priority of aircraft mortgages is governed by the Mortgaging of Aircraft Order 1972 (MAO).^[363] The MAO provides that an aircraft registered in the UK nationality register, or such an aircraft together with any store of spare parts for that aircraft, may be made security for a loan or other valuable consideration.^[364] Registered mortgages^[365] have priority over unregistered mortgages and charges, and priority between registered mortgages is decided by reference to the date of registration, although nothing in the priority rules is to be construed as giving a registered mortgage any priority over any possessory lien for work done to the aircraft or statutory right of detention.^[366] Priority notices may also be entered in the mortgage register.^[367]
3.315     Leasing is also extremely significant in the airline financing industry. We understand that in the late 1990's, in the world as a whole, about half of the more modern jet aircraft were owned, but about 30% were on finance lease and about 20% on operating lease.^[368]
3.316     Bearing in mind that the scheme we provisionally recommend is one that covers quasi-securities and well as mortgages, we have considered three possible options:

(1) bringing all SIs over aircraft within our scheme and taking over the mortgage registration function from the CAA (effectively closing the aircraft mortgage register),

(2) excluding mortgages that have been registered in the aircraft mortgage register, but otherwise bringing all SIs within our scheme (which would be the effect of the provisional proposal we made in the CP); or

(3) excluding all interests over aircraft, where that aircraft - as opposed to any mortgage - has been registered at an aircraft registry (whether in the UK registry or elsewhere).

3.317     The first option, taking over the security registration function of the aircraft registry, is unlikely to be acceptable three reasons. First, the system of aircraft registration and registration of aircraft mortgages is well-established and accepted. There seems no reason to disturb it.^[369] Secondly, such a move might be seen as premature, given the work being done in relation to SIs over airframes under the Mobile Equipment Convention.^[370] Thirdly, our scheme is just for companies. The existing aircraft mortgage scheme would have to continue at the CAA for unincorporated persons, and we doubt whether presenting the international aviation financing world with such a split system would prove to be attractive, even though there are already differences in the treatment of charges created by companies and unincorporated persons.
3.318     The second option, bringing all SIs within our scheme save for mortgages registered on the aircraft mortgage registry, is likely to cause problems or confusion when quasi-securities are considered. A mortgage over an aircraft would be governed by the MAO, a finance lease by our scheme. Which would have priority? It would be possible to devise rules of priority to deal with the conflict, but since title-retention devices over aircraft do not seem to cause any difficulty (because aircraft are sufficiently expensive that few will be bought or mortgaged without a careful investigation of the title to them) there seems little point in trying to include them in our scheme at the cost of introducing avoidable complications.
3.319     We think that it would be preferable to follow the third option, and exclude all SIs over registered aircraft. The existing law relating to security and quasi-security would continue to apply to interests over such aircraft. This would avoid any conflict between registered aircraft mortgages and SIs under our scheme. Materials and parts that become accessions will be governed by our scheme until they become accessions.^[371]
3.320     Our scheme will apply to any SIs over aircraft that are not registered because they are in the course of construction. When the aircraft is registered, the SI over it will no longer be perfected under our scheme, nor its priority protected. If it amounts to a mortgage, the secured party will have to ensure that it is registered as soon as the aircraft is registered. We do not see that this will be unduly burdensome.
3.321     We would apply this exclusion whether the aircraft is registered in the UK registry or elsewhere in the world. It is true that not every aircraft registration system provides for the registration of mortgages and charges over the aircraft. To this extent our proposal would mean that if a company registered in England and Wales owns an aircraft registered in such a system and creates a charge over the aircraft, the charge will not be registrable. We have consulted experts in aviation finance and have been told that aircraft financing is so specialised that this will cause no problem. General lenders are most unlikely to think that they will be able to have recourse to an aircraft owned by a company if they have not taken a specific SI over it.
3.322     We provisionally recommend that SIs over aircraft registered in the UK or anywhere else in the world should be excluded from our scheme.

Ships

3.323     The 'ship registry' is administered in the UK by the Registry of Shipping and Seamen. As with aircraft, there are registration provisions for the asset itself, and a system of registering mortgages over ships, together with priority rules for such registered mortgages, based on date of registration. However, the mortgage provisions do not apply to all types of registered ship.^[372]
3.324     The Merchant Shipping Act 1995 (MSA) and the Merchant Shipping (Registration of Ships) Regulations 1993^[373] (MSR) provide for a single centralised register for ships, which is divided into separate Parts for different kinds of ship.^[374] The registration provisions are not mandatory, although in practice ships will be registered in order to gain the benefits of establishing a nationality and to assist in proving or transferring ownership.^[375] The legislation also contains what it calls 'private law provisions' (MSA, Schedule 1), which govern both transfers and mortgages of ships. However, the private law provisions do not apply to certain ships even though they have been registered.^[376] Where the private law provisions do not apply, it is not possible to register any mortgage that may exist at the ship registry.^[377]
3.325     In addition to providing for a prescribed form of mortgage, the legislation also sets out a priority rule between two or more registered mortgages, based on the order of registration (although there is power to allow priority notices^[378]).
3.326     As with aircraft, we considered the three possible policy options of:

(1) bringing all SIs over ships within our scheme and taking over the mortgage registration function from the ship registry (effectively closing the ship mortgage register);

(2) excluding mortgages that are registrable at the ship registry, but otherwise bringing all SIs within our scheme (the CP proposal), and

(3) excluding all interests over ships, where that ship - as opposed to any mortgage - has been registered at a ship registry (whether in the UK registry or elsewhere).

3.327     The first option we again reject as being unlikely to be acceptable. The system of registration of ship mortgages is very well-established^[379] and we have not heard of dissatisfaction with it. Moreover, because our scheme could deal only with ships that are mortgaged by companies, the existing scheme would have to continue for unincorporated persons.
3.328     The second option (that provisionally proposed in the CP^[380]) suffers from similar problems to those identified in relation to aircraft, when viewed in the light of a scheme that applies to all SIs and not just charges. There would be a real risk of competing interests over the same ship being governed by two different schemes, and hence confusion.
3.329     We therefore provisionally recommend taking a similar approach to that taken for aircraft, but with an additional qualification. Since a mortgage cannot be registered over every type of registered vessel, the exclusion should be limited to those where under English (or Scots) law registration of the mortgage is possible. Otherwise mortgages over those types of ships would be 'invisible.'^[381] We have not, however, seen the need to introduce this qualification as regards overseas ship registers, for the same reasons as with aircraft.^[382]
3.330     Thus we provisionally recommend that we should exclude from our scheme all interests in ships where the ship has been registered at the UK ship registry (or an equivalent one anywhere else in the world), provided that a mortgage is capable of being registered at the ship registry (that is, registrable), but otherwise bringing all SI's within our scheme.^[383]
3.331     It follows that where the ship has been registered at the ship registry, and the registration is one to which the 'private law provisions' apply, so that a mortgage over the ship could (but does not have to) be registered, then any interest in the ship – whether by way of mortgage or quasi-security – is excluded from our scheme. Where such a ship has been registered, the current law will continue to exist more or less as it does at the moment (save that there would be no dual registration requirement), both for charges and for quasi-securities. We return to the point we made earlier that any lender serious about using a registered or registrable ship as security should ensure that the ship and mortgage registration provisions are complied with. Conversely, where the ship itself is not registrable either in the UK or elsewhere, or it has been registered where the mortgage registration provisions do not apply (for example, because the ship is a 'small' ship), then there is no way a lender can protect itself by registering a mortgage at the ship registry, or others find out about it. SIs over such ships fall within our scheme.^[384]
3.332     It is possible that an SI could be perfected under our scheme whilst a registrable ship had not actually been registered, but then the ship becomes registered. In this case the interest over the ship 'drops out' of our scheme and is then governed by what is the 'current' law (under which the court will look to the form of the security agreement and see what sort of security or quasi-security exists outside our scheme). Hence there should never be a conflict between the priority rules of our scheme and the rules in relation to the 'excluded' interests. However, we do not think this situation will be common, and in any event it can be avoided by the lender insisting that all that can be done to register the ship is done before it takes its security.
3.333     We provisionally recommend that any SI over a ship that is registered in the UK and to which the 'private law provisions' apply, or over a ship registered anywhere else in the world, should be outside our scheme.^[385]

Enforcement of ship mortgages

3.334     There is an additional matter to consider regarding the enforcement of mortgages. Under current law, it is probable that matters relating to the enforcement of ship mortgages will be dealt with by the Admiralty jurisdiction of the High Court, which applies to all mortgages or charges, whether registered or not, including those created under foreign law.^[386] Admiralty jurisdiction in respect of claims in respect of mortgages or charges can be brought in personam, or in rem against the ship or property in connection with which the claim arises.^[387] The in rem action, allowing the creditor to arrest the ship and have it sold by the Admiralty marshal, is seen by some commentators as having advantages over traditional mortgage remedies.^[388] We are cautious about disturbing established practice in this specialised area, particularly if it would result in a different enforcement regime for an SI created by a company and a mortgage created by a partnership or individual. At present, there is a consistent dedicated remedial scheme that can be used for all ships, and we are cautious about altering this unless consultees advise us to the contrary.
3.335     Although the effect of our provisionally recommended policy in this area is that most company-owned or operated ships are likely to fall outside our scheme, the draft regulations contain a provision that the statement of rights and remedies is without prejudice to Admiralty practice relating to the enforcement of mortgages or charges on ships and interests in ships. We would welcome the views of consultees as to whether such a provision is necessary for those SIs over ships that fall within our scheme.
3.336     For those SIs in ships that fall within the scope of the draft regulations, we provisionally recommend that the statement of rights and remedies contained in Part 5 of the draft regulations should be made without prejudice to current Admiralty practice relating to the enforcement of charges and mortgages in ships.^[389]

Intellectual Property

3.337     The position for interests over intellectual property is complicated by the fact that it does not comprise one particular type of asset, such as an aircraft or a ship, but rather takes several forms, each subject to its own statutory and common law provisions.^[390] In some cases registration of the asset at a specialist registry (and interests in it) is possible, but in other cases there are no registration provisions.
3.338     The approach we provisionally recommend for SIs over the various forms of intellectual property follows the approach we took for aircraft and ships. We suggest that where the intellectual property right has been registered at an appropriate registry, either in the UK or anywhere else in the world, and where a mortgage or charge over that intellectual property is also capable of registration in that register (whether or not it actually has been) then any interest over that registered intellectual property will fall outside our scheme.
3.339     There are no legislative provisions affecting goodwill, and SIs over this will thus fall within our scheme. There are legislative provisions covering copyright and design rights, but no separate registration provisions with respect to either of them, or for the registration of any security affecting them (other than the Companies Act 1985 requirements).^[391] Interests over copyright and design rights will thus also fall within our scheme (unless an overseas jurisdiction allows for registration).^[392]
3.340     There are registration provisions with respect to registered designs, under the Registered Designs Act 1949, which also allow for notices of interests such as assignments and mortgages of registered designs to be entered in the register.^[393] Interests in registered designs will thus be excluded from our scheme. Interests in registered patents and in registered trademarks will also be excluded from our scheme, as the Patents Act 1977 and the Trade Marks Act 1994 provide for both registration of a patent/trade mark and of transactions affecting registered patents and trade marks.^[394]
3.341     At the moment the draft regulations refer to patents, trademarks and designs, as our understanding is that these are the only forms of IP that can be registered (all currently registrable at the Patents Office) and over which charges, mortgages (and other interests) are also capable of being registered. We have not referred to copyright in the draft regulations, as this is not subject to registration in the UK, although this would be necessary if copyright and charges over copyright can be registered elsewhere in the world. We would welcome the advice of consultees on this point.
3.342     We provisionally recommend that SIs over registered designs, patents and trade marks should be excluded from our scheme.

SIs over assets abroad or created by 'foreign' companies

3.343     Determining policy for whether and how the draft regulations should apply to SIs created by companies registered in England Wales over collateral outside the jurisdiction, and SIs created by companies incorporated or registered elsewhere over assets in England Wales, proved to be a difficult task. The CP considered some of the issues that arise,^[395] but it focussed on registration, and not all the issues were fully explored. The CP did not refer to the Regulation on Insolvency Proceedings.^[396] We have also to consider that under European law – as recently made clear by the Inspire Art^[397] case – companies may be registered in one Member State but have their entire operation in another. Consultees' responses were helpful but also left many of the issues untouched. We are fortunate that subsequently we have received valuable advice from a number of academic and practitioner experts.
3.344     Space precludes a full discussion of all the issues we have had to consider in reaching our conclusions. In a paper for an informal seminar^[398] we considered following the North American and New Zealand models,^[399] which set down relatively comprehensive schemes dealing with the issues of private international law that may arise in relation to the validity, perfection and the effect of non-perfection, and priority of SIs. For example, we suggested that there would be advantages if the validity and perfection of non-possessory SIs over intangibles in general were governed by the jurisdiction in which the debtor company is registered. We also explored the relative advantages of different approaches: for example, with non-possessory SIs over goods, whether it would be better to follow the PPSA approach of leaving questions of perfection to the law of the jurisdiction where the goods are located (the 'lex situs') at the date of attachment, save with 'mobile' equipment, where perfection is governed by the law of the place of the debtor's incorporation; or the approach of Revised Article 9, which refers to the latter law in all cases of non-possessory SIs over goods.
3.345     After discussion at the seminar and with experts subsequently, we have concluded that it would not be sensible for us to try to regulate such issues of private international law. First, it seems unnecessary to do so. It is true that the some aspects of the current law - for example, on what law governs the assignment of receivables - seem either unclear or less than wholly satisfactory, but we have not heard that the problems cause serious difficulty in practice. Secondly, we think that it would not be practicable for England and Wales to alter its law in the way in which the law of North America has been altered. To put it simply, some of the rules adopted there make good sense if the 'foreign' jurisdictions that are likely to be involved have adopted broadly similar systems, but would not make sense in the European or wider context, in which there is enormous diversity. The necessary changes to English law would either be difficult to introduce, or would be ineffective because the 'new English rules' would probably not be followed in other jurisdictions.
3.346     Therefore we have reverted to a minimalist approach. We deal only with questions of how the scheme will apply to SIs created by companies registered in England and Wales over their assets outside the jurisdiction, and to SIs created by companies incorporated elsewhere, or registered in Scotland, over assets here.

Companies registered in England and Wales

3.347     In relation to SIs created by 'English' companies^[400] over assets outside the UK,^[401] it will be seen that the draft regulations provide that in general the scheme is to apply to all types of collateral,^[402] wherever the collateral is located in the world.
3.348     In practice, the effect of the scheme in relation to assets overseas will be limited. We illustrate this point by considering first possessory SIs and then non-possessory SIs over goods.

Possessory SIs

3.349     Questions of validity, priority and (so far as it can be separated from the issue of validity) perfection of possessory securities is traditionally left to the lex situs. In practice most issues relating to a possessory security created by an English company over its assets located in another jurisdiction will be determined in the local jurisdiction, which will apply the lex situs. Our scheme will not normally be relevant.

Non-possessory SIs over goods

3.350     Current law requires an English company to register at Companies House charges over its goods wherever the goods are located;^[403] issues over the law governing validity and priority are left to the general law. In practice the registration requirement - or rather its only effective sanction, that an unregistered charge is 'void against the liquidator or administrator or any creditor of the company'^[404] - is likely to be of limited effect in relation to goods that are overseas. This is because in many cases the issue will be between the secured party and another creditor who claims to have acquired rights according to the lex situs, and it is very unlikely that the lex situs will treat a security device that it recognises as valid, but which under English law amounts to a registrable charge, as invalid for want of registration under English law.
3.351     The problem may be illustrated by considering the operation of the Regulation on Insolvency Proceedings.^[405] An English company may have its Centre of Main Interest in another country. Where this is another Member State, the Regulation provides that on an insolvency the principal proceedings will be conducted under the law of that State.^[406] The same applies if the company merely has an establishment and some assets in the State and the proceedings there are secondary ones. Thus the lex situs will be applied.
3.352     Even if the only proceedings are in a Member State other than that where the goods are located, under article 5 of the Insolvency Regulation the rights in rem of the creditor must be respected. Normally these rights will be governed by the lex situs.
3.353     Thus in many cases the relevant question will be decided by the lex situs. Whether or not the SI had been perfected according to English law would only be relevant if the law of the relevant Member State required non-possessory SIs created by companies registered in other Member States to be perfected by filing in their jurisdiction of company registration. This is unlikely to be common, particularly as regards quasi-securities.
3.354     Thus the Insolvency Regulation creates some weakness even in the current scheme of registration: the company is required to register charges wherever the goods are located but, provided that the charge is valid under the lex situs, the 'real' sanction that an unregistered charge will be invalid against other creditors is lost. This also has implications for our proposed scheme under which filing is voluntary. If the 'usual' sanctions of possible loss of priority and of ineffectiveness in the event of the company's insolvency do not apply, secured parties taking non-possessory SIs over goods outside England and Wales may not think it worthwhile to file under our scheme. Perfection under our scheme would really matter only if the goods (or their proceeds) were subsequently brought into England and Wales.
3.355     Where the non-possessory interest created by the English company is valid under the lex situs, and is one that would amount to an SI under our scheme, it might be thought that there is little point in applying the draft regulations. First, the secured party might need to perfect its SI under the local law, and so could not rely on filing in England and Wales to perfect its SI. To apply our scheme might result in a need for 'dual registration', a concept which we are trying to avoid if possible.^[407] Secondly, the argument that applying our scheme so that perfection is needed in England and Wales, in order to enable creditors or others to find out what SIs the company has created over its overseas assets, is undermined if in practice the secured party would choose not to perfect under our scheme. The local law may treat the SI as perfected provided that the secured party complies with local requirements alone. If the goods are not likely to be brought into England and Wales, the secured party may take the view that the goods will never become subject to English law, and not bother to file under our scheme as well.
3.356     This might suggest that the draft regulations should take the approach of the Canadian and New Zealand PPSAs, which is that an SI over goods in general should be perfected in a jurisdiction only if the goods are in the jurisdiction at the time, or are brought into it subsequently.
3.357     In fact this is not an end of the matter. The SI might be recognised by English law but give no rights under the lex situs (for example, because the lex situs does not recognise non-possessory SIs over that type of asset^[408]). This would initially appear to give the secured party no rights at all, and if a second secured party took an SI that is recognised by the lex situs, or if the goods are validly seized by way of execution under that law, the first secured party would be unable to claim the goods against the other creditor, since that would involve an action under the lex situs.
3.358     However, where there are no competing secured parties or creditors who have yet levied execution, the outcome under current law seems to depend on whether the English company has an establishment in the jurisdiction where the goods are.

(1) If it does, then under the Insolvency Regulation secondary proceedings may be opened there in relation to the assets in the jurisdiction, and the proceedings will be governed by the law of the same jurisdiction.^[409] Again, perfection under English law is irrelevant since the lex situs will not recognise it.

(2) If it does not have an establishment where the goods are, the liquidator may be able to get hold of the assets for the benefit of the unsecured creditors, but it appears that secured party will be able to enforce its SI even though it is not recognised by the lex situs. The English court may exercise its jurisdiction in personam over the liquidator to enforce the contract between the secured party and the company, and may require the liquidator to pay the proceeds to the secured party, as it did in Re Anchor Line.^[410] This outcome under current law depends upon the charge being properly registered in England and Wales. We think that for our scheme to change this would be to risk misleading unsecured creditors and possibly subsequent secured parties.

3.359     We have concluded that the best course would be for the draft regulations to maintain the current approach, and accordingly they have the effect that non-possessory SIs created by English companies over their personal property must be perfected (by filing in the case of goods) wherever the assets are. We accept that secured parties who take SIs that they are confident will be enforceable in the lex situs, or who are dealing with companies that have an establishment where the goods are, will have little incentive to file. This means that other parties must realise that they will need to investigate whether or not there are SIs over the goods under local law, rather than rely merely on the register established under our scheme.
3.360     We think that it is not just the registration requirement that should apply in respect of assets overseas but the scheme as a whole. In a case like Re Anchor Line (admittedly a rare situation) a question may arise as to whether it was necessary for the secured party to file in order to perfect its SI, or whether it was perfected by possession or, in the case of financial collateral, 'control'. Questions of priority might also arise between competing secured parties neither of whom had an SI recognised by the lex situs. We think that in principle such issues should be governed by the rules of our scheme. This is so even though in practice the vast majority of issues involving assets outside England and Wales will fall to be decided by the lex situs and any provision of our scheme that purports to apply will be ignored.
3.361     We have considered whether it should be provided explicitly that where the collateral is located outside England and Wales, the application of the scheme is without prejudice to proprietary rights of a secured party or third parties under the law of that jurisdiction. We have been advised that this is unnecessary. However, we have provided that the application of the scheme is without prejudice to regulation 19 of the Financial Collateral Arrangements (No 2) Regulations 2003^[411] (which is concerned with collateral comprising investment property).^[412] This is because for book entry securities collateral in accounts within the EU Member States it appears that questions of perfection will always be governed by the law of the place in which the account is maintained. Article 9 of the Financial Collateral Directive provides that:

the requirements for perfecting a financial collateral arrangement relating to book entry securities collateral ... and the completion of the steps necessary to render such an arrangement and provision effective against third parties shall be governed by the law of the country where the account is maintained.

3.362     We have provided that our scheme should be without prejudice to regulation 19 of the Financial Collateral Arrangements (No 2) Regulations 2003, which implement the Directive, to avoid our provisions being misleading.
3.363     We provisionally recommend that the scheme should apply to SIs created by companies registered in England and Wales over assets outside the UK.^[413]

Companies incorporated outside the UK

3.364     For companies incorporated outside the UK ('oversea', or as they are termed in the draft regulations, 'foreign' companies) the draft regulations apply only to SIs over assets that are in England and Wales or to which the law of England and Wales would apply for the purposes of determining questions of perfection and priority (for example, when financial collateral is held in an account that has no physical location but is governed by English law). We think it is appropriate that the scheme should apply as the lex situs. This applies to any foreign company, not just one that has a place of business in England and Wales.^[414]
3.365     We consider this approach to have advantages for all concerned. First, whether the company is a UK one or a foreign one, parties who are thinking of buying or taking SIs over the goods in England will want to able to check to see what SIs may exist over them already, as will unsecured creditors wishing to know whether they have any chance of being able to levy execution against the company's goods in England. Secondly, we think that secured parties taking SIs over the 'English' assets of foreign companies will appreciate the certainty of knowing that if they have perfected, their interest will be valid and (subject to the normal rules) its priority will be protected. Thirdly, this should help the debtor company, as it will be able to offer better security to creditors.
3.366     Revised Article 9 provides, in effect, that filing should take place in the jurisdiction in which the debtor company is registered. That approach has great attractions; a secured party will only have to file in that jurisdiction, and searchers will only have to search there. However, it is not a workable approach in our context in which most relevant jurisdictions have no directly equivalent registers and in which the relevant jurisdiction may also require other forms of registration of certain types of SI.
3.367     We think that our scheme, including the perfection rules, should apply to SIs created by any foreign company, not just one that has a place of business in England and Wales. We do not think that a scheme that applied only to companies with places of business here would offer sufficient protection to buyers or potential secured parties.^[415] We also suspect that modern business methods may enable companies to operate in the UK on quite a large scale without having a 'place of business' here, for example, if their goods are stored with third parties. Moreover, a 'registered place of business' solution would not be appropriate were the scheme to be extended to unincorporated debtors, which will not have any obligation to register even if their sole place of business is in England and Wales. We understand that Companies House would be able to deal with filings against foreign companies that are not registered here.^[416]
3.368     Where an SI has been created by a foreign company over goods that are subsequently brought into England and Wales, it would be harsh to require that it has to be perfected immediately if it is to be valid in the company's insolvency or to retain its priority as against other secured parties. Instead, the draft regulations adopt the Canadian approach of giving the secured party a 'grace' period^[417] in which to perfect its SI in accordance with the draft regulations. During that time the SI is treated as perfected, provided that it was perfected under the law of the previous jurisdiction, and continues to be so during the grace period, although it will be subordinate to the interest of a buyer or lessee who acquires its interest without knowledge of the SI and before it is perfected by possession or control.^[418]
3.369     In the case of SIs over receivables where the lex situs of the receivable is English law, the draft regulations apply to the SI even though the debtor under the security agreement is a foreign company. Without this, those looking to buy or take security over English debts, or to take garnishee proceedings, would find it difficult to know whether there is an existing SI over them. The scheme will also apply to SIs created by foreign companies over investment property and bank accounts that are governed by English law.^[419]
3.370     We note that our proposal fits with the EC Insolvency Regulation. We have said that article 5 of the Regulation requires that, whatever the law of the proceedings, as regards assets in another jurisdiction the creditor's rights under the lex situs must be respected.^[420] For this purpose:

The right, recorded in a public register and enforceable against third parties, under which a right in rem within the meaning of paragraph 1 may be obtained, shall be considered a right in rem.^[421]

The meaning of this provision is not completely transparent but we believe its effect to be that the right in rem may be subject to local registration requirements. It does not appear to be limited to rules that require registration for the right in rem to come into existence (for example, in Scots law a security overland cannot exist without registration). The words 'may be obtained' seem to us to include registration that must be made for the right to be enforceable by the third party, which would be the case under our scheme.

3.371     We also note that the nature of our scheme, which may require the secured party to file if it wishes to perfect a non-possessory SI, appears wholly compatible with European Community company law. EC company law limits the restrictions that may be imposed on a company that is established in another Member State. Articles 43 and 46 of the EC Treaty prohibit restrictions on the freedom of establishment, including restrictions on the setting up of branches by nationals of one Member State in the territory of another Member State, unless the restriction can be justified on the grounds of public policy, public security or public health. In the Inspire Art case^[422] it was held by the ECJ that, when a company was properly incorporated in England, the Dutch authorities could not impose on it capital adequacy requirements, nor requirements that its directors be jointly and severally liability with the company, equivalent to those required by Dutch law for domestic companies, even though the company was trading exclusively in the Netherlands. But the scheme that we propose, though it applies to SIs created by companies, does not affect the company itself.^[423] There is no requirement on the company to file. It affects secured parties who deal with the company. Any restrictive effect on the company is at most very indirect and it is arguable that the effect will be to make it easier for the company to raise finance on the strength of its assets in England. As we have seen, the Insolvency Regulation seems to require that such requirements be given effect.^[424]
3.372     We provisionally recommend that SIs created by foreign companies over their assets in England and Wales, or to which the law of England and Wales would apply for the purposes of determining questions of perfection and priority, should be subject to the scheme.

Scotland

3.373     Issues parallel to those just discussed arise in relation to SIs created by companies registered in England and Wales over assets in Scotland and by companies registered in Scotland over assets in England and Wales.
3.374     The current position was described briefly in the CP.^[425] A much fuller account of Scots law will be found in the Scottish Law Commission's Discussion Paper on Registration of Rights in Security by Companies.^[426] Very briefly, the law of security in Scotland is different to that in England and Wales. For example, Scots law does not recognise fixed non-possessory charges over goods, nor can a fixed security be created over an incorporeal such as a debt unless the debt is assigned and notification of the assignment is given to the account debtor.^[427] Scots law recognises the floating charge. Particulars of charges created by companies registered in Scotland are registrable at Companies House in Edinburgh. It appears that a floating charge created by an Scottish company will be treated as effective in England and Wales provided that it was properly registered in Scotland, and vice versa with a floating charge created by an English company over assets in Scotland.
3.375     The SLC has not yet published its report.^[428] However, if the provisional proposals made in the discussion paper are confirmed as recommendations and are brought into effect, it seems likely that the 'mutual recognition of registration' of floating charges just described would no longer apply. This is because it was proposed that under Scots law, in accordance with its general tradition, registration of the floating charge should be regarded as necessary to constitute the floating charge; and suggested that the text of the charge document itself, not just particulars of the charge, might have to be registered.^[429] Particulars of other charges would cease to be registrable at Companies House.
3.376     This would seem to mean that even if English law remained unchanged, Scots law would no longer recognise a floating charge over assets in Scotland merely because particulars of it had been registered in Cardiff; the charge itself would have to be registered (presumably in Scotland since there is no facility for this in England and Wales). A change to a system of notice-filing would certainly mean the end of 'mutual recognition'; the filing of a financing statement would definitely not satisfy the proposed requirements for the charge to be constituted in Scotland. However, if Scots law were to be changed but not English law, there seems no reason why an English court should not enforce a floating charge created by a Scottish-registered company over its assets in England, provided that the requirements of Scots law as to 'constitutive registration' had been met.
3.377     Were Scots law to remain unchanged, so that particulars of charges created by Scottish companies remain registrable in Edinburgh, but our scheme adopted for England and Wales, Scots law would be faced with the questions (1) whether to recognise 'new style' SIs created by companies registered in England and Wales over assets in Scotland as forms of security recognised by Scots law, or otherwise valid transactions;^[430] and (2) whether to take into account whether the perfection requirements of English law have been satisfied.
3.378     In effect, if there is to be change on either side of the border, it may have the result predicted by the SLC in its discussion paper:^[431] the two jurisdictions may revert to the position before 1982 when each regarded a company registered in the other jurisdiction as an oversea company.
3.379     In the light of this, we think that the approach we outlined above in relation to SIs created by companies registered in England and Wales over their assets outside the UK, and by companies incorporated outside the UK over their assets here, should in general terms be applied as between Scotland and England and Wales.
3.380     Thus an SI created by an English company over assets in Scotland should be subject to the scheme, including the normal rules of perfection. Whether the scheme will 'bite' will depend on what takes place. If the contest is between a party claiming rights under Scots law – for example, a judgment creditor or a buyer of the goods – and a party claiming an SI, the dispute will normally come before a Scottish court, which will apply Scots law. As we indicated earlier, it will be for Scots law to decide whether the SI is to be recognised and treated as enforceable. If the changes provisionally proposed by the SLC were to be implemented at the same time as our scheme, and the SI were to be the equivalent of a floating charge under Scots law, the secured party would presumably need to ensure that the charge document had been registered in Scotland. If, however, the contest were to be between two parties claiming interests under English law, and were to come before an English court, the English court would presumably apply the rules of our scheme even though the assets were in Scotland.^[432]
3.381     Conversely, we think that a Scottish-registered company with assets in England and Wales should be able to create over them any of the full range of SIs recognised here, but should be subject to the normal rules of the scheme just like a foreign company. In other words, it should be possible for the Scottish company to file and the normal sanctions for not filing should apply. As was suggested to the SLC, and noted in its discussion paper, if it were not possible for the Scottish company to offer its English creditors the advantages of the notice-filing scheme, it might find itself at a competitive disadvantage.^[433]
3.382     However, it should be possible to make administrative arrangements that may simplify the position for Scottish companies slightly. We understand that though companies registered in England and Wales are required to register particulars of charges in Cardiff and Scottish companies in Edinburgh, the information is in fact kept on the same computer database. Thus if charges created by Scottish companies (or, under the SLC's provisional proposals, floating charges) continue to be registered with Companies House in Edinburgh (or on any other electronic register), there seems no reason why the system should not be configured so that a search of the 'English' register would reveal the 'Scottish' floating charge. The registration could be treated as perfection by filing for the purposes of our scheme, so as to save the need to register also in Cardiff.
3.383     We provisionally recommend that an SI created by an English company over assets in Scotland should be subject to the scheme, including the normal rules of perfection. An SI created by a company registered in Scotland over assets in England and Wales, or to which the law of England and Wales would apply for the purposes of determining questions of perfection and priority, should also be subject to the scheme.

Transitional provisions

3.384     Two periods of time need to be considered: a period before commencement and a transitional period affecting both pre-commencement charges that are not currently registered and pre-commencement quasi-security transactions.

Commencement

3.385     There will have to be a period before commencement of the draft regulations for the electronic register to be commissioned, constructed and tested. During the course of this project we have worked on the basis that Companies House would administer the registry functions, building to some extent on its existing records, rather than a new registry being created (at least for so long as the draft regulations do not apply to non-corporate debtors). Even so, the time taken to construct the register is likely to be heavily influenced by factors outside our control, and this task should not be underestimated. We do note, however, that electronic registers of the type we envisage already exist, so it may be possible to 'buy in' at least the beginnings of a system. Nonetheless, it is likely that commissioning, constructing and bringing an electronic system to operational readiness would take at least two years.
3.386     The regime introduced by the draft regulations would effect a number of significant changes to existing law and practice. Whilst the register is being constructed we think that the registry or responsible government department would need to undertake a significant programme of 'education' for potential users, such as financial and legal practitioners, trade associations and representative organisations. This may also require something in the order of two years, although at least some of this education could be done concurrently with the construction of the register.

A transitional period?

3.387     The second possible period of time would be a transitional period, starting from the commencement of the draft regulations once the register is brought into operation. Any new SI created after commencement will be fully subject to the new scheme. The more difficult issue is how pre-existing interests - whether charges or quasi-securities created under the 'old' law - should be treated. In the following paragraphs we consider the position of (1) pre-commencement charges that have been registered at Companies House in accordance with the Companies Act 1985, (2) pre-commencement charges that are not registrable, and (3) pre-commencement quasi-securities.

Pre-commencement registered charges

3.388     For charges that have been registered under the Companies Act 1985 before the commencement of the draft regulations ('pre-commencement charges') there need be no transitional period.
3.389     At an earlier stage in this project we thought that it would be necessary for pre-commencement charges to be perfected by filing by the end of a transitional period if they were to remain effective thereafter. We received several representations that this would have had significant cost implications. We now think that this will not be necessary.
3.390     During our discussions with the Registrar's staff at Companies House, they indicated that they considered it feasible to establish an electronic link between the new register introduced under our scheme and their existing charge/mortgage records, which are held in electronic format. Previously we had thought this would not be possible. This would allow for the electronic system to be configured so that a search of the notice-filing register could locate the information currently held on the Companies House mortgage database and present it as a search result. The current mortgage details held at Companies House will contain most, if not all, the information that would be contained on a financing statement - indeed, somewhat more information, for example about the 'collateral description', than would be found on most financing statements. If a search of the notice-filing register can indeed locate and present the existing information held about company charges, it would make unnecessary any requirement that there be a transfer of information from one register to another, or that pre-commencement charges be re-registered (that is, perfected by filing) by the end of any transitional period. In effect, the existing registration will be treated as perfection by filing and therefore existing charges that were registered before commencement will continue to have effect indefinitely. The search result should carry an indication that it relates to a pre-commencement charge, so as to warn searchers that they should make enquiries on the point. We think that the Registrar's Rules could deal with this, and so it does not appear in the draft regulations.
3.391     In terms of priority, pre-commencement fixed charges that were properly registered before commencement will retain their existing priority as against other pre-existing charges. As against post-commencement SIs their priority will depend on the normal rules of priority of the new scheme. (In other words, if priority depends on date of filing they will have priority by virtue of having filed first, but they will not have priority over later-filed PMSIs.)
3.392     Pre-commencement floating charges will also retain their existing priority against other pre-commencement charges. In practice this priority will depend on the date of crystallisation and whether competing chargees had notice of any negative pledge clause in the agreement. From the moment of commencement the old floating charge will be treated as a 'new-style' SI: that is, it will be treated as attaching (and since it is already 'filed', being perfected) at the moment of commencement. The only exception would be if the provisions of the charge indicate that the SI is not to attach until some future event; but a mere description of the charge as 'a floating charge' will not have this effect.^[434]
3.393     We provisionally recommend that pre-commencement registrable charges that were registered before commencement should be treated as perfected under the scheme. They should retain their existing priority as against other pre-commencement SIs. As against post-commencement SIs their priority should depend on the normal rules of priority of the new scheme.

Pre-commencement unregistrable charges

3.394     Those charges that are currently not registrable at Companies House will also become subject to the new scheme on commencement and will retain their existing priority position. However, with unregistrable charges there is a question whether the chargee should have to file a financing statement in order to perfect (or perfect their SIs in some other way under the draft regulations) before the end of a transitional period; or whether the charge should simply continue to be effective indefinitely without filing.
3.395     Our initial thought was that previously unregistrable charges should have to be registered within a transitional period. Without this, there would continue to exist a set of invisible but effective charges. In order to preserve the charge's priority for the future, the date and time of filing would be deemed to be the date of original creation of the charge. Again, the financing statement should make this clear.
3.396     It has been put to us, however, that this would have significant cost implications for secured parties, not so much in the filing itself but in determining whether financial institutions have previously unregistrable charges that need to be perfected. We are told that the records of many secured parties are incomplete or not in a form that makes it easy to determine such a question. Given that we expect the number of such unregistrable charges to be relatively small, as there are few types of charge that are currently not registrable that will need to be perfected by filing under the new scheme, it may be more cost-effective not to require filing. Users of the register would have to be warned that it will not reveal pre-commencement unregistrable charges; and these will have priority as from the date of creation, as under existing law.
3.397     We ask consultees whether there should be a transitional period during which pre-commencement charges that are not registrable under current law should have to be registered.

Pre-commencement quasi-securities

3.398     A similar question needs to be asked in relation to the much larger category of pre-commencement quasi-securities, including both title-retention devices that have a security purpose and the 'deemed' SIs such as sales of accounts. Quasi-securities that are created after commencement will of course be fully subject to the new scheme. Should there be a transitional period during which existing quasi-securities should retain their effectiveness and priority but after which they should have to be perfected (typically by filing) in order to do so? We will return to this question after describing how the two alternatives - a transitional period and no such period - would work.

A transitional period

3.399     If there were to be a transitional period we think it should be of at least five years. Just as we sought to reduce the need to 're-register' existing company charges (in effect requiring it, if at all, only for currently unregistrable charges), so we would like to reduce the inconvenience and cost of having to re-register existing quasi-securities. We understand that many typical title-retention agreements (such as finance leases or hire-purchase agreements) are in the order of three to five years. Quasi-securities over aircraft and ships can be much longer, but these will generally be outside the scope of the draft regulations.^[435] We think that if there is a long transitional period – of at least five years – this would allow most 'standard' finance leases and hire-purchase agreements created before commencement to run their course before the end of the transitional period. At the end of the transitional period, those pre-commencement quasi-securities that are still in existence (for example, factoring and block discounting agreements, which we assume are less likely to be limited to a set term) would become subject to the rules of our scheme, including the perfection requirements.
3.400     In terms of priority, pre-commencement quasi-securities would continue to have the same priority, both among themselves and as against charges, as under existing law until the end of the transitional period. At the end of the period the new law would apply to them and, if they had not been perfected, the normal consequences would result. However, with a long transitional period most pre-commencement title-retention transactions would have expired before it ends, so that no action will be required. Where the quasi-security is older than this (for example, a long-term factoring agreement or a long equipment lease) and is duly perfected by filing within the period, its priority would continue to date from when the agreement was made. Again, when a financing statement was filed it should indicate that the SI dates from before commencement. Again, this is something for the Rules, and does not appear in the draft regulations.
3.401     As between conflicting pre-commencement quasi-securities and subsequent SIs over the same asset, the pre-commencement quasi-security would have priority over any post commencement SI, but would be at risk of losing any priority if not perfected by filing before the end of the transitional period.

No transitional period

3.402     The alternative is not to have a transitional period for some or all types of quasi-security. Pre-commencement quasi-securities would simply continue to be effective in insolvency, and to enjoy their existing priority position as against other-pre-commencement SIs, without any filing being made.
3.403     As against any post commencement SI, the rule for pre-commencement title-retention devices would be simple: they would have priority. They would also bind any buyer of the goods.
3.404     Pre-commencement sales of accounts would be more tricky. We think that their priority as against post-commencement purchasers (buyers or secured parties) should probably depend on whether the buyer had notified the account debtor before the date of filing for the post-commencement SI. The other possibility would be that it would depend on which party first notified the account debtor, but that would mean that post-commencement purchasers would have to notify the account debtor to protect the priority of their SI. That would not be consistent with our general scheme.

Conclusion on quasi-securities

3.405     Although it was put to us that the cost of identifying and filing for long-term pre-commencement quasi-securities would outweigh the benefits, as was argued also for pre-commencement unregistrable charges, we think there is a substantial difference between the two cases.
3.406     On the one hand, with quasi-securities the benefit of applying the normal perfection rules after the transitional period would be much greater. They are far more likely to occur. Requiring perfection by the end of the period would mean that those dealing with the debtor – whether potential buyers, secured lenders, unsecured creditors or (if things go badly) an administrator or liquidator – would not have to worry about 'hidden' pre-commencement quasi-securities.
3.407     On the other, while there would be many more long-term quasi-securities, the cost of identifying them should be lower than for charges. The cost is not in the registration itself, which is cheap and easy. We were told that the cost of identifying existing charges would be high because many financial institutions have inadequate records of their charges. We think that existing quasi-securities will be much simpler to track, if only because from each one there would normally be an income stream. It should also be borne in mind that it will not be necessary to identify every agreement precisely in order to file. The secured party can perfect any number of agreements with a debtor by a single filing in general terms. Even a party that is not sure whether it has any security agreement with a particular company can make a precautionary filing if it gets the other party's consent.
3.408     We think that there should definitely be a transitional period after which pre-existing sales of receivables should be filed, since such agreements may last for an indefinite period. On balance we think that the same should apply to title-retention devices; the potential benefits seem to us to outweigh the costs, at least if the transitional period is long enough (say five years) that the vast bulk of agreements will expire before the end of the period. We have therefore drawn up the draft regulations to include a transitional period for quasi-security devices.
3.409     We provisionally recommend that:

(1) Pre-commencement sales of receivables should retain their existing effectiveness and priority for a transitional period of [five] years. If they are perfected by filing within that period they will retain their priority (as from the date of creation). If by the end of that period they have not been perfected by filing they will cease to be effective in insolvency and will lose their priority as against other post-commencement SIs.

(2) We ask consultees whether they agree with our conclusion that a similar scheme should apply to post-commencement title-retention transactions and, if so, how long the transitional period should be.

Insolvency issues

3.410     As we noted in Part 2, the effect of our scheme on the 'floating' charge will have a number of consequences for the insolvency legislation, which at present treats fixed and floating charges differently.^[436] We also noted that, although determining policy in this area was not a matter for the Law Commission, we considered that we should suggest possible solutions to the issues that arise as a result of our provisional proposals.
3.411     We are aware that our provisional recommendations will require consequential amendments to primary and secondary legislation dealing with insolvency matters. However, it has not been possible to include a list of the necessary amendments in the draft regulations at this stage. It is our intention that the draft regulations should be substantially neutral in their effect on insolvency (although clearly aspects such as the improved priority position under our scheme of what would currently be floating charges will mean the effect will not be entirely neutral). The Insolvency Act 1986 - and other pieces of insolvency legislation - contain references to a number of words, phrases or concepts that will or may be affected by our proposals, and which in turn will need to be considered for amendment. One obvious amendment that will be needed is in relation to references to the floating charge (and the knock-on effects for preferential creditors, for example). We note in passing that the determination of whether a charge is fixed or floating for the purposes of insolvency continues to trouble the courts. In National Westminster Bank PLC v Spectrum Plus Ltd and others,^[437] Lord Phillips MR said:

Priorities in the event of insolvency should not turn upon the technical skill with which the bank accounting arrangements have been set up. Professor Goode recommends 'structured personal property security legislation' of a type to be found in other common law jurisdictions. This appeal may underline the desirability of such legislation.

3.412     However, the need for amendments will go far beyond references to fixed or floating charges. For example, the terms 'secured creditor' and 'security' appear in the legislation; the definitions of these terms, and the instances of where they are used will need to be amended as appropriate (for example, the power of an administrator to deal with property of a company that is 'subject to a security').^[438] 'Hire-purchase agreements', 'chattel leasing agreements', and 'retention of title agreements' are all defined terms, and amendments will need to be considered to these definitions and the circumstances in which the terms appear.^[439] The provisions dealing with receivers will be affected. We do not underestimate the task of identifying all necessary consequential amendments. We have been in contact with the Insolvency Service and will continue to work with them and others on this issue. We hope to be able to include consequential amendments by the time we publish our Final Report.
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Note 1    Part 4 also covers SIs over the right to proceeds of letters of credit where these are perfected by ‘control’.    [Back]