The Law Commission

PART 2

THE BUSINESS CASE

INTRODUCTION

2.1      We explained in Part 1 that many features of the scheme we recommend are widely supported. This is particularly the case with electronic filing. There is wide-spread recognition that the Registrar should no longer have to check the particulars submitted against the charge document or issue a conclusive certificate. Many consultees also agreed with the scheme for priority by date of filing. Even those who opposed the scheme based their objections not so much on opposition to the proposals themselves as on the argument that the system works adequately and no sufficient case has been made for changing it.

2.2      We agree that reform should not be undertaken for its own sake. The question is whether there is a 'business case' for the scheme that we are proposing. We firmly believe that there is. We consider first the registration and priority of company charges, and then sales of receivables.

THE SCHEME FOR COMPANY CHARGES

2.3      We outlined the principal features of the scheme we are recommending in Part 1.^[1] In summary, the central elements of the scheme for company charges are:

(1) Electronic filing will replace the current paper-based system.

(2) It will only be necessary to submit brief particulars of the charge in a 'financing statement'. Registry staff will not check the information in the statement against the charge document, which will no longer be sent to the Registrar. Provided that the financing statement identifies the correct company as debtor, the charge will be validly registered in respect of the property listed in the particulars.

(3) The formal time-period for registering a charge will be removed. Instead, a charge may be filed before or at any time after the transaction (save during the 'run-up' to insolvency).^[2]

(4) The priority of a charge will depend on the date of filing.

(5) Filing will be voluntary, in the commercial judgement of the secured party (though an unfiled charge would be ineffective against an administrator or liquidator). The present criminal sanction against companies that fail to register will be removed.

(6) The current list of charges that must be registered will be replaced by a provision that all charges are registrable unless specifically exempted.

(7) The position of floating charge-holders will be strengthened. First, the priority of the charge will depend on the date of filing, unless otherwise agreed. This means that floating charge-holders will no longer have to rely on negative pledge clauses to prevent borrowers from granting subsequent fixed charges or from selling their receivables. Secondly, property subject to a floating charge will not be liable to be seized by execution creditors. This will remove the need for automatic crystallisation clauses to protect the chargee's interest.

(8) The position of buyers will be clarified. Briefly, buyers will take free of an unregistered charge unless they know about it. They will take subject to a fixed charge that has been registered unless the chargee authorised the sale. Where collateral is subject to a registered floating charge, buyers will continue to take free of it when they buy goods in the ordinary of course of the seller's business.

(9) Registration will not be necessary for charges over 'financial collateral' provided the chargee has either 'possession or control' within the meaning of the Financial Collateral Arrangements (No 2) Regulations 2003,^[3] or has 'control' of it as defined by the scheme. A charge where the chargee has obtained control will have priority over one where the chargee has not. Purchasers of securities or securities entitlements for value and without notice of existing security interests will not be affected by them.

2.4      The scheme will bring substantial benefits.^[4] There will be direct savings both to users (secured lenders, other parties dealing with companies who borrow and the companies themselves) and to Companies House. Other benefits will result from simplification and clarification of the law. The principal costs consist of setting up an electronic system for registering company charges on-line and training staff. However, we explain below that the costs will be relatively low and should quickly be recouped.

Direct savings and costs

The current cost of registration

2.5      In 2003-04, Companies House registered 197,000 mortgage documents for England and Wales. In each case, the secured party or the company prepared particulars of the charge and posted or delivered them with the original charge document to Companies House. There the paper work was checked by staff and entered manually on the register. In many cases, the party registering also requested a certificate of registration, which was sent by post.

2.6      We believe that the current fees of £28 (for registration and a certificate) reflect the costs to Companies House, which is in turn passed on to debtors. The fee income received by Companies House for this in 2003-04 was £1.7 million.

Submission of documents on-line

2.7      Even if the only change were to make it possible to complete the particulars of a charge on-line and send the charge document electronically, registration would be somewhat simpler and cheaper for secured lenders.^[5] It might also be easier for Companies House were all documents to be received in an electronic format.^[6] However, we think the savings to lenders and to Companies House would be small.

Submission of particulars only

2.8      In contrast, we believe that substantial savings would be made if Companies House staff are no longer required to check the particulars against the charge document and issue a conclusive certificate of registration. We understand that this requires a significant number of staff,^[7] and even then there are concerns that Companies House staff are not always able to check the particulars thoroughly.^[8] They might be able to do so were the fees increased to cover the cost of employing more staff, but it does not seem justifiable to increase the cost to protect lenders against the small risk of their, or their advisors', avoidable mistakes. Further, it seems wrong in principle that lenders who make mistakes should be protected but a party who relied on registered particulars that are inaccurate should be without a remedy.^[9]

2.9      We are not able to give figures for either the cost of setting up the system, any re-training of Companies House staff that will be involved or the number of staff that will be required to work on charge registration were the new scheme to be in force. However, the evidence from the introduction of a wholly electronic scheme for registering security over personal property in New Zealand^[10] is very encouraging.^[11] In 2003-2004 over 465,000 financing statements were registered on the Personal Property Security Register.^[12] The Registry currently has the full-time equivalent of five staff (including business service advisors who provide promotion and training), plus some part-time computer support. We understand that the charges for registering and searching reflect the real costs of the system. The fee for registering a security interest was initially a mere NZ$5 (about £2), and $3 to search. This fee resulted in an income that enabled the set-up costs to be recovered in around 7 months, and it has since been reduced to NZ$3 to register and NZ$1 to search. This suggests that were the scheme we recommend to be introduced, there would be significant reductions in public expenditure and the fees for registration.

2.10      Lenders will also find their costs reduced. There will be no need to submit the charge document, and the financing statement will be easy to complete. We anticipate that it will normally be unnecessary to employ staff with legal expertise to register charges.

2.11      The only serious difficulty that consultees raised was that, while there was support for allowing the particulars in the 'financing statement' to be brief in order to simplify filing, lenders' staff might find it hard to produce the 'brief description of the collateral' that the CR proposed should be required.^[13] We now intend that lenders will be given a choice. They will be able either provide to a short description of the collateral (for example, 'all present and after-acquired property' or 'the equipment in the plant at X') or to copy the full description in the charge document directly from that document into the financing statement.^[14]

2.12      The changes to the registration procedures will have direct costs in the form of some re-training of staff, but the experience of the New Zealand scheme suggests that training staff is not difficult.^[15] Training staff to use simpler procedures is unlikely to be difficult.

2.13      We conclude that a system that allows on-line registration without human intervention is the only plausible way forward.

Facilitating the development of electronic conveyancing

2.14      The procedures for taking security over land will be simpler and quicker for both lenders and Companies House, since there will be no need to register charges over registered land at Companies House if they are registered at the Land Registry. The saving in cost from this will not be major. What is much more important is that the changes will assist the Land Registry in developing electronic conveyancing. They tell us that the current law is causing difficulties for this important project.

Removing the time-limit for registration

2.15      Removing the time limit for filing will also save significant costs each year. At present, Companies House rejects around 3000 applications because they are received outside the 21-day time period. The lender in these circumstances has two options. It may ask the debtor to re-execute the documents. This causes inconvenience, annoyance and the cost of repeating the submission of paperwork. Alternatively, the lender must apply to court to register out of time, an operation which must result in a costs bill for the applicant of at least several hundred pounds, and which we are told by Companies House is also time consuming (and thus presumably costly) for them. Allowing the secured party to file at any time (at the risk meanwhile of loss of priority or of the unregistered charge being ineffective in insolvency)^[16] will save these sums.

2.16      This change will not have direct costs, nor will it affect other secured parties or purchasers, who will not be affected by an unregistered charge. We believe that the impact on unsecured creditors will be slight: they are already vulnerable to charges created after they have decided to advance credit.^[17]

Improved searching

2.17      At present, the required particulars of registration and charge documents have to be sent to Companies House within 21 days of creation. It takes up to five working days from receipt of the documents for the charges to appear on the public register. This results in the risk of a 'period of invisibility' of up to 28 days (including weekends) before a charge appears on the register. During this time the charge is valid, and may take priority over charges created subsequently. Yet a potential secured party affected by the charge will not find out about it. Under the proposed scheme, priority will date from registration. As charges that have been registered will appear on the system instantaneously, there will be no 'periods of invisibility'^[18] when a potential secured party may be affected by a valid charge that has yet to be registered. Searching will be simple and more reliable, and lenders will not have to wait before advancing funds.

Increased information

2.18      There will be public notice of charges over certain important types of asset not currently on the list of charges that must be registered.^[19] This will help secured parties and others concerned to discover the company's financial condition.

2.19      Some consultees were concerned that less information would be provided on the new register than is currently available from Companies House, and this would increase the cost of searching. They were worried about our original proposal that charges over assets for which there is a specialist mortgage register should no longer have to be registered at Companies House.^[20] We have now revised our recommendations. Charges over registered land will not require registration in the Company Security Register if they are registered at the Land Registry, but information about the charges will be forwarded by the Land Registry to Companies House and will be available to searchers.^[21] Charges over other assets will remain registrable in the Company Security Register.^[22] Thus there will be no effective loss of information about company charges currently registrable at Companies House.

Indirect benefits and costs

Simplicity

2.20      The rules we recommend for both registration and priority are both simpler than the current law. In the long term that will reduce the cost of training staff, of creating charges and resolving disputes.

Increasing confidence

2.21      Determining priority by date of filing will mean that once the chargee has filed a financing statement, it can be confident that its security will have priority over any other charge for which a filing has not yet been made.^[23] Similarly, someone who has bought assets that are charged from the company will no longer be affected by the charge if it has not been registered. There will be a corresponding loss to charge-holders but it can arise only if, by accident or design, they have omitted to file.

Removing clauses with uncertain effect

2.22      The negative pledge and automatic crystallisation clauses that are frequently included in floating charge agreements (and which are unreliable in their effects) will no longer be required. Any waiver of priority by a secured party (chargee or pledgee) will depend on its agreement. There will be a corresponding loss to a subsequent secured party who might have been able to prove that it took without notice of a negative pledge clause and thus took priority over an earlier floating charge. However, as intending chargees normally conduct thorough inquiries, this loss seems minimal. Unsecured creditors may find it harder to execute judgment against a company subject to a floating charge. However, we were told they rarely find this to be possible because there will normally be an automatic crystallisation clause. In any event they have a powerful alternative, where the debt amounts to more than £750, of threatening insolvency proceedings.

Increasing certainty

2.23      Many of the points already mentioned will bring increased certainty to the law. In addition, replacement of the current list of charges that must be registered by a provision that any charge is registrable unless specifically exempted will reduce uncertainty as to what charges must be registered.^[24]

2.24      The present rules governing when buyers take free of a charge are complex and uncertain. Whether a buyer takes subject to a fixed charge depends on whether the charge was legal or equitable, and whether the buyer will be put on notice of the charge merely because it was registered.^[25] Under our scheme, these rules will be simplified and clarified. Buyers will not be subject to unregistered fixed charges, but will be subject to registered ones.

2.25      It would be unwise to claim that the introduction of a new scheme will not cause any uncertainty over points which currently do not arise or which are settled. What we can say is that we have considered possible uncertainty at every turn and that we are not aware of any area in which the scheme for charges remains significantly uncertain. Overall we are convinced that it will reduce uncertainty.^[26]

Supporting financial markets

2.26      Our recommendations on financial collateral will provide additional clarity on when charges over financial collateral need to be registered, the priority of competing charges and when an innocent purchaser will take free of a charge. They are designed to ensure that financial collateral is freely transferable. For example, a secured party or other purchaser will be able to take simple steps to ensure that it has priority over, or takes free of, an existing charge of which it does not know without the need for searching. Equally a chargee will be able to protect its own interests by taking simple, clearly defined steps.

2.27      We received strong support for our proposal to provide rules for charges over financial collateral, particularly from specialists in the field. We have refined our proposals in the light on the detailed responses received. The reforms will improve certainty and transferability in the financial markets.

Deregulation

2.28      The scheme that we recommend means that it would no longer be a criminal offence for a company and its officers to fail to comply with the requirements of the registration scheme.^[27] This sanction is seldom applied in any event. The commercial consequences of failure to register – loss of priority and invalidity against the administrator or liquidator – are sufficiently important to ensure compliance. The removal of an unnecessary and rarely used criminal offence is a benefit in itself.

2.29      Companies will also be relieved of the responsibility to maintain their own registers of charges, though we understand that this obligation is frequently not complied with.^[28]

EU developments

2.30      The EU is already showing interest in harmonising the law of personal property security interests across the Member States. There are frequent references to this in the European Commission's Action Plan on Contract Law;^[29] and we understand that the Commission has commissioned a preliminary study of the differences between the laws of the Member States. There is enormous disparity in these laws of the Member States and it is frequently said that the differences constitute a real hindrance to the operation of the internal market. Any moves towards this form of 'sectoral harmonisation' will almost certainly involve establishing a public register and rules on the order of priority. Any EU directive or regulation is likely to involve priority by date of registration, since this is the scheme followed by the widely-cited EBRD model law.^[30]

2.31      Some view the prospect of EU intervention as a reason for deferring any change to our law. We take a different view, as do many of those we consulted. We should not wait to do anything until we are compelled to. It would be better to have already developed a modern law that is flexible and efficient. This can then be put forward as a model for adoption by the EU, just as existing Directives have frequently been constructed on the basis of an existing national system.^[31]

Conclusion on the scheme for company charges

2.32      Overall, there is a good business case for the changes that we propose both for registration of company charges and on their priority. The lower costs of the scheme to the lender, and its greater certainty and reliability, will make it easier for companies to obtain secured credit and reduce its cost.

Enabling further developments

2.33      The other reason for adopting the proposed notice filing scheme for company charges is that this would be more readily compatible with what is required for sales of receivables, which we propose should be brought within the scheme.^[32] We now turn to the case for this extension to sales of receivables.

SALES OF RECEIVABLES

2.34      In Part 4 we explain that the responses to CP 164 and the CR supported bringing sales of receivables within the scheme of registration and priorities, even among some who were opposed to extending the scheme to 'quasi-securities' in general. The trade body for the factoring and discounting industry, the Factors and Discounters Association, has consistently supported dealing with sales of receivables. We are firmly of the view that the priority rules relating to sales of receivables need to be modernised, so that priority will normally be governed by the date of filing. On balance, our view is that registration of sales of receivables should be required not only in order to preserve priority but also as a condition of the validity of the sale as against an administrator or liquidator.

2.35      There was also strong support from the industry for the proposal to include a provision that a prohibition on assignment of an account should be of no effect against the assignee. Others, particularly in the legal profession, were opposed. Many of the opponents were concerned that the change might have unintended effects outside receivables financing. In Part 4 we recommend that this proposal should be carried forward but with a more closely-limited scope of application.^[33]

2.36      The principal reason for our recommendations on priority of sales of receivables and on prohibitions on assignment is that there is a strong business case for each of them.

2.37      Changing the rule of priority of assignments of debts to one of priority by date of filing is widely seen as advantageous. It will mean that once receivable financiers have filed they will ensure their own priority, without having to notify account debtors who owe the receivables. Notifying debtors is expensive. It is often not commercially desirable and sometimes it is not feasible.

2.38      Similarly, receivables financiers think it important that prohibitions on assignment of a receivable should no longer be effective against the assignee. We are told that the current rule causes serious difficulty in bulk receivables financing, when it is simply not feasible to find out whether particular receivables contain an anti-assignment provision.^[34] This provision should be restricted to the relevant types of receivables,^[35] but we think it would be a valuable improvement to the law.

2.39      The business case for making sales of a company's receivables registrable is less obvious but it is nonetheless real. The extension would be of particular benefit to receivables financiers in terms of visibility and priority. Though they would have to file when they buy or take a charge over a company's receivables, they will have a ready way of discovering any existing charge or sale of the receivables that has been filed, and can safely ignore any that has not. Specialists in receivables financing (such as the Factors and Discounters Association) see registration as worth the cost.^[36] The cost will be low, particularly as it will be possible to file one financing statement that can cover any number of transactions between the same parties. Requiring that outright sales be registered would also provide unsecured creditors with valuable information about the company's finances.

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Note 1    See paras 1.32-1.37.    [Back]

Note 2    See Insolvency Act 1986, s 245.    [Back]

Note 3    SI 2003 No 3226.    [Back]

Note 4    Above, paras 1.38-1.41.    [Back]

Note 5    It is difficult to separate out registration costs from general transaction costs. We have been told that transaction costs are usually hidden, and that lawyers do not separate them out.     [Back]

Note 6    As Companies House fees include the cost of checking the particulars, it is not easy to say how much is attributable simply to Registry staff having to deal with paper rather than electronic documents.     [Back]

Note 7    We understand that some 32 staff are employed in the mortgage section.     [Back]

Note 8    See CP 164 para 3.16. Our informal discussions with staff at Companies House suggested that they had a number of concerns. One was that the production of certificates takes a great deal of work and time. The certificates are produced overnight. Staff have to marry up the deed with the certificate and ensure it is sent to the correct address. Although they are used to handling this problem, if something goes wrong it can cause considerable difficulties. Another was the quality of information relating to mortgage charges. They said that mortgage charges are often difficult for the staff to fully grasp. They have to précis the information from Form 395. This sometimes leads to problems with the mortgagor or their solicitors, who may consider that the staff have not captured the essence of the charge properly.     [Back]

Note 9    It is not clear whether a party who had been misled by incorrect particulars might have a remedy against the Registrar: see CP 164 para 4.216.    [Back]

Note 10    Implementing the New Zealand PPSA 1999 (as amended).    [Back]

Note 11    The first project manager for the New Zealand registry, Andrew Bridgman, indicated that the costs to government of introducing the NZPPSR came to just over US$1.2 million. Software development costs amounted to US$846,800, with other costs (dedicated staff, hardware, publicity, travel, internal training and ‘miscellaneous’) adding an additional US$234,000. With quality assurance and consultancy costs, the total was US$1,1803,00. He also indicated that the system paid for itself from fee income in the first few months: total net revenue for the transitional period of 1 May - 31 October 2002 was US$1.6 million. Mr Bridgman noted that the costs were substantially reduced because: (a) development of the system was built off the back of an existing IT platform; (b) a trusted IT developer was used with low overheads and previous familiarity with government IT development, and (c) the development team used existing staff from high performing units within the Ministry. We do not know whether there would be equivalent factors here.     [Back]

Note 12    The New Zealand scheme covers to title-retention devices and applies to individuals and unincorporated businesses as well as companies.    [Back]

Note 13    CR paras 3.124-3.125.    [Back]

Note 14    Assuming that the charge document is in electronic format. If it is not, the relevant clauses could of course be scanned and then copied over into the financing statement.    [Back]

Note 15    Re-training costs are likely to be low because the information is principally a sub-set of that required for Form 395.    [Back]

Note 16    Or being vulnerable because it was registered only in the run-up to insolvency.     [Back]

Note 17    See further below, para 3.80.     [Back]

Note 18    Under the new scheme there may be short periods before charges over goods recently brought into the jurisdiction by an oversea company: see para 3.270.    [Back]

Note 19    Eg, charges over computer software and film negative rights; see CP 164 para 3.13. We do not recommend that existing charges that do not currently require registration should have to be registered. Responses to the CR indicate that most would prefer the risk that these will remain invisible to the burden of identifying and registering them within a transitional period. See para 3.290.    [Back]

Note 20    See CR paras 2.51 and 3.289-3.342.    [Back]

Note 21    See further below, para 3.38.    [Back]

Note 22    See further below, paras 3.38(3) and 3.41.    [Back]

Note 23    Save in those cases in which there is specific provision to the contrary, e.g. with a subsequent charge over investment property that is perfected by ‘control’, see Part 5.    [Back]

Note 24    Eg, there has been litigation over the meaning of ‘book debts’: see CP 164 para 3.14.     [Back]

Note 25    See CP 164 paras 2.58-2.61.    [Back]

Note 26    In this context we were interested to read the comments of the Financial Markets Law Committee. The Committee is particularly concerned with issues of legal uncertainty that may affect financial markets. The Working Group did identify some potential problems, but most of the issues raised in the Committee’s response related either to the extension of the scheme to ‘quasi-securities’ in general or to the statement of rights and remedies. These no longer form part of our recommendations for the company charges scheme. The principal remaining issues relate to the definition of receivables. This is not part of the core scheme. We deal with the issues below, see paras 4.15. and 4.32 The Committee made it clear that they expressed no view on policy issues, and that silence on a point should not be taken as either assent or disapproval of our proposals.    [Back]

Note 27    Companies Act 1985, s 399.    [Back]

Note 28    See below, paras 3.298-3.300.    [Back]

Note 29    Action Plan on a More Coherent European Contract Law COM (2003) final, OJ C 63/1, para 63.    [Back]

Note 30    It is certainly unlikely that the EU will adopt a model that depends upon the distinction between legal and equitable interests!    [Back]

Note 31    A prime example is the Directive on Unfair Terms in Consumer Contracts (93/13/EEC of 5 April 1993, OJ L 95/29), which is closely modelled on the German legislation.    [Back]

Note 32    See para 1.36.    [Back]

Note 33    See para 4.29.    [Back]

Note 34    There are devices that can mitigate the problem, such as requiring the assignor to ‘buy back’ non-transferable receivables; but these will not offer adequate protection when the assignor (the company) is insolvent.    [Back]

Note 35    The definition of ‘receivable’ (in the draft regs in the CR, referred to as an ‘account’) has been re-drafted in more precise terms: see para 4.29.    [Back]

Note 36    Because of questions raised by consultees, we have made particular enquiries about whether the filing requirement would cause unacceptable costs, in particular loss of confidentiality, in relation to (1) ‘confidential invoice discounting’ and (2) securitisation. The answer we have received from specialists is that it would not cause a problem in either context. See further below, paras 4.19-4.22.    [Back]