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You are here: BAILII >> Databases >> The Law Commission >> Company Security Interests (Consultation Paper) [2004] EWLC 176(SUMMARY) (13 August 2004) URL: http://www.bailii.org/ew/other/EWLC/2004/176(summary).html Cite as: [2004] EWLC 176(SUMMARY)

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Executive Summary

Introduction

1. This consultative report and draft regulations set out a scheme for the registration and priority of mortgages and other forms of security created by companies. It also makes general recommendations on the law that applies to security created by unincorporated businesses.
2. The consultative report is detailed and complex. This is necessary. Many of the responses to our first consultation paper on this topic (CP No 164, Registration of Security Interests: Company Charges andProperty other than Land (2002)) expressed great interest in the scheme but said that it was not possible to evaluate all its aspects properly without seeing the detail. Much of the report is intended for the specialist reader.
3. This summary deals only with the general issues at stake: the difficulties with the current law that make reform necessary, the broad outline of our proposals for reform, and the advantages, as we perceive them, of the scheme that we provisionally recommend.

Background

4. Companies, like other businesses, are often dependent on credit. They obtain credit from a number of sources – for example, from lenders such as banks, from suppliers of goods who are prepared to deliver on credit terms and from financiers who are prepared to advance money against the company's future income.
5. Any creditor faces the risk that the debtor will be unable to repay. A lender will often insist that the loan be secured by a mortgage or charge over the company's assets, so that if the company becomes insolvent the creditor may take the assets charged and sell them to pay off the debt. Secured lending is of great importance to small and medium-size enterprises, which may not have a sufficient credit-rating to be able to borrow on an unsecured basis at reasonable rates. It is of enormous importance in the financial sector, and it is frequently used by large companies to protect themselves when they are involved in projects through 'single purpose vehicles' that they set up for the project.
6. The protection of the secured creditor may be at the expense of other, unsecured creditors. The security could also affect other people who deal with the company: they might buy the asset, or themselves take security over it, without knowing about the rights of the secured creditor. For these reasons it has long been the law that most mortgages and charges over a company's property have to be publicised by registration on the Companies Register. (There is a separate register for unincorporated businesses.) There are also rules on the 'priority' of charges against other secured creditors and those who buy the property that has been charged. These depend on a complex set of factors. One is whether the charge was 'fixed' or 'floating'. A company that has given a fixed charge over an asset cannot dispose of the asset without getting the chargee's agreement. A floating charge allows the company greater freedom to continue business as usual, but for the lender is a weak form of security.
7. The current law provides that details of most company charges have to be registered at Companies House within 21 days. If this is not done and the company goes into liquidation, the charge will be invalid; in effect, the lender will become just another unsecured creditor. The charge will also be void against other creditors, which means that it will lose priority to later charges, providing these are properly registered. The Companies Act 1985 sets out a fixed list of the types of charge that are registrable. Charges that are not on the list do not have to be registered, and can be effective against third parties even though there is no way of finding out about them.

Difficulties with the present law

8. The current system is open to a number of criticisms. For instance:

the registration process is unnecessarily cumbersome and expensive for what it achieves. It is paper-based; for each registrable charge a form stating particulars of the charge, and the original charge document, must be sent to Companies House. Registration after 21 days requires a court order;

in theory Companies House will check the particulars submitted against the document. In practice this cannot always be done. As a result the Registrar may certify that a charge is properly registered although the particulars on the Register are not accurate;

the list of what charges are registrable is arbitrary. A fixed charge over shares, for example, is not registrable, but a fixed charge over the dividends that those shares produce is registrable (as a charge over book debts);

charges over certain types of property, such as land, may have to be registered twice: at Companies House and at the Land Registry. This seems unnecessary and can give rise to complications that are needless;

the rules that determine priority of competing charges or other interests over the same assets are complex, unclear and in some cases unsuited to the needs of modern methods of business finance;

recent EC legislation on taking security over 'financial collateral' (investment property such as shares, and bank accounts), because it refers to concepts such as 'control' that have not hitherto been found in our law, has left the law in a somewhat uncertain state. It is not clear what amounts to 'control';

for unincorporated businesses there is a separate and quite different scheme. This scheme restricts secured lending to unincorporated businesses in ways that seem unnecessary, both because it imposes restrictions on the types of charge that may be taken and because the registration process is so complex and risky that few lenders are willing to use it.

9. In addition to these criticisms of the system that applies to mortgages and charges used by companies and other businesses, the current law is open to a more fundamental criticism. It determines whether a transaction amounts to a 'security' on the basis of legal form, rather than looking at function. There are many transactions which fulfil the same purpose as a charge, namely of securing an obligation, but which are not treated by the law as creating security. For example, when a company obtains goods on credit, the supplier may 'retain' ownership of the goods (by using a conditional sale, hire purchase agreement or finance lease) so that, if the company defaults, it may repossess the goods to satisfy the debt due to it. Equally a financier may advance money to the company as against its future income, but rather than take a charge over the company's 'receivables' it may simply 'buy' them.
10. The differences between the way the law treats charges and the way it treats these 'quasi-security' transactions, as they are often called, causes difficulties:

none of the 'quasi-security' transactions has to be registered. Although there are some voluntary schemes of registration, it may be difficult for other creditors or buyers dealing with a company to find out which goods on a company's premises belong to it, and which still belong to the supplier under a conditional sale, hire-purchase agreement or finance lease. It is also hard to find out which of a company's 'receivables' have been sold. Nonetheless the 'quasi-security interest' will frequently be effective against anyone who buys the relevant assets or takes another security interest over it;

if the company defaults on its loan, the remedies of the creditor and the rights of the debtor company are quite different to those under a mortgage or charge. This makes the law unduly complex. It leads to results that seem inappropriate and which the courts have on occasion struggled to avoid.

Our proposals

11. We suggest replacing the current registration scheme set out in the Companies Act 1985 with a more comprehensive legislative scheme. At a later stage the scheme could be extended to unincorporated businesses.
12. This legislation on charges would:

introduce a wholly electronic registration system ('notice-filing'), so that both registration ('filing') and searching can be done via the internet or, for regular users, via direct computer links. This will make it cheaper and faster to register and to search, and will reduce the cost of maintaining the registration system;

eliminate the need to register twice for land and other property for which there is a specialist mortgage register. There would be no requirement to file at Companies House;

remove the 21-day time limit for registration and any need for a court order for 'late' registration;

enable filing in advance of the actual transaction, and a single filing to be made for a series of transactions between the same parties;

in practice, remove the distinction between the 'fixed' and the 'floating' charge, whilst retaining the commercial advantages of the latter;

set out clear and rational rules on priority, broadly preserving the existing balance between competing security interests but linking priority to readily-determined facts such as the date of registration and whether the creditor financed the company's purchase of the asset in question;

set out clear and rational rules on when a person who buys property from a company will be bound by, or take free of, any security interest over it, so that the buyer knows when it needs to search the register.

13. In a separate Part dealing with financial collateral, the consultative report provisionally recommends the adoption of rules that reflect the particular needs of the financial markets:

filing would not be needed where 'control' was taken of the financial asset;

'control' would be defined in a way that fits with commercial good practice;

the priority rules would be clarified and would give priority to secured parties who have taken 'control' of financial collateral.

14. The consultative report provisionally recommends that the scheme should be extended to quasi-securities, and deal with the question of the remedies available on default. It should:

provide for filing of sales of receivables;

subject to the views of consultees when they have had the chance to evaluate the scheme in detail, cover conditional sales, hire-purchase agreements and finance leases; and

set out in legislative form a statement of rights and remedies in the case of the company defaulting on its obligations.

The advantages

15. We think our proposals would bring advantages:

•    To companies:

they will be no longer be legally responsible for registering charges: filing would be up to the secured party;

the lower costs of the scheme to the lender, and its greater certainty and reliability, should make it easier to obtain secured credit and reduce its cost.

•    To the secured lender who uses the current registration system:

filing would be simple, using only readily available information, and not requiring legal expertise. There would be no need to prepare special documentation for sending to the registry, or to send the charge document;

there would be no fixed time limit on filing and no need for court proceedings for 'late' registration;

the filing could be made, provided the other party agrees, before the security agreement is finalised; and one filing could cover a series of future transactions;

searching will be fast and cheap;

charges will appear on the register the moment a filing has been made. Periods of 'invisibility' after a charge has been created but before it has been registered would be largely eliminated;

the rules of priority would be clearer and suited to modern financing methods. Once the secured party had filed, it could be confident that its security would have priority, as against any other secured party, as from the date of filing, save in those specific cases in which the scheme provides otherwise. The same would apply as against someone who has bought the assets charged from the company;

it will have a new form of security that has all the advantages of the floating charge but with fewer disadvantages.

To those who take security over financial collateral:

the uncertainty surrounding the notion of 'control' will be removed in a way that will encourage good commercial practice;

there will be clear rules of priority over financial collateral.

To receivables financiers. 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. Once they have filed they will ensure their own priority, without having to notify account debtors who owe the receivables.

To finance companies. If the scheme is extended to cover conditional sales, hire-purchase agreements and finance leases, the same advantages will apply to finance companies. They will normally retain their existing priority.

To materials suppliers who use 'retention of title' clauses. Although the scheme will require them to file, it will enable them to take a security interest over 'new' goods made out of their materials.

To buyers of goods from a company:

they will not be affected by any unfiled non-possessory security of which they were not aware;

it will be clear when they will be bound by filed security interests, and so should search the register, and when not;

with vehicles, the system will allow a search by vehicle identification number alone; if no filing is found they can buy in confidence that they will not be affected by any finance agreement over the vehicle.

To liquidators and administrators, who will find it much easier to determine who has an effective security interest over what assets.

Companies House would no longer have to check particulars of charge documents; the register will show the information as supplied by the secured party.

The law on:

priority of competing interests; and

the respective rights and duties of the parties in the case of default by the company (for example, the procedures for realising collateral)

will be clearer and easier to find.

16. The scheme that we have outlined above is one that we put forward for consultation. We would very much welcome views and comments.
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