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THE LAW COMMISSION

COMPANY SECURITY INTERESTS

To the Right Honourable the Lord Falconer of Thoroton, Secretary of State for Constitutional Affairs and Lord Chancellor

PART 1

INTRODUCTION

1.1      This report is about the system for registering mortgages and charges over property owned by companies and about the 'priority' rules that apply when there is more than one mortgage or charge over the same property. It also deals with similar issues when a company sells it 'receivables', for example under a factoring agreement.

1.2      Charges and other forms of security over the property of companies are of great practical importance. As the Cork Committee put it, 'credit is the lifeblood of the modern industrialised economy'^[1] - words that are as true today as when they were written in 1982. Some borrowers, particularly well-established public companies, are able to borrow readily on an unsecured basis, but for many smaller enterprises credit can be obtained on significantly better terms – and sometimes can only be obtained – if the borrower is able to offer security to the lender. Even public companies frequently make use of forms of security in particular situations, and secured financing is a crucial feature of financial markets.^[2] As Professor Sir Roy Goode comments:

Security in personal property has become enormously important both within a country and in relation to cross-border transactions. Without an adequate legal regime for personal property security rights, it is almost impossible for a national economy to develop.^[3]

1.3      It is generally agreed that it is important that there be a public record of charges created by companies over their property. As Professor Diamond reported:

… the general requirement for the registration of charges under the Companies Act commands almost universal support and there is no demand for its abolition. Apart from the objective of providing information for persons proposing to deal with the company so that they, or credit reference agencies on their behalf, can assess its creditworthiness, persons considering whether to provide secured credit can find out whether the proposed security is already the subject of a charge; by the same token, a registration system benefits the company itself if it is enabled to give some sort of assurance to a prospective secured creditor that the property it is offering as security is unencumbered. Registration can also ease the task of a receiver or liquidator in knowing whether to acknowledge the validity of an alleged mortgage or charge, and does away with the risk of fraud by inventing a security only when a receiver is appointed or the company goes into liquidation. One can also recognise that, in addition to the use of information by financial analysts and persons considering whether to invest in a company, there is today a general climate of opinion in favour of public disclosure of companies' financial activities.^[4]

1.4      It is also important that the law should set out clear rules to resolve disputes when two or more parties lay claim to the same property. This may occur, for example, when the same asset has been charged to two separate lenders, and where charged property has been sold to an innocent buyer. Priority disputes may arise rarely but the rules have a significant impact on the steps that potential secured lenders and buyers of company property have to take to safeguard their interests.

1.5      Despite its importance, the current law on company security interests has been severely criticised for many years.^[5] The scheme for registering company charges dates back to 1900 and is now inappropriate to modern needs.^[6] It is particularly inefficient in two ways. First, it requires charge documents to be submitted in paper form, although the register of company charges maintained at Companies House is electronic. Secondly, registry staff must check the particulars submitted against lengthy legal documents before the registrar issues a conclusive certificate of registration. This requires a significant number of staff and is, in our view, unnecessary and impossible to justify. A system of electronic on-line registration, with the party filing being responsible for ensuring that the information registered is accurate, would be far more efficient.

1.6      Other serious criticisms can be made of the current law. The requirement to send particulars of a charge for registration within 21 days and the provisions for late registration cause a great deal of unnecessary trouble and expense each year. The scheme for registering charges over the property of 'oversea' companies requires charges to be registered if the company has a place of business here whether or not it has duly registered that place of business. This results in particulars of large numbers of charges being sent to Companies House as a precaution. The information is not recorded and is not available to searchers. Large numbers of trust deeds entered into by corporate members of Lloyd's have to be registered though this produces no apparent benefit. But at the same time the list of charges that need to be registered reflects nineteenth century commercial practice, and omits charges over kinds of property that are commonly used as security today.^[7] There is uncertainty over which charges over receivables have to be registered, while sales of receivables, which perform a very similar economic function to charges, do not have to be registered at all.

1.7      The current rules to resolve these priority issues are unnecessarily complex. They depend, for example, on distinguishing between legal and equitable interests and whether certain buyers should be expected to check the register. They may also take lenders by surprise, as where a charge-holder that registers first finds it is subject to a charge created up to three weeks earlier that it knew nothing about. The rules for charges over receivables and sales of receivables grant priority to those who notify account debtors, a process increasingly unsuited to the needs of modern receivables financing.

1.8      Registration of security has been the subject of two major reports, the Crowther Report and the Diamond Report.^[8] Both recommended that the current law should be replaced by a scheme of 'notice-filing' and priority rules modelled on Article 9 of the American Uniform Commercial Code. This system has been adopted (with variations) in most Canadian provinces^[9] and, more recently, in New Zealand.^[10]

1.9      Our recommendations draw on the best and most relevant features of those schemes, tailored to the particular needs of company financing in England and Wales. We recommend a scheme of electronic 'notice-filing' for charges created by companies. The principle behind 'notice-filing' is that the creditor should file notice of a charge rather than register the charge itself. This ensures that the process of registration is simple. It is limited to what other creditors need to know and does not get bogged down in the detail of legal documentation. It will be done electronically, which is quick and inexpensive. The information appears immediately, removing the dangers associated with delay. The time limit for registration will be removed. Lenders may also file in advance of creating a charge, so as to protect their position during negotiations. Furthermore, they may cover several transactions with the same chargor in a single notice.

1.10      As far as priority rules are concerned, the general principle underlying the scheme is that the party who registers first should gain priority. When the contest is between a chargee and someone who has bought the property that is subject to the charge, priority will for the most part depend on whether the charge is registered and, if it was, whether the charge permitted the chargee to sell the property free of the charge (a 'floating charge', as opposed to a fixed charge which permits sale only with the chargee's agreement to the specific sale).

1.11      There are distinct rules for charges over investment securities and other forms of 'financial collateral', crafted to meet the requirements of European Community legislation. We clarify when a charge over financial collateral needs to be registered; the rules governing the priority of competing charges over financial collateral; and when a person who buys the property without being aware of the charge will be affected by it.

1.12      We recommend extending the scheme to cover outright sales of receivables as well as company charges. It would apply, for example, where a company sells its debts to a factor or invoice discounter. At present, a factor can only be sure of its priority if it writes to each account debtor. In future it will be able to secure its position more cheaply and easily by filing in the register. This meets an urgent need and is strongly supported by receivables financiers.^[11]

1.13      The scheme we recommend would replace Part XII of the Companies Act 1985. We hope it can be implemented by the Company Law Reform Bill that the Government intends to introduce.^[12] These and the other changes recommended in this report will bring real benefits to companies, financiers who lend to them, other parties who deal with them and the economy as a whole.

1.14      In this report we do not advocate such radical changes as did the Crowther and Diamond reports. They recommended that the scheme should apply to a wider range of transactions that perform a similar economic function to charges but which current law does not regard as 'security'. These 'quasi-securities' would include finance leases, hire purchase, conditional sales and retention of title clauses. We think there may be a case for extending the scheme to such transactions at a future date, but the issue requires further study.^[13] We also think that any such extension should apply to all business transactions, not just those entered into by companies. The earlier reports also recommended that notice-filing should apply to security interests created by unincorporated businesses and individuals. At least so far as charges created by unincorporated businesses are concerned, we agree in principle. The law is so technical and restrictive that an unincorporated business wishing to borrow on the security of its assets (other than land) will often come under pressure to incorporate.^[14] However more work is needed on the details of the scheme and we do not make final recommendations on it in this report.^[15]

TERMS OF REFERENCE

1.15      The reference for this project came from the Secretary of State for Trade and Industry, following a recommendation in the Final Report of the Company Law Review Steering Group.^[16] That Group developed a set of provisional proposals to establish a 'notice-filing' scheme, but did not have the time to consult on them widely.^[17] Our terms of reference require us to:

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

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

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

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

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

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

(5) make recommendations for reform.

THE 2002 AND 2004 CONSULTATION PAPERS

1.16      This report is made in the light of responses to two formal consultation documents.^[18] We published our first consultation paper, Registration of Security Interests: Company Charges and Property other than Land ('the CP') in July 2002.^[19] It provisionally proposed a scheme of 'notice-filing' and priority rules similar to those recommended by the Crowther and Diamond reports. The scheme would replace both the current scheme of registration of charges created by companies under Part XII of the Companies Act 1985 and the scheme for charges created by non-corporate debtors over personal property under the Bills of Sale Acts. We asked whether a 'functional approach' should be taken, so that devices such as finance leases that fulfil a similar economic function to security ('quasi-securities') should also be subject to the scheme of registration and priority. We also asked whether a legislative statement of the law of security would be desirable as part of any reforms.^[20]

1.17      Our proposals to reform the scheme for registering company charges received broad support, though consultees had reservations on particular points and some raised questions about the effects of the scheme. There was also broad support for extending the scheme to cover unincorporated businesses. The proposal to include quasi-securities proved more controversial. A particular issue for many was whether the extension to quasi-securities should form part of the 'companies-only' scheme or should await extension of the scheme to unincorporated debtors. The largest group of consultees said that they wished to see how the scheme would operate in more detail before deciding whether it was justified.

1.18      Therefore our consultative report, Company Security Interests: a consultative report ('the CR')^[21] set out detailed provisional proposals covering both company charges and 'quasi-securities'. It dealt with both registration and priority, with detailed provisions on financial collateral. It also included the statement of rights and remedies that we thought would be desirable. The CR contained draft regulations covering each aspect of the scheme. It did not deal in any detail with security interests created by individuals and unincorporated businesses, but repeated the earlier proposal that the scheme for companies should be extended to unincorporated debtors as soon as practicable.

RESPONSES TO THE CONSULTATIVE REPORT

1.19      We received 70 responses to the CR, including 21 from practitioners and practitioner organisations, 10 from banks and banking organisations and 12 from academics. Some responses were very detailed. The Financial Law Committee of the City of London Law Society examined our proposals in particular depth,^[22] and their response was adopted by a further 11 respondents, some of whom added comments and clarifications of their own. We are also grateful for the detailed responses we received from financial organisations, including the Factors and Discounters Association, the Finance and Leasing Association, CREST, HPI and the British Bankers' Association. Inevitably, we received more responses from lawyers and lenders than from companies, though the Confederation of British Industry sent a considered response. A full list of respondents is to be found in Appendix B.

1.20      The consultative report was a long, complex document and, in parts, it was controversial. It was not easy to analyse the responses. Most consultees agreed with our conclusion that the current law has significant weaknesses,^[23] but there was less agreement on what should replace it. In the light of the responses to the earlier consultation paper and much informal discussion with interested parties, we believe that the reactions to our proposals may be summarised as follows.

Registration

1.21      There was clear support for our provisional recommendations on issues relating to the registration of charges. Support for changing to a system of electronic registration was almost unanimous. There was general support for removing the obligation on the company to ensure that particulars of charges were sent for registration. Registration should be a matter of choice for the chargee, but with the sanctions that an unregistered charge would be at risk of loss of priority and ineffective in the company's insolvency. There was widespread if sometimes reluctant recognition that it is no longer justifiable for the Registrar of Companies to be responsible for checking the particulars of charges and issuing a certificate of registration. The responsibility for registering correctly should lie on the chargee, provided that it is made easy for the party who files (normally the chargee or its agent) to provide a correct description of the collateral.

Priority

1.22      There was wide support for a simplified scheme of priority by date of filing. Not all respondents agreed, but those who did not support the recommendations usually argued that change was not needed because priority disputes were uncommon, rather than that our proposals were wrong. Several consultees supported changes that would strengthen the position of the floating charge, making devices such as negative pledge clauses and automatic crystallisation clauses unnecessary.

1.23      There was concern, however, at proposals that would have made it possible for any charge to permit the company to dispose of its assets free of the charge. The proposals would have made it unnecessary for lenders to take both a fixed and a floating charge. The concern was not about the substance of the proposed change but because of the implications for the law of insolvency, where the distinction between floating and fixed charges is deeply imbedded. There have recently been major upheavals to the law of insolvency and consultees were reluctant to see any further changes.

Financial collateral

1.24      There was strong support for our proposals on financial collateral, even from bodies opposed to some other aspects of the scheme. They welcomed our proposals to provide greater clarity about when a secured party has 'control' of financial collateral (and so is exempt from the need to register the charge) and on the associated rules of priority. That said, it was pointed out that there were some technical difficulties with the draft regulations.

Sales of receivables

1.25      Views on whether the scheme should provide for filing of outright sales of receivables, and whether the priority of competing interests should be governed by the date of filing, were divided. Some were strongly in favour, others wholly or partly opposed. There were equally divergent views on our proposal that any contractual prohibition on assignment of a receivable should be of no effect against an assignee.

Recommendations that were not widely supported

1.26      Other provisional recommendations in the CR received less support. There was considerable opposition to the proposed obligation on the secured party to give information about the amount due under a charge and the collateral subject to it. There was also opposition to the proposal to remove from the registration scheme all charges over assets such as land, registered aircraft, registered ships and the forms of intellectual property for which there is a specialist mortgage register. There was only limited support among practitioners or the finance industry for including title-retention devices (such as finance leases, hire purchase, conditional sales and retention of title clauses) in a companies-only scheme.^[24] There was also opposition to including a statement of rights and remedies in the companies scheme. Some of the opposition seemed to be based on a misunderstanding of the effects of the scheme; some was to particular aspects of it (in particular the mandatory rules). There was some support, however, for a statutory restatement that would (in reality or perception) be closer to existing law, particularly if it extended to all security, not just that created by companies.^[25]

SUMMARY OF OUR RECOMMENDATIONS

1.27      In the light of the consultation, we recommend that there should be a new system of electronic notice-filing for company charges. The charge document should no longer be submitted. The registry should not be responsible for checking the particulars submitted and conclusive certificates of registration should no longer be issued.

1.28      Priority should be linked to the date of registration. The opportunity should be taken to deal with various problems that arise under the current law and generally to clarify and simplify it. For the time being the distinction between fixed and floating charges should be preserved, particularly in the context of insolvency, but the scheme should make the floating charge simpler and more effective as a security.

1.29      The scheme to be introduced for companies should apply to 'traditional' security interests such as charges, mortgages and pledges, and to sales of receivables. It should not affect title-retention devices such as finance leases or retention of title clauses. It should not include rules giving super-priority to purchase-money security interests nor a statement of the rights and remedies of the parties to a security agreement. Registration and priority of title-retention devices and a legislative codification of the law of security will be considered further in future reports.

1.30      In the light of the limited nature of the scheme, the draft regulations should revert to the traditional language of charges and pledges and should avoid using concepts that are necessary only for the wider scheme envisaged by the CR.

1.31      We repeat our strongly-held view that, as soon as possible, there should be further legislation to extend the scheme recommended for company charges to charges created by unincorporated businesses; but we indicate that further work is needed on this. The introduction of the companies–only scheme should not wait on it.

PRINCIPAL FEATURES OF THE SCHEME WE RECOMMEND

1.32      The principal features of the scheme recommended in this report for the registration of company charges over property in general are:

(1) Electronic filing will replace the current paper-based scheme of registration of company charges.^[26]

(2) To register a charge, it will be necessary only to send brief particulars of the charge in a simple, electronic format. The original charge document will not be sent.^[27]

(3) There will be no period of 'invisibility' between submission of the particulars and their appearance on the new 'Company Security Register'. It will be possible to search quickly and reliably on-line.^[28]

(4) Formal responsibility for registration, and the rarely-applied criminal liability for failure to register, will be removed from the company. It will be up to the lender taking the charge (the 'chargee') to file if it wishes to protect its security.^[29]

(5) Failure to file before insolvency will render the charge ineffective against an administrator or liquidator. An unregistered charge will also be ineffective against execution levied by judgment creditors.^[30]

(6) The Registrar of Companies will no longer be responsible for checking the particulars that have been filed. It will be up to the party who files (normally the chargee or its agent) to ensure that the financing statement identifies the correct company as debtor and that the description filed is adequate to cover the property subject to the charge. Provided the financing statement does identify the correct company as the debtor, the charge will be validly registered in respect of the property listed in the particulars.^[31]

(7) The property may be described in general terms, but there will be a facility for parties who are concerned that the filing should cover precisely what is in the charge agreement to include the exact terms of the agreement.^[32]

(8) The current list of charges that must be registered will be replaced by a provision that any charge is registrable unless specifically exempted.^[33]

(9) The formal time limit for registration (and thus the need for court applications for late registration) will be removed.^[34]

(10) It will be possible to file in advance of the transaction and a single filing may cover more than one transaction between the same parties.^[35] This will be particularly important for sales of receivables, discussed below.^[36]

1.33      As to the priority of charges and other security over property in general:

(1) Priority between competing charges will be by date of filing (unless otherwise agreed between the parties involved). This will simplify the current law and will remove the current '21-day period of invisibility'.^[37] In the case of a floating charge, it will be unnecessary to rely on a negative pledge clause in order to prevent subsequent charges gaining priority.^[38]

(2) It will no longer be necessary to employ 'automatic crystallisation clauses', with their uncertain effects, in order to protect property subject to a floating charge from seizure by judgment creditors.^[39]

(3) The effect of registration on the rights of a person who buys the property without knowing of the charge will be clarified. If the charge is fixed but has not been registered, it will not affect a buyer who does not know of it; if the fixed charge has been registered it will be binding on the buyer.^[40]

1.34      Charges over unregistered land, registered ships and aircraft, and all kinds of intellectual property, will remain registrable at Companies House.^[41] It will no longer be necessary to register a fixed charge over registered land at both Companies House and the Land Registry. Information about company charges over land registered at the Land Registry will be forwarded automatically to Companies House so that the information will be available to those searching the Company Security Register.^[42] The priority of competing charges over these types of property will be set out in clear rules.^[43]

1.35      Charges created by companies registered in England and Wales over their property in other jurisdictions will remain registrable, but without prejudice to rights acquired in those assets by the secured party or third parties according to the law of that jurisdiction. Charges created by any oversea company or company registered in Scotland over its property in England and Wales will fall within the scheme.

1.36      Sales of receivables (defined so as to apply only to those receivables that are commonly the subject of factoring or discounting arrangements) will also be governed by the scheme. Sales of receivables will be registrable.^[44] Priority over receivables will be determined by the date of filing, rather than the date on which account debtors are notified.^[45] Provisions in a contract generating a receivable that purport to restrict its assignment will no longer be effective as against the assignee.^[46]

1.37      The principal features of the scheme for financial collateral are:

(1) Registration will not be needed where the chargee has obtained 'possession or control' of the collateral (within the meaning of the Financial Collateral Arrangements (No 2) Regulations 2003),^[47] or has 'control' of it as defined by the regulations we propose.^[48]

(2) A chargee will have control of financial collateral if the company can no longer deal freely with the assets free of the charge.^[49]

(3) A security which is perfected by control will have priority over one merely perfected by filing; priority between charges perfected by control will depend on the order in which control was obtained.^[50]

(4) Purchasers of securities or securities entitlements for value and without notice of existing security interests will not be affected by them.

ADVANTAGES OF THE SCHEME

1.38      The scheme we recommend will bring significant benefits.^[51] 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.

1.39      There will be short-term costs but these should be slight. The main costs will arise from setting up an electronic system, which is widely supported and will produce demonstrable savings in a short period of time. The cost of the other changes is likely to be relatively low. It will be necessary to re-train staff, but training staff to use simpler procedures is unlikely to be difficult. The changes will mean that standard charge documents can be simplified but there will be no need to do so. Some clauses used hitherto will no longer be necessary and can be deleted when the document is next revised.

1.40      Other benefits will result from simplification and clarification of the law. They are less easy to quantify, but nonetheless real. If the law is simpler, clearer and more certain, and the documentation required for transactions is less complex, the costs to lenders and to borrowers will fall in the long term.

1.41      Some consultees expressed concern that changes to the law may result in damaging uncertainty. It is not possible to guarantee that a new scheme will generate no uncertainty at all. However, we have considered the question of certainty carefully in relation to each proposal. We believe the changes proposed will make the law on many points significantly more certain; and that, in the form in which they are now put forward, they do not pose significant new risks of uncertainty.

SCOTLAND

1.42      When we received our reference from the Department of Trade and Industry, the Scottish Law Commission was also asked to consider registration of company charges, but their terms of reference were more limited than our own. At the end of 2002 the Scottish Law Commission published a Discussion Paper,^[52] in which it made provisional proposals which did not involve any form of 'notice-filing'. It published its report in 2004.^[53]

1.43      One reason for the difference in the terms of reference was that the law of security in Scotland is different from that in England and Wales.^[54] Equally the approach of the Scottish Law Commission's report is different from ours. They recommend that there should no longer be a requirement to register any security created by a Scottish company with the Registrar of Companies.^[55] However, in order to constitute a floating charge under Scots law, it should be necessary to register the text of the deed in a Register of Floating Charges.^[56] Information about these and other forms of rights in security (which under Scots law generally require some form of publicity for their constitution) would also be available in the company's annual return supplemented by more up-to-date information which the company would have to supply on request.^[57]

1.44      As we explain in Part 3,^[58] if these changes are implemented then, whether or not our recommendations are also implemented, the current system of 'mutual recognition of registration' between the two jurisdictions will come to an end. The Scottish Law Commission report and our report fit together by both making the same assumption. This is that charges created by a company registered in Scotland over its assets located in England and Wales would be treated in the same way as charges created by a company registered outside Great Britain over its assets in England and Wales. Such charges would have to be registered if they are to be enforceable in the debtor's insolvency.^[59] Thus charges created over assets in England and Wales that on the Scottish Law Commission's recommendations would cease to be registrable at Companies House in Edinburgh would become registrable in the Company Security Register that we propose. With a floating charge that covered assets on both sides of the border, it would it be necessary both to register the text of the deed in a Register of Floating Charges in Edinburgh (in relation to collateral in Scotland) and to file a financing statement (in relation to the collateral in England) in the Company Security Register.^[60]

FURTHER WORK

1.45      There are three issues on which we intend to carry out further work. These are (1) the extension of the scheme to unincorporated businesses, sole traders and possibly consumers, and also to unregistered companies; (2) whether a scheme that applies to both companies and other debtors should include title-retention devices; and (3) whether there should be a statutory restatement of the law of security over personal property.

Consumers, unincorporated businesses and unregistered companies

1.46      For most of this project we have concentrated on security interests created by registered companies. The Secretary of State for Trade and Industry also asked us to consider whether any new scheme for company charges should be extended to unincorporated businesses and individuals.^[61]

1.47      Charges over the goods of unincorporated businesses and individuals, and also general assignments of their book debts, require registration under the 'Bills of Sale Acts'.^[62] The Acts impose many formal requirements, including a requirement that many details about the charge be registered. The penalties for failing to abide by these rules may be severe: under the 1882 Act a single technical defect may render the bill void between the parties. This means that the charge cannot be enforced even if the borrower is solvent. As the Crowther Report commented in 1971, 'it is difficult to imagine any legislation possessing more technical pitfalls'.^[63]

1.48      In the CP we asked consultees whether they agreed that the current law on the creation and registration of security interests by non-corporate debtors was complex, unworkable and in need of reform.^[64] The vast majority (over 90%) of consultees who responded agreed with our assessment.

1.49      In the time available to us, we have only been able to make very general recommendations on the general principles to be applied to charges created by other debtors. We look first at charges created by individuals in their capacity as consumers, and secondly at charges created by non-corporate businesses, such as partnerships and sole traders. We then consider charges created by unregistered companies.

Consumers

1.50      At present, consumers routinely buy goods using hire purchase and other 'quasi-security' devices. It is common, for example, to finance the purchase of a car through a hire purchase agreement, which gives the lender the right to repossess the car on default. It is also possible for consumers to borrow on the security of their existing goods, but there are very significant legal obstacles. If a lender wishes to take a charge or mortgage over a consumer's existing goods, they must comply with the complex requirements laid down in the Bills of Sale Acts. Some of the restrictions imposed by those acts are valuable. For example, the requirement that all the consumer's property be listed in the documents prevents consumers from charging goods that they may acquire in the future and from creating a floating charge over their goods. In the CP we said that we thought these were important elements of consumer protection that should be maintained.^[65] Consultees agreed. In contrast, the extreme technicality of the registration requirements and the severe sanction if a mistake is made seem hard to justify.

1.51      In some respects the legal obstacles to consumers using their goods as security may not be bad, since consumers who do so fall outside important consumer credit protection measures. Under the Consumer Credit Act 1974, where a debtor under a hire purchase or conditional sale agreement has paid more than a third of the price, the lender may not repossess the goods except by order of the court.^[66] This does not apply to bills of sale. Instead, where a debtor defaults on a loan backed by a bill of sale, the lender may issue a default notice and then take possession of the goods without a court order.^[67] These gaps in protection may be significant because, despite the difficulties, a good number of bills of sale are given by consumers each year.

1.52      In the CP we noted that few bills of sale were granted: in 2001, only 2,840 were registered, most with a single group that specialised in lending on the security of cars. Since 2001, however, the number of loans secured by registered bills of sale has grown dramatically. In the first six months of 2005 nearly 11,000 bills were registered, and it is likely over 20,000 will be registered by the end of 2005. Several new firms have entered this market, with consumer loans generally secured over cars. Such rapid growth strengthens the case for reforming this problematic area.

1.53      We consider that there is almost certainly a case for replacing the Bills of Sale Acts with a modern system of registration of security over consumer goods, probably modelled on the scheme we are recommending for company charges, but containing proper safeguards for consumers. It should probably include the kind of protection provided by the Consumer Credit Act 1974 for those who obtain goods on hire-purchase and the like. However we think that this reform can best be undertaken by others with greater expertise in the field of consumer credit law. We therefore recommend that the Department of Trade and Industry, who are already involved in an extensive review of consumer credit law, should examine the question of replacing the Bills of Sale Acts with a more efficient and effective scheme.

Unincorporated businesses

1.54      The Bills of Sale Acts also make it difficult for unincorporated businesses to create fixed charges over goods, and prevent them from creating floating charges. The law adds complexities to the way that unincorporated businesses may assign their receivables.^[68] In the CP we described the current law as out-of-date, unfair and fettering the ability of unincorporated businesses to raise finance.^[69] We provisionally proposed that the Bills of Sale Acts should be repealed. Instead the notice-filing system we outlined for companies should be extended to non-corporate business debtors. As we reported in the CR, this was widely supported by consultees.^[70]

1.55      If the notice-filing system were extended to non-corporate business debtors, it would have three main consequences for them. First, they would be able to created fixed charges without complying with the technical requirements of the Bills of Sale Acts. Instead, charges would be registered on-line in a similar scheme to the one used for companies. Secondly, they would acquire the right to grant floating charges over existing and after-acquired business property. Thirdly, the present distinction between general and specific assignments of book debts would be removed. The general rule would be that both were registrable.

1.56      Consultees identified various practical problems which would need to be addressed if the company scheme were to be extended to unincorporated businesses:

(1) In the absence of an existing register of unincorporated businesses, it may be difficult to identify the debtor, whether the debtor is a sole trader or a partnership.

(2) It is difficult to reconcile the idea of a partnership granting a charge with the current legal position under which partnerships do not have legal personality.

(3) If the procedure for insolvent partnerships is to recognise the rights of floating charge-holders, it will require significant reform.

1.57      Our current view is that these practical problems are soluble, and that notice-filing could be extended to unincorporated businesses, but more work is needed to determine how best to deal with these problems and others. We will consider whether to return to the question of unincorporated business debtors when we know whether our proposals for companies are to be implemented.

Unregistered companies

1.58      In the CP we provisionally proposed that charges created by unregistered companies should be included within the scheme.^[71] There was broad support from those who addressed this issue. In the CR we said that on further consideration it seemed to us that the main issue of principle was 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 provident societies, for example, there are additional requirements to register charges with the Financial Services Authority.^[72] We sought views on whether the scheme we provisionally propose should be limited to registered companies and Limited Liability Partnerships (LLPs), or should apply also to other corporate bodies; and if so, as to which corporate bodies should be included.^[73]

1.59      We did not receive many responses on this question and we have not had time to take the matter any further. The draft regulations in this report are therefore applicable only to registered companies and LLPs. We will return to this question if and when we take up the issue of charges created by unincorporated debtors.

Title-retention devices

1.60      Our CR included, as many consultees had requested, a detailed scheme for the registration and priority of title-retention devices, such as finance leases, hire purchase, conditional sales and retention of title clauses. It included provisions for the registration of 'security interests' over vehicles, and possibly other items that have unique serial numbers, using the serial number. This would allow anyone contemplating buying the vehicle or taking security over it to search by the serial number. If the financing statement did not include the serial number a buyer would not be affected by the security interest unless they knew of it.^[74]

1.61      The response to these proposals was mixed. Some academics and organisations with extensive experience in North America supported the inclusion of title-retention devices even in a companies-only scheme. Among practitioners and the finance industry in the UK, however, there was almost no support for including title-retention devices of any kind, or the scheme for registration of security interests over vehicles, in a companies-only scheme. The Finance and Leasing Association, which had informally suggested that they were interested in including title-retention, were in the end against doing so at this stage. Some respondents thought that title retention should never be included. Others, including some from the finance industry, thought that registration and priority of title-retention devices should be considered as part of overall review of questions of transfer of title, within a scheme that would apply to all debtors.

1.62      There appear to be three critical issues. The first is whether there should be registration of title-retention devices so as to give 'public notice' to those dealing with a company that assets in its possession do not belong to it. Some argued strongly that there should be, because title-retention devices perform a similar economic function to charges; other said they were completely different because the supplier retained the title. Thus no clearly right answer emerged from the responses. The question is whether publicity should depend on the formal nature of the transaction or the underlying economic reality. The need to register also depends on the nature of the arrangements. There may be a stronger case, for example for requiring registration of a finance lease than for requiring it of a simple retention of title clause over materials supplied to a company. We think this merits further investigation.

1.63      The second issue of concern to consultees was that under the scheme proposed, the same remedies on default would have applied to title-retention devices as apply to charges. In particular, some consultees opposed the mandatory provision that after default, any surplus must be returned to the debtor.^[75] Curiously, the opposition to this came principally from lawyers. The finance industry was less concerned. Representatives volunteered that they have no real interest in any surplus; that agreements sometimes provide for any surplus to be returned; and that, even where there is no such provision, financiers would normally hand it over to be distributed to other creditors, if asked to do so by the liquidator.^[76] Thus again no clear answer emerged from consultation.

1.64      The third issue, and the one that has persuaded us that further work on title-retention is justified, is the need to protect buyers and subsequent lenders. The innocent person who buys an asset subject to a financing agreement or who takes a security interest over it will normally obtain no title.^[77] In practice the danger is greatest with frequently traded assets such as vehicles, and here there is a well-established voluntary system (operated by HPI Ltd and Experian Ltd). However, a financing arrangement that has not been registered under these schemes will still be effective against the innocent purchaser. We aimed, in effect, to strengthen and widen the voluntary schemes by providing that any unregistered title-retention device would be invalid against an innocent purchaser.

1.65      Our scheme would only have applied to finance agreements made by companies. Many people expressed concern about treating company vehicles and other assets differently to others.^[78] Some respondents (including HPI) thought the scheme might well be valuable as part of a rationalisation of the rules on when purchasers are protected, provided it applied to all financing arrangements and not just those made with companies.

1.66      Our Ninth Programme of Law Reform^[79] includes a project on transfer of title by non-owners. When that project was proposed originally, its aim was to tidy up the rest of this area of law after the transfer of property subject to security interests (including title-retention devices) had been dealt with by the present project. We now recommend that the registration and priority of title-retention devices (including finance leases, hire purchase, conditional sales and retention of title clauses) should be re-considered as part of, or in the light of, that project.^[80]

A statement of the law of security over personal property

1.67      The scheme proposed in the CR, like the North American and the New Zealand statutes, contained provisions setting out the law on the creation of security interests, the rights and duties of the parties to the security agreement, and the enforcement of security interests following default. These rules would have applied to all 'in substance' security interests,^[81] whether they were traditional securities, such as charges or mortgages, or quasi-securities such as title-retention devices.^[82]

1.68      The proposed statement was based on the overseas models, but in substance its contents were similar to current English law. However it contained a small number of mandatory rules, in particular that before disposing of collateral for which there is no recognised market, the creditor should give 10 days' notice to the debtor and other interested parties. That is not part of current English law; we included it because it seemed to us to be a fair and sensible rule. The draft regulations also provided that the disposal must be made in a commercially reasonable manner. In substance this is close to current law, which requires a mortgagee to obtain the best price reasonably obtainable,^[83] but the form of the rule is different.

1.69      The statement in general, and these two provisions in particular, were criticised heavily.^[84] The main reason for proposing a restatement for companies only was to clarify which rules would apply to various types of quasi-security. If title-retention is not to be covered in the companies-only scheme, we see no pressing need to include the statement. We are therefore no longer proceeding with these proposals for the time being. If the further work on title-retention mentioned in the last section suggests that title-retention devices are to be included, then we will consider whether some provisions on the applicable remedies are needed.

1.70      Meanwhile some consultees argued that it would be valuable to have a statutory restatement of the current law of security over personal property that reproduced the existing law. It might include setting out the assets over which security can be taken and the nature of the security that may be taken.^[85] The aim would be two-fold: to clarify English law for its users (particularly those from overseas, many of whom say they find English security law inaccessible and mysterious) and to provide a model for European and international harmonisation. We intend to carry out a scoping study to see how much support there would be for a statutory restatement of this kind.

PLAN OF THIS REPORT

1.71      Part 2 sets out the business case for reform. Part 3 describes our detailed recommendations for the scheme for charges over property in general. Part 4 discusses registration and priority of sales of receivables. Part 5 deals with financial collateral. Finally, Part 6 contains a list of recommendations.

1.72      If the Government decides to implement our recommendations, it is likely that it will do so by making regulations under powers to be taken in the forthcoming Company Law Reform Bill. Appendix A sets out the draft regulations that we recommend should be made, together with explanatory notes.^[86]

1.73      A list of consultees is to be found in Appendix B.

ACKNOWLEDGEMENTS

1.74      Many of those who contributed to the earlier stages of this project were listed in the CR.^[87] A number of them and many others have helped us to prepare this report. We are grateful to them all. We would like to give particular thanks to a number of individuals who have given us extraordinary assistance since the CR was published. They are Richard Calnan of Norton Rose, who chairs the working party of the Financial Law Committee of the City of London Law Society, and Mark Evans of Travers Smith and Geoffrey Yeowart of Lovells, who are members of that Committee; Peter Graham, who chaired the working party of the Company Law Committee of the Law Society; Graham McBain; Edward Wilde of Hammonds, Honorary Legal Adviser to the Factors and Discounters Association; Professor Philip Wood of Allen and Overy; and Professor Sir Roy Goode QC, Mrs Louise Gullifer and Professor Harry Sigman, who have acted as consultants. The contents of this report are, of course, our responsibility and ours alone.

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Note 1    Report of the Review Committee on Insolvency Law and Practice (1982) Cmnd 8558, para 10.    [Back]

Note 2    We are most grateful to Mr Philip Wood for graphic information on the use of secured lending.     [Back]

Note 3    R Goode, ‘Security in Cross-Border Transactions’ (1998) 33 Texas ILJ 47, referred to in I Davies, ‘The reform of English personal property security law: functionalism and Article 9 of the Uniform Commercial Code’ (2004) 24 LS 295. Both authors note that this thinking has informed initiatives by the World Bank, the European Bank for Reconstruction and Development, UNCITRAL and UNIDROIT.     [Back]

Note 4    See A L Diamond, A Review of Security Interests in Property (1989) (the ‘Diamond Report’), para 11.1.5.    [Back]

Note 5    See Report of the Committee on Consumer Credit (1971) Cmnd 4596 (the ‘Crowther Report’), Parts IV and V; and the Diamond Report. See also Law Commission, Registration of Security Interests: Company Charges and Property other than Land (2002) Consultation Paper No 164 (the ‘CP’), Part 3 and Company Security Interests, a consultative report, Consultation Paper No 176 (2004) (the ‘CR’), paras 2.3-2.6.    [Back]

Note 6    Companies Act 1900, s 14. It is currently set out in Part XII of the Companies Act 1985.    [Back]

Note 7    J de Lacy comments that the list of charges set out in the Companies Act 1985, s 396 ‘had effectively crystallised by 1928’. See ‘Reflections on the ambit and reform of Part 12 of the Companies Act 1985 and the doctrine of constructive notice’ in J de Lacy (ed), The Reform of United Kingdom Company Law (2002) 337.    [Back]

Note 8    See above, para 1.3, note 4.    [Back]

Note 9    Alberta, British Columbia, Manitoba, New Brunswick, Newfoundland and Labrador, Nova Scotia, Ontario, Prince Edward Island and Saskatchewan, plus Northwest Territories, Nunavut and Yukon Territory.    [Back]

Note 10    New Zealand Personal Property Securities Act 1999, amended by the Personal Property Securities Amendment Act 2000, the Personal Property Securities Amendment Act 2001, and the Business Law Reform Act 2004. It is also being considered for adoption by Singapore: see G McCormack, ‘Reforming the Law of Security Interests: National and International Perspectives’ [2003] Singapore JLS 1. (We understand that decisions on reform in Singapore are awaiting the outcome of our reform exercise.) It has also influenced the Model Law promulgated by the European Bank for Reconstruction and Development , which adopts priority by date of filing. The Model Law has been adopted in whole or in part in several countries of Central Europe.    [Back]

Note 11    See further below, paras 2.34-2.39.    [Back]

Note 12    See the Queen’s Speech of 17 May 2005.    [Back]

Note 13    See further below, paras 1.60-1.66.    [Back]

Note 14    Charges created by unincorporated businesses are subject to the Bills of Sale Act 1878 and Bills of Sale Act (1878) Amendment Act 1882. The Crowther Report commented that ‘it is difficult to imagine any legislation possessing more technical pitfalls’ (para 4.2.12).    [Back]

Note 15    See further below, paras 1.46-1.57.    [Back]

Note 16    Modern Company Law for a Competitive Economy: Final Report (2001) URN 01/942 ch 12.    [Back]

Note 17    See CP 164 paras 1.12-1.15.    [Back]

Note 18    We also circulated a number of draft papers to individuals and organisations that had shown interest in the project. These formed the basis of discussion at a series of seminars: see CR para 1.13.    [Back]

Note 19    Registration of Security Interests: Company Charges and Property other than Land (2002) Consultation Paper No 164 (‘the CP’).    [Back]

Note 20    The alternative approach taken by the Company Law Review Steering Group, of making adjustments to the existing system, was dealt with in an Appendix to CP 164.    [Back]

Note 21    Company Security Interests, a consultative report, Consultation Paper No 176 (2004) (the ‘CR’).    [Back]

Note 22    Referred to hereafter as CLLS FLC. We would also like to thank the CLLS Insolvency Law Committee, the Law Society Company Law Committee, Clifford Chance, DLA LLP and Graham McBain for their detailed comments.    [Back]

Note 23    See CR para 2.6.    [Back]

Note 24    Including our proposals in relation to uniquely identifiable assets (i.e. motor vehicles). The proposals to give purchase-money security interests priority over earlier-registered security interests, which were included principally to protect those employing title-retention devices, were criticised as unduly complex.    [Back]

Note 25    This would include a statement of the types of security that can be taken and the kinds of obligations that can be secured, which were not included in the draft regulations in the CR.    [Back]

Note 26    See paras 3.69-3.71.    [Back]

Note 27    See paras 3.97-3.120.    [Back]

Note 28    See paras 3.92-3.93.    [Back]

Note 29    See para 3.77.    [Back]

Note 30    See para 3.78.    [Back]

Note 31    See paras 3.74-3.76 and 3.124-3.131.    [Back]

Note 32    See paras 3.107-3.109.    [Back]

Note 33    See paras 3.14-3.16.    [Back]

Note 34    See paras 3.79-3.82.    [Back]

Note 35    See paras 3.86-3.91.    [Back]

Note 36    See para 1.36 and Part 4.    [Back]

Note 37    See paras 3.149-3.155.    [Back]

Note 38    See paras 3.177-3.180.    [Back]

Note 39    See paras 3.201-3.204.    [Back]

Note 40    See paras 3.210-3.224.    [Back]

Note 41    See paras 3.35-3.41.    [Back]

Note 42    See paras 3.30-3.34.    [Back]

Note 43    See paras 3.231-3.245.    [Back]

Note 44    See paras 4.19-4.25.    [Back]

Note 45    See paras 4.12-4.19.    [Back]

Note 46    See paras 4.35-4.40.    [Back]

Note 47    SI 2003 No 3226. It has not proved feasible to define ‘possession or control’ for the purposes of those regulations but the draft regulations give clear guidance as to when a chargee has sufficient ‘control’ that registration is not required.    [Back]

Note 48    See para 5.68.    [Back]

Note 49    See also para 5.68.    [Back]

Note 50    See paras 5.95-5.102.    [Back]

Note 51    The costs and benefits are explored in more detail in Part 2.     [Back]

Note 52    Discussion Paper on Registration of Rights in Security by Companies (2002), Discussion Paper No 121.    [Back]

Note 53    Scottish Law Commission, Report on Registration of Rights in Security by Companies (September 2004), Scot Law Com No 197.    [Back]

Note 54    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, DP No 121.    [Back]

Note 55    Scot Law Com No 197 above, para 7.13.    [Back]

Note 56    Ibid, paras 7.1-7.3.    [Back]

Note 57    Ibid, paras 7.15-7.18.     [Back]

Note 58    See paras 3.273-3.277 and 3.282.    [Back]

Note 59    See para 3.284.    [Back]

Note 60    This would apply whether the company was registered in Scotland or in England and Wales.    [Back]

Note 61    See above, para 1.15.    [Back]

Note 62    Principally the Bills of Sale Act 1878 (the ‘1878 Act’) and the Bills of Sale Act (1878) Amendment Act 1882 (the ‘1882 Act’). The Bills of Sale Act 1890 and the Bills of Sale Act 1891 add minor provisions to these Acts. For further detail see CP Part VIII.    [Back]

Note 63    Crowther Report on Consumer Credit, Cmnd 4596, para 4.2.11.    [Back]

Note 64    Para 12.90.    [Back]

Note 65    CP 164 para 10.26.    [Back]

Note 66    Section 90.    [Back]

Note 67    The debtor who wishes for more time to pay must initiate court proceedings for a time order under s 129(1)(b)(i).    [Back]

Note 68    A ‘general assignment’ of existing or future book debts must be registered as a bill of sale, or it will be void against a trustee in bankruptcy: Insolvency Act 1986, s 344.    [Back]

Note 69    CP 164 para 10.4. In this we followed the Crowther Report para 4 and Diamond Report para 18.1.8.    [Back]

Note 70    See CR para 2.71.    [Back]

Note 71    CP 164 para 5.122.    [Back]

Note 72    Industrial and Provident Societies Act 1967, s 1. We did not deal with this aspect in the CP.    [Back]

Note 73    CR para 3.8.    [Back]

Note 74    See CR para 3.263. A subsequent secured party would take free of security interests over vehicles that were part of the debtors’ ‘equipment’: CR para 3.179.    [Back]

Note 75    That is, if, after a default by the debtor, the creditor has re-possessed the collateral (or it has been sold by a receiver, etc) and when all that is due (capital, credit charges and costs) have been paid to the creditor there is a surplus, the surplus must go back to the debtor. This is currently the rule for charges but not for finance leases or hire-purchase agreements.    [Back]

Note 76    They said that they would often have more than one finance lease with the same debtor and would reckon to set off any surplus on one against deficits on others (in other words, to consolidate). This would have been permissible under the scheme as we had drafted it, if the agreements concerned provided for it.    [Back]

Note 77    Unless it is a conditional sale or the purchaser falls within the protection of Hire Purchase Act 1965, Part III (non-trade buyers of motor vehicles subject to Hire Purchase). This is not a major issue in the case of retention of title clauses, because innocent buyers will normally be protected by the Sale of Goods Act 1979, s 25.    [Back]

Note 78    The Finance and Leasing Association was also concerned about the effect of making a mistake in typing the vehicle identification number, which has 17 digits. We do not think that this is an insuperable obstacle. Often the information will be in digital form or can be scanned from machine-readable documents, so that the risks would be low. HPI also offer data cleansing to pick up mistakes of this kind, and we envisage that their service would continue.     [Back]

Note 79    Law Com No 293, HC 353, March 2005.    [Back]

Note 80    One issue that we addressed in the CR (paras 2.111-2.119) was whether the proposals to include title-retention devices would mean a change in the tax treatment of leases etc. The Inland Revenue told us that their opinion was that our proposals ‘could introduce uncertainties regarding 'ownership”’, and that therefore it might be appropriate to take a precautionary approach and make special provision to ensure that the tax treatment of leases is not altered by our proposals. This aspect may need to form part of any future reconsideration of title-retention.     [Back]

Note 81    See CR para 3.30 ff.    [Back]

Note 82    The provisions relating to default and enforcement would not have applied to ‘deemed’ security interests (that is, sales of receivables, and leases for more than one year or commercial consignments which do not secure payment or performance of an obligation).    [Back]

Note 83    Cuckmere Brick Co Ltd v Mutual Finance Ltd [1971] Ch 949.     [Back]

Note 84    Some criticisms were based on an incomplete grasp of how the scheme was to operate. For example, some consultees seemed to believe that our proposals required that notice must be given before any step could be taken to enforce a security interest, and as requiring that everything done must be commercially reasonable. Neither is correct.    [Back]

Note 85    It would not necessarily include retention of title.    [Back]

Note 86    In the footnotes to this report we refer to the draft regulations in Appendix A of this Report as ‘draft regs’. The draft regulations that were proposed in the CR are referred to as ‘CR draft regs’.    [Back]

Note 87    CR para 1.35.    [Back]