учебный год 2023 / Goode, Legal Problems of Credit and Security

V FIXED AND FLOATI:-IG CHARGES: SOME PROBLEMS OF PRIORITY

depends upon its priority. This does not, of course, mean that second, or even third, mortgages or charges have no value, merely that each successive mortgagee or chargee must be satisfied that after giving the prior security interests the debtor retains sufficient equity in the asset to provide the assurance each junior incumbrancer requires. However, a first mortgage is obviously superior to a second, not only because the first mortgagee has the primary claim on the asset but also because priority gives him control in the event that the debtor gets into financial difficulties. This control used to be at its most visible when a creditor holding a floating charge covering, with any fixed charges, the whole or substantially the whole of a debtor company's property appointed an administrative receiver to run the business, where possible sell it as a going concern either directly or through a hive-down, 2 and pay off his debenture holders. 3 The creditor in a similar position now has the ability to appoint an administrator out of court, which gives less but still significant controL4 Further, the Holder of a first fixed charge or mortgage over a particular asset can still appoint a receiver' or enforce it security interest by sale or other means.6 It is in the priority stakes that perfection of a security interest' acquires sigf!ificance. Perfection does not guarantee priority, but an unperfected security interest will almost always be subordinated to or displaced by competing interests and by unsecured creditors in the debtor's bankruptcy or winding up.

The subject of priorities is of great complexity because English law has never developed a coherent legal structure for the ordering of competing interests. The common law adopted a straightforward first-in-time principle. The development of equitable ownership and security interests brought in its train a number of refinements, such as the relationship between an equitable interest and a subsequent legal title, priority as between competing equitable interests, including interests in debts and other intangibles. and the concepts of inferred and constructive notice of an interest. The introduction of a variety of statutory registration systems, each with its own priority rules and its own sanctions for failure to register, added to the complexity, and this has been exacerbated by the dual perfection requirements imposed by s.860 of the

2A procedure by which some or all of ~e assets of the company are sold, without transfer of the-llabilities, to a ~pecially formed sub&j:diafy which is controlled by the receiver and which as a clean Company free of debt may be ~tble_to trade profitably w:ith a view to its sale, the proceeds}lowing back to the company in payment of the price for the transferred assets. See generally Lightman and Moss, The Law of Receivers and Administrators of Companies 4th edn

(London: Sweet & Maxwell, 2007) paras 12--083 et seq.

3The receiver also has a duty to discharge preferentiai-'debts from the proceeds of assets subject

to, a floating charge to the extent that the company's free assets are not sufficient tbr the p~rpose. See below, para.5---65. For the near~demise of administrative receivership, see above. pa'ta.4---09.

4See above para.~37.

5Pursuant loa power in the security agreement, or, if the agreement is by deed, under the power in Law of Jlroperty Act 1925 &lOL

6Either pursuant to an express powet· in tile agreement or, again if tile agreement is by d(:ed; under the pO\ver in Law of Property Act s.101. Once the underlying obligation has become

due, a mongagee also h!:lS a power of sale implied by law, Re 111orrttr (1886) L.R. 18 QBD 222,

233; Deverges v Sandemna, Clark & Co [1902]1 Ch. 579, 588~589.

7 See above, paras 2-16 et seq.

174

INTRODJ;cTION

Companies Act 2006, as regards categories of charge listed in s.860(7), and statutory provisions regulating the various specialist registers.' The courts have also had to consider the extent to which registration of a charge constitutes constructive notice of the existence of the charge and of its provisions. The result is an amalgam of common law rules and statutory provisions many of which lack any rational policy or responsiveness to modern commercial and financial requirements and by their complexity add significantly to transaction costs.

That this state of affairs continues to be tolerated in the 21st centur'l when 5-02 the US and Canada have for ma'uy years had highly developed, ~arket­

responsive legislation which has worked and when successive government reports have recommended the adoption of similar legislation in this country,9 is a shocking indictment of the indifference of successive govermnents to the modernisation of our commercial law. It is, furthermore, very unfortunate that the work of the Law Commission on .registration of company charges,10 which the Law Commission rightly concluded could not be considered in isolation from general issues of perfection and priorities, led to no legislative response in the Companies Act 2006, and that no decision has been taken by the Government regarding any future response.

At the outset we need to be aware of the fundamental difference between a fixed mortgage or charge and a floating charge. In relation to the subject of a fixed charge, the priority of the charge as against competing interests is governed primarily by rules of property law and equity.ll But in the case of assets the subject of a floating charge, the power of disposition given to the company attracts rules of commercial law as well, for the company is trading in the assets comprising the security with the consent of the debenture holder, so that under the principle of authority akin to that which underlies agency law the debenture holder's security interest may be overreached by a disposition which is within the company's actual or ostensible powers of management. This does not mean that the company is the agent of the debenture holder; on the contrary, the company deals with the charged assets on its own behalf. But in so doing it is held out by the debenture holder as authorised to deal with the assets in the ordinary course of business free from the floating charge, and a third party taking without notice of any restriction of such authority is thus entitled to the act in reliance on the company's apparent powers of disposition even if the transfer to the third party is in breach of the terms of the debenture. In general, those apparent powers are limited only by the requirement that the dealing be in the ordinary course of the company's business, a requirement liberally interpreted by the courtsl' Accordingly priority issues arising in relation to floating charges will be examined separately.

8See above, paras 2-21 and 2~30.

9See above, para.1~(}4, fn.l4.

10Company Security Interests (a consultative report) CP 176 (2004) and Company Security Interests Report No. 2% (2005).

n See below.

12 See below, para.~39,

175

VFIXED AND FLOATING CHARGES: SOME PROBLEMS OF PRIORITY

2.PRINCIPLES OF PRIORITY AT COMMON LAW13

5-03 The following are the principal priority rules established at common law to regulate the priority of competing fixed interests generally. 14 The impact of legislative registration requirements on competition between fixed security interests is discussed in section 3 and between a fixed security interest and other types of interest in section 4, while the ranking of the floating charge is examined in section 5.

Rule 1: nemo dat quod non habet

5-4!4 A person cannot in general transfer a better title than he himself possesses. Another formulation of the rule ,js that as between competing interests the first-in-time prevails. The first formulation is usually used in relation to competing legal interest in goods, the second to competing equitable interests and interests in land. The rule applies where the competing interests are both legal interests and also where thefare both equitable interests. However, in a competition between an equitable interest and a subsequent legal interest, this rule may be overridden by Rule 2, below. It follows that as between competing equitable interests, the conversion of one of these into a legal interest may move the case from Rule I to Rule 2.

Rule I is subject to a number of exceptions at common law. 15

Common law exceptions to the nemo dat rule

(I) Actual or apparent (ostensible) authority

5-05 A non-owner can sell or charge an asset if he has either actual or apparent (ostensible) authority from the owner to do so. Even if not in fact authorised to make the disposition, he will have apparent authority to do so if he has been held out by the owner as authorised to dispose; and where there is such a holding out, an innocent third party will not be bound by limitations on the power of disposal which were not known to him. 16 This principle is of particular importance in the cas~'of the floating charge. The chargee confers on the ci)argor power to deal with its assets in the ordinary course of business free from the charge, but may seek to impose restrictions on the exercise of such power. The question then is what steps are necessary and sufficient to give notice of those restrictions to third parties, a matter discussed earlier. 17

'~

13 "Common law", as opposed to st~tute, is here used in its broad sense of judge~made law, including equity. '~

14 For a very clear description of the pfinci:Pal rules, see the judgment of Millett J. in Macmillan

!ne v Bishopsgate Investment Trust plc (No. 3) [1995] 1 W.L.R. 978 at 999 et seq.

15For the statutory exceptions, see below, paras 5-13 et seq.

16For a detailed treatment, see Bowstead & Reynolds on Agency 18th edn (London: Sweet &

Maxwell, 2006) paras 8-013 et seq.

17 See above, paras 2-24 et seq.

176

applies also to a contest between the holder of an equitable right to claim a debt as proceeds of his property and a subsequent purchaser or mortgagee of the same debt. 21 The statutory provisions for registration of seci\rity interest considerably reduce the impact of the rule in Dearle v Hall in receivables financing, for the second assignee will usually have notice of a prior security interest by virtue of its registration. 22 The rule is wholly unsuited to modern receivables financing. Over a century ago Lord Macnaghten commented: "I am inclined to think that the rule in Dearle v Hall has on the whole produced at least as much injustice as it has prevented".23 The proposals of the Law

18 Lloyds and Scottish Finance Ltd v Williamson [1965]1 W.L.R. 404, 410. See also Bowstead &

Reynolds on Agency para.S-127 fn.38.

19(1828) 3 Russ. 1.

20The requirement that the later assignee be without notice of the earlier assignment, which is the so~called second limb of the rule in Dearle v Hall, was not in fact part of the decision in

that case and was a refinement added by later cases. For a good historical account of the development of the rule see John de Lacy, "Reflections on the Ambit of the Rule in Dearle v

Hall and the Priority of Personal Property Assignments," (1999) 28 Anglo~American Law

Review 87, 197.

21See below, para.5-36 above.

22See discussion para.2-24 et seq. on what amounts to constructive notice.

23Ward v Duncombe [1893] A.C. 369 at 393. See also F. Oditah, Legal Aspects of Receivables Financing, (London: Sweet & Maxwell, 1990) pp.140 et seq; G. McCormack, "Secured Credit under English and American Law" (2004) 244--245; Beale, Bridge, Gullifer and Lomnicka, The Law of Personal Property Security 13-10,

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V FIXED A:-ID FLOATING CHARGES; SOME PROBLEMS OF PRIORITY

Commission for registration of all assignments of receivables,24 would have replaced the rule in Dearle v Hall with a much more rational system of priority based on date of registration, in relation to receivables financing.

The rule does not apply at all in relation to the assignment of registered shares in a company, since the company can neither enter a notice of assignment in its register of members" nor validly accept such a notice,26 and the same applies to an assignment of dematerialised ("uncertificated") securities registered electronically in the CREST system27; nor does the rule apply to a contest between the holder of a floating charge and a subsequent fixed chargee or assignee'' or to the assignment of debt which by the terms of the contract creating it is non-assignable, for the debtor is then under no obligation to recognise a notice of assignment. 29 Further, the rule does not apply to a negotiable instrument, so if the holder of a bill of exchange assigns the underlying debt to A and then negotiates the bill to B, B has priority notwithstanding that A has given'1notice of assigrunent to the acceptor, for the latter is required to pay the cnrrent holder who presents the bill for payment, and no one else."'

Rule 2: a legal interest acquired for value and without notice overrides prior equitable interest

5-09 An equitable interest is overreached by a disposition of the legal title to a bona. fide purchaser for value without notice. The principle remains unaffected by the 1925 property legislation, but the registrability of most categories of security interest in one register or another makes it difficult tor a subsequent legal purchaser to claim that he took without notice. However, the concept of notice continues to give rise to difficulties, as is discussed above.31

14. Report No. 296. {Company Security Interests) Ch. 4.

z:; Companies Act 2006 sJ26, which provides that no notice of any trust, express, implied or constructive shall be entered on the register. The assignment of shares constitutes the assignor a trustee for' the assignee (Hardoon v Bdilios [1901] 1 A.C. liB. Hence the method by which a mortgagee perfects his title is by entry on the register in place of the mortgagor, a process which is a novation, not an assignment.,~ee above, para.3-14; below, para.6-26.

16 Soctetr? GCnCrale de Paris v Walker (lB85}.11 App. Cas. 20, per Earl of Selbourne at 30-31, con1irmillg that the ruie in Dearle v ilall does. not apply _to re~istered shares. See also

Macmillart !ne v Bishopsgate Investment Trust plc (No.3) (199:t] 1 W.L.R. 978,993.

17Uncerti1icated Securities Regulations 2001 reg.23(3)_, which prohibits an Operator of a system from entering on its register ·notice of any trust, express, implied or constru~tive. ~cfOre he has boon entered on the register a mortgagee or other transferee has a mere equttabJe mterest, and tf:Us contmues to be the case during the period between the time the transferor has been

rcinoved from the register and the ~me the transfe;ee is entered-?~ it, during, which time the transferor is a trustee for the transferee (Unceruflcated Secuntles Regulations2001, regs 31(2)(b), 31(4)).

?.s See below, para5--39, 211 See above, para.:>-39.

30 Indeed even if the holder of the bill assigns it while retaining the instrument, the debtor can ignore 'the notice of assignmenl, for his duty remains to the holder who presents the bill, whether the holder is the assignor or anyone else (Bence v Shearman [1898] 2 Ch, 582).

~~ para.2-23 et seq.

178

PRINCIPLES O:F PRIORITY AT COMMON LAW

The time when the subsequent purchaser is required to be without notice is not when he takes the legal title but when he makes his advance. This rule enables the holder of a later equitable interest who makes his advance without notice of the prior equitable interest to effect a tabula in naufragio by getting in the legal title,32 thereby securing priority even if by the time he takes the legal title he has acquired notice of the prior equitable right.l3 But it would seem that only a fixed equitable interest can be promoted in this way, and that the interest of the holder of a floating charge is too nebulous to enable him to jump aheed of a prior fixed charge by getting in the legal title after notice of the fixed charge. The tabula in naufragio is not available in the case of competing assignments of a debt. A statutory assignee, despite having the legal title, is postponed to a prior equitable assignee who gave notice first, for s.l36 of the Law of Property Act 1925 expressly provides that the statutory assignee is to take subject to equities, and this includes a prior equitable interest of which the debtor has been given notice34 However, a statutory assignee who collects payment without notice may be able to rely on his legal title. 35

Rule 3: a mortgagee may in certain conditions tack further advances for whicb he will rank in priority to a subsequent mortgagee

The common law attached great importance to the legal estate, so much so 5-10 that it provided two situations in which a legal mortgagee or a person having

the best right to under a mortgage could tack such. advances to his initial advance and rank in priority to a subsequent mortgagee even if the mortgage was not expressed to cover further advances and even if these were not made until after the execution or the second mortgage. The tii·st situation was where the further advances were made without notice of the second mortgage. Under the rule in Hopkinson vRolt,36 notice of the seeond mortgage

32Or having the best right to the legal title, as where he procures the mortgaged property to be conveyed to trustees on his behalf, jlfacmillan Inc v Bishopsgate Trust plc (No.3) [1995] 1 W.L.R. 978, lOO!.

33Taylor v Russell [1892J A.C. 244; Bailey v Barnes [1894] 1 Ch. 25. The rule applies also to a

mortgage of shares, where a creditor who takes a share certificate and executed transfer by way of equitable mortgage and makes his advance without notice of a prior equitable interest can obtain priority by registering the transfer (Dodds v llills (1865) 2 H. & M. 424; which Millett l in lvfaemiUan !ne v· Bishopsgate Jnvestmen.r Tnnt plc (No.3) [1995] 1 W.L.R. 978 oonsidere-d (at 1004) to he still good law despite attacks made upon it).

34E. Pfoiffer WeinkellereiWeineinkauf Gmbii & Co v AJ'buthnot Factors Ltd [1988] 1\V.L.R, 150; Compaq Computers Ltd v Abercorrt Group Ltd[199lJ B.C.C. 484. See also Hdrding Corp Ltd v

Royal Bank of Canada [1980] WWR. 149. This view is isstrongly criticised by F. Oditah, Legal Aspect& of Receivables Financing (London: Sweet & Maxwell, 1990), para.6.15, and see also G. Tolhurst, The AJ.signment of Contractual Rights (Oxford: Hart Publishing, 2006) Ch.S~ who disagrees with the premis underlying these decisions that the difference between a statutory and an equitable assignment is procedural and not substantive.

35 A point left open by Phillips l in E Pfeiffor WeinkellereiWeineinkauf -Gmb H & Co v

Arbuthnot Factor.s Ltd [1988] 1 W:L.R. 150 at 163 but co-nceded in Compaq Computers Ltd v Abercorn Group Ltd [1991] B. C. C. 484 at 500.

"(1861) 9 Cas. 514.

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V FIXED AND FLOATING CHARGES: SOME PROBLEMS OF PRIORITY

terminated the right to tack further advances, a rule considered necessary to avoid the first mortgagee having a monopoly over the debtor's financing. The rule was applied even if the prior legal mortgagee was under an obligation to make the further advances. The second situation was the tabula in naufragio, where if a legal mortgage was granted to A followed by a mortgage to B and then a third mortgage to C, who made his advance without notice of B's mortgage, C could purchase ~s interest and use the legal estate he had thereby acquired to tack his own advance in priority to B, who was thus squeezed out. In addition to these cases, any mortgagee, legal or equitable, could tack further advances if the mortgage expressly covered such advances and the mortgagee, at the time of making them, had no notice of the subsequent mortgage. As will be seen, the tabula in naufragio in this context has been abolished by statute but the other form of tacking remains, albeit modified by statute.

!

Rule 4: priority rules may be varied by agreement

'I

5-11 The rights of a secured creditor may be subordinated or waived altogether by agreement with the party in whose favour the subordination or waiver is to be given. The priority effect of waivers and subordinations is discussed later in the present chapter.37

3. THE IMPACT OF LEGISLATION

5--12 The priority rules laid down at common law have been significantly affected by legislation, which either changed the rules or, through the operation of registration systems, provided a new system of perfection and greatly reduced the number of cases in which a person could claim to be without notice of a competing interest, as well as making notice irrelevant in some cases.

Statutory exceptions to the nemo dat rule

'

'·

5-13 The principle nemo dat quod non habet, to which, as we have seen, there were several exceptions at common law, has bee11 further qualified by legislation designed to protect innocent transferees for value and thereby facilitate the fre~ movement of goods in the stream of trade. Principal among these are dispositions by a mercantile agent," a seller or buyer in possession" and a

37See below, paras 5-53 et seq. As to wh~ther a subordination agreement creates a security interest, see above. paras l-79 et seq.

38Factors Act 1889 s.2.

39Factors Act 1889 ss.8, 9; Sale of Goods Act 1979 ss.24, 25. A disposition by a buyer holding under a conditional sale agreement falling within the Consumer Credit Act 1974 is excluded from the operation of s.8 of the Factors Act and s.25 of the Sale of Goods Act.

180

THE IMPACT OF LEGISLATION

hirer or buyer holding a motor vehicle under a hire-purchase or conditional

primary, first-in-time common law rule prevails so long as the registration is effected within the statutory 21-day period. In relation to other registers, the priority of interests registrable in other specialist registers is usually determined by the order of registration,<' not by the order of creation. This

40Hire-~urchase Act 1964 s.27-30. For detailed analyses of the common law and statutory exceptwns to the nemo dat rule, particularly in the context of sale transactions, seeR. Goode,

Commercial Lmv 3rd edn (London: Lexis Nexis, 2004) Ch.16; Benjamin's Sale of Goods 7th edn (London: Sweet & Maxwell, 2008), Ch.7.

41See above, para.2-29.

42See below, para.5-22.

43Law of Property Act 1925 s.198.

44Land Registration Act 2002 s.48(1).

45s.32. This gives protection under s.29(2)(a)(i).

46Subject to certain rules designed to give protection for a limited period to a party who registers a priority notice or makes a pre-completion search prior to registration of the security interest. See below, paras 5-30, 5-31.

181

V FIXED AND FLOATING CHARGES: SOME PROBLEMS OF PRIORITY

is true, for example, of mortgages of registered land,47 ship mortgages,48 aircraft mortgages;' agurcultural charges50 and bills of sale.51 It seems also to be true for successive charges over unregistered land, though the position remains a little more unclear. Under s.97 of the Law of Property Act 1925 the priority of puisne mortgages" is determined by the order of registration, whereas s.4{5) of the Land Charges Act 1972 renders such a puisne mortgage void against a subsequent purchaser (including a subsequent mortgagee) unless this is registered before completion of the purchase. The combined effect of these two sections appears to be that a registered puisne mortgage takes priority over a an earlier unregistered interest, and also over later (registered) ones.53 However, the position in relation to an earlier mortgage which is registered after the creation of, but not the registration of, a second mortgage is unclear. On the better view, the second mortgage has priority over the first: the registration of !he first is irrelevant as it is already void vis-a-vis the second. This means that s.97 takes effect subject to s.4(5)/4 and that registration is a perfectiorl requirement, not a priority point. To this extent registration under the· Land Charges Act possesses the .same characteristic as registration un'tler the Companies Act. H owevet, the requirements of the two systems for the preservation of priority are different. Under s.860 of the Companies Act all that the first chargee has to do is to register within the 21 days allowed55; under s.4{5) of the Land Charges Act he has to register before completion of the subsequent mortgage. Registration of a mortgage of a patent is largely but not entirely determinative of priority, in that a registered mortgagee will only have priority over an earlier unregistered mortgage if he does not have notice of it."' The same is true of mortgages of trade marks, 57 and probably mortgages of registered designs." ·

47 Land Registration Act 2002 s.4K Thls is subject to the qualification that an equitable charge may be protected by notice in the register (d2(3)).

48 Merchant Shipping Act 1995 s.16(1) and Sch.l, para.8(1}.

49 Mortgaging of Aircraft Order 1972, SI 1972/1268, art.14. Art.5 allows for the registration of

a priority notice, but the intended mortgage must be completed and registered within the ensuing 14 days. In aU these cases notic~.of the prior interest is irrelevant.

so AgricultutaJ Charges Act 1928 s.8(2). ·· ~'

51Bills of Sale Act 1878 s. 10.

52i,e. mortgages not protected by deposlt of the title deeds.

53Megarry and \Vade, Law of Real Property 6th edn {L:mdon: Sweet & Maxwell, 2000) paras

19~221.

!M M~garry and Wade. Law of Real Pmperty paras 19-225 et seq,

~Tlie effect is that -the subsequent chargee who makes a search before expiry of the 21. days allOWed to the first chargee for registration and who finds nothing on the register w1H be postponed to the first chargee if the first c}largee registers within the ::n.:.ctay period, even if by

then the second chargee has registel'OO,

S6 Patents Act 1977 s.33(1). It is not clear whether this rule applies where the second mortgage is also not registered, see Beale, Bridge, Gullifer and Lomnicka, The Law of Personal Property Security 13-94. The contrary interpretation woul.d be consistent with the nemo dat prinClple,

57 Trade Marks Act 1994 s.25(3},

sg See Registered Designs Act 1949 s.19(4) and the dJscussion in Bea[e. Bridge, Gullifer and Lomnicka, The Law of Personal Property Security 13.104.

182 ..

~-·--~------------------

THE IMPACT OF LEGISLATION

Statutory changes to the rules on tacking

Section 94 of the Law of Properly Act modified the existing rules for tacking 5-17 of further advances, and, except in this regard, the right to tack was abolished

by s.94(3). The exact scope of s.94(3) is a matter of some debate. It does not apply to registered land; it covers mortgages of unregistered land and also, it would seem, mortgages of personalty. 59 The term 'tack' is not defined in s.94: it clearly includes the tacking of further advances by a mortgagee,'0 but whether it includes the tabula in naufragio rule61 is less clear.62 The context of s.94 appears to indicate that the abolition only relates to the tacking of future advance (an alternative scheme for which is established by s.94(l)) while ss.94{2) and (4) indicate that the section only relates to mortgages of land. Millet! J. in Macmillan Inc v Bishopsgate Trust ( No.3 ) 63 stated that the tabula in naufragio doctrine had been abolished 'in relation to mortgages': this statement was made in the conteKt of a discussion of mortgages of land, and he later made it clear that the doctrine still operates in relation to mortgages of shares.64 Further, in an earlier flrst instance case, it was held that the doctrine had only been abolished as regarded priority between mortgagees and that it still applied where one of the equitable interests was not a mortgage, but arose from rights under a specifically enforceable contract65 This uncertainty is very unfortunate: there are good policy reasons for abolishing the doctrine, so that the holder of a legal interest only has priority over an equitable interest if he had no notice of it at the time he took his legal interest.66

(!) Mortgages of unregistered land

Where a mortgage67 of unregistered land is taken to secure further advancesthe typical case is a mortgage to secure a bank current account-~s.94{1) of the Law of Property Act 1925 gives the mortgagee the right to make further

advances ranking in priority to subsequent mortgages, legal or equitable, in 5-18 three cases:

59 Even this is far from clear, see Beale, Bridge, GulUfer and Lomnicka, The Law of Personal Property Security 13-118. Tacking in relation w mortgages of registered land is governed by s.49 of the Land Registration Act 2002, which introduces significant changes.

60See above para5.l0.

61Above para.5,09.

61 See Beale, Bridge, Gullifer and Lomnicka, The Law of Personal Property Security 13.122~13.123 and R. Calnan, j'Reforming Priority Law'' (2006) 1 JJ.B.F.L. 4.

" [199511 W.LR. 978, 1002.

44 Since mortgages of shares are not required to be registered, it is possible for a second equitable mongagee to acquire bis mortgage without constructive notice of the fnst equitable mortgage. f>j McCartlry & Stone Ltd v Julian S Hodge & Co Ltdfl97l] 2 AJl E.R 973, 98L See also Paget's

Law of &mktng (ed. M Hapgood} 13ib edn (London: Butterworths Law, 2006) 32.36. <:6 R. Calnan, "Reforming Priority Law" (2006) 1 II.B.F.L 4.

ii7 Tbi.<; includes a charge (Law of Property Act 1925 s.205(1)(xvj)}.

183

VFIXED AND FLOATING CHARGES: SOME PROBLEMS OF PRIORITY

(a)where an arrangement has been made to that effect with the subsequent mortgagees;

(b)where the prior mortgagee had no notice of such subsequent mortgage at the time he made the further advance; and

(c)where the mortgage imposes on him an obligation to make such further advances.

Hence a mortgagee who makes a further advance without notice of the subsequent mortgage is now given priority even if he is only an equitable mortgagee and the mortgage is not expressed to secure further advances. But unless the prior mortgagee makes the further advance pursuant to an arrangement with the subsequent mortgagee or alternatively is committed by the terms of the prior mortgage~to make the further advance, the prior mortgagee will be postponed t9 'lhe subsequent mortgagee if he makes the further advance after notice o(the second mortgage. If the legislation had stopped at this point, banks opersting current accounts would have been in considerable difficulty, for registration of the second mortgage constitutes actual notice,"' and it is obviously impracticable for the bank to make a search every time the mortgagor draws on his account and before honouring such drawing, To deal with this, s.94(2) of the Law of Property Act provides that a mortgagee is not deemed to have notice of a mortgage merely by reason that it was registered as a land charge if it was not so registered at the time when the original mortgage was created or when the last search (if any) by the prior mortgagee was made, whichever last happened. The correct sequence for the prior mortgagee to adopt is: take mortgage, search, make initial advance. To make a search and then lake the mortgage and make the initial advance is not safe, for the second mortgagee might register between the time of the search and the time of the first mortgage.

5-19 It should be borne in mind that s.94 only gives protection in relation to further advances. Thus if the mortgagor grants a mortgage to M! to secure a current account and before drawing on the account mortgages the same property to M2, who registers his mortgage, and MI then makes his initial advance, then under the rule in Hopkinson v Ro/t69 he will be postponed to

M2 as regards that advance evert'i( not having actual notice of the second mortgag~, and even if committed t6 make the advance,'" though as to any

further advances he would enjoy the protection of s.94. The moral for M! is to search before making his initial advance,··

The first mortgagee should be careful to ensure that he reserves in his mo~tgage instrument the right to exclude the rule in Clayton's Case,71 e.g. by

ruling off the debtor's accoUnt upon receiving notice of a subsequent

tiB Law of Property Act 1925 s.198. For the effect of registration under s.860 of the Companies Act 2006, see below, para.S-22.

69 (1861) 9 H.LC. 5!4, See above, para.5-l0.

?V On which point the rule surely deserves reconsideration by the House of Lords.

71 Devaynesv Noble, Clayton's Case {1816) 1 Mer. 572.

!84

THE IMPACT OF LEGISLATION

----- ,

mortgage and crediting later payments to a new account. If the creditor fails to do this, sucb payments will, under the rule in Clayton's Case, be applied in reduction of the earlier indebtedness first, thus reducing that part of the debt as regards which the mortgagee has priority over the later mortgage. For example, M! takes a charge to secure a current account and has advanced £1,000 when he receives notice of a second charge in favour of M2. Subsequently the debtor pays £800 into his account, and later draws £800 out of it. The debit balance is £1,000, the figure at which it stood when M! received notice of M2's charge, but. the effect of Clayton's Case is to reduce the pre-notice indebtedness to M! to £200, leaving the post-notice advance of £800 postponed to M2's charge. A line across the account is all that is necessary to prevent this unfortunate occurrence, It was the failure of Barclays Bank to draw that line which led to their having to meet almost the whole of the plaintiff's claim in the Siebe Gorman Case, 72 despite having won the argument on the legal issues raised in that case,

(2) Mortgages of registered land

Section 94 of the Law of Property Act 1925 does not apply to mortgages of 5-20 registered land,73 and the position is governed by s.49 Land Registration Act

2002,74 which provides that the proprietor of a registered charge may only make a further advance ranking in priority to a subsequent charge if:

(a)he has not received from the subsequent chargee notice of the creation of the subsequent charge;

(b)the further advance is made pursuant to an obligatiorf which was entered in the register at the time of creation of the subsequent charge;

(c)the parties to the prior charge have agreed a maximum amount for which the charge is security and such agreement was entered in the ret,>ister at the time of creation of the subsequent charge; or

(d)there is agreement with the subsequent chargee.

Limb (c) represents a marked departure from the rule in Hopkinson v Roll in that it applies even if the further advance is made after notice of the subsequent charge and is entirely voluntary. Effectively this enables the first chargee to obtain a monopoly of the debtor's non-purchase-money fmancing75 by the simple device of specifying a maximum sum well beyond

72 Siebe Gorman & Co Ltd J.' Barclays Bank Ltd[l979]2 Lloyd'& Rep. 142.

7) Law of Property Act 1925 s..94(4).

74Sch,l3,

75A purchase-money security interest will usually enjoy favoured treatment. See below,

pafa.5~2.

!85

V FIXED AND FLOATING CHARGES: SOME PROBLEMS OF PRIORITY

any amount that the chargee is likely to lend or the asset given in security is likely to be worth. This seems a retrograde step.76

(3) Mortgages of personalty

5-21 Where the mortgage relates to pure personalty, such as goods or receivables, the mortgagee's right to tack further advances is governed by s.94(1) of the Law of Property Act 1925,77 but the provisions of s.94(2) as to the effect of registration as a land charge do not, of course, apply, and notice of the subsequent mortgage, whether actual of constructive,78 puts an end to the right to tack except where the further advance is made by arrangement with the subsequent mortgagee or the first mortgagee is obliged to make it by the terms of the mortgage.

(4) Registration under the Companies Act 2006

. "t

5-22 Whilst s.94 of the Law of Property Act 1925 prevents registration of a land charge from constituting notice for the purpose of tacking, no such provision has been enacted in relation to the effect of registration in the Companies Registry of a charge (whether on land or on other assets) of a charge given by a company, pursuant to s.860 of the Companies Act 1985. If such registration were to constitute notice to a prior mortgagee under a mortgage securing a current account it would destroy the efficacy of s.94(1 ), a conclusion any court would be reluctant to reach. There is in fact nothing in the Companies Act itself which makes registration equivalent to notice; such an effect, where it occurs at all, results from the equitable doctrine of constructive notice which (inter alia) fixes a party with notice of facts which he would have discovered if he had riiade usu.al and proper enquiries. Registration in a public register may constitute constructive notice of matters recorded in the register,79 but as has been submitted earlier80 this is the case only where the circumstances are such that the party in question could reasonably have been expected to search. Having regard to the impracticability of searches by banks prior to each drawing by the

mortgagor, and to the express provisions of s.94 of the Law of Property Act designed ~pecifically to deal with the problem, it seems clear that registration

76 I(has received criticism from other quarters. See, for example, Emmet and Fan·and on Title,

BlUletin No. 21, July 2002, p.6 and Paget's Law of Banking 32.33. The Law Commission ackiwwledged these reservations itt its paper which led to the 2002 Act, but stressed that this method was only one option, whicq. might be useful in some circumstances, such as where a development was to be financed by a series of agreed advances. The method is used in some other countries, including Sweden (see Law Commission, Land Registration for the Twenty-First Century (Report 271, 2001) para.7.35).

77See above para.S-18

78For the effect of registration under s.860 of the Companies Act2006, see above para.2-23 et seq.

79See, for example, Re De Leeuw [1922] 3 Ch. 540.

80See above, para.2-29.

186

THE IMPACT OF LEGISLATION

under s.860 of the Companies Act does not constitute notice sufficient to put an end to the prior mortgagee's right to tack. 81

4. PRIORITY OF COMPETING SECURITY INTERESTS

·r now turn to examine the particular case of competition among fixed 5-23 security interests. This would be much easier if, as under art.9 of the Uriiform Commercial Code, it was possible to take the .requisite steps for perfection in

any order, with priority going back to the time of filing of a financing statement covering an existing or intended security interest, and filing was always a priority point, not merely a perfection requirement. Unhappily the lack of a coherent system of perfection and priority means that the outcome of a priority dispute concerriing registrable interests depends very largely on the particular type of registration system that is applicable, coupled, if the charge is unregistered, with the overriding effect of s.874 of the Companies Act 2006 where the charge is given by a company and falls within the list set out in s.860(7) and the company later goes into liquidation or administration. The rules discussed in section 2 above also come into play. The number of variables thus involved makes it difficult to set out a simple set of rules. The right to tack further advances ranking in priority has already been discussed82 and we do not need to return to it.

We should note as a preliminary that ss.860 and 874 trump all other perfection requirements in the sense that where a security interest registrable under s.860 is also registrable in a specialist register, any priority given by registration in the latter will be displaced if the security interest is not also registered under s.860 within the time allowed. A charge regisirable under that section and not registered within 21 days or such later time as is permitted by the court is void against a liquidator or administrator and creditors. 83- For this purpose "creditors" means secured creditors, execution creditors and lienees and creditors in the winding-up or administration 84; it does not include unsecured creditors of a company that is not in winding-up or administration. A charge not registered within the 21-day period may be registered later with leave of the court,85 which is almost invariably given unless the company is already in liquidation or administration or the process for putting it into liquidation or administration has been initiated. But the order granting leave is invariably expressed to be subject to a proviso that it is without prejudice to the rights of intervening secured creditors, so that the penalty for late registration is subordination to a security interest created

81 See Bea1e, Bridge, Gullifer and Lomnicka, The Law of Personal Property Security 13.115.

82See above, paras 5-10, 5-17.

83S.874 Companies Act 2006.

84Re Ashpurton Estates Ltd [1983] Ch. 110, 123.

85Co?lpanies Act 2006 s.873. The order does not itself perfect the unregistered security interest, whtch must be registered in conformity with the order.

187

V FIXED AND FLOATING CHARGES: SOME PROBLEMS OF PRIORITY

after the expiry of the 21 days allowed for registration of the earlier interest.86 The proviso does not, however, protect intervening unsecured creditors.87

There are five main priority rules.

First rule: where there are no additional perfection requirements,88 priority is determined by the order of creation, subject to any applicable exceptions to the nemo dat rule89

5--24 There are various cases in which attachment alone suffices to perfect a security interest without more. 90 In such case priority is determined by the rules set our in section 2 above.

Second rule: normal priority rules''apply to registrable security interests which are unperfected by registration (

5--25 Where there are statutory provisiflns which require registration as perf~ction, the question arises whether an unperfected security interest is void or valid as against the holder of another unperfected security interest. There are three possible views: either the first interest is void as against the second, but the second is valid against the first, so that in terms of priority the second wins. This was the view preferred in previous editions of this book, and is based on the argument that registration (or lack of it) affects as subsequent encumbrancer but has no effect on a prior encumbrancer.91 This view is also based on the argument that, since s.874, which renders an unregistered charge void against creditors does not state that their charges must have been registered, this must mean that it is not so limited and includes chargees with unregistered charges. However s.874 also does not state that it is limited to secured creditors and yet we know this to be the case. A second view is that each charge is void against each other, so that neither has priority until an application is made to the court to register out of time.92 A third view is that each charge is valid against the other, so that the normal priority rules apply93

86If the litter interest is created within \P.~ 21-day period it is not protected by the proviso

(Watson); Duff, M organ & Vermont (Holdihgs) Ltd[1974] 1 W:L.R. 450). This makes sense in policy -terms because the later chargee, by taking his security in reliance on a clear search before expiry of the time allowed for registration of the earlier charge, is taking a chance and qannot claim to have been misled by the absence of 'a registration which had not become due. For criticism of the 21 day invisibility period, see above para.2-22.

87.Re MIG Trust Ltd [1933] Ch. 542, per Romer L.J. at 570.

88Here 'perfection' is used in the wid~<sense to include the giving of public notice in order to gain priority even when it is not required .. by statute in order for the security interest to be enforceable in the debtor's insolvency. Se~ para.2-l6 above.

89See above para.5-04 et seq.

90See above, para.2-18.

91This argument has some support from the old American case of United States v New Odeans Railroad (1870) 79 U.S. 362, 365.

92Pennington, Company Law 8th edn (London: Lexis Nexis UK, 2001) 635.

93These are the rules set out in ·section 2 above.

188

,.,.

~?;....

l···.

•' ~

94Law Conunission Report No. 296 (2005) 3.152.

95See Rice v Rice (1854) 2 Drew 73, per Sir R.T. Kindersley V.C. at 77-78.

96 Mortgage Corp Ltd v Nationwide Credit Corp Ltd [1994] Ch. 49.

97Land Registration Act 2002 s.93.

98Again, 'perfection' is used in the wide sense mentioned above fn.87 and para.2-16.

99However, this will not help the unregistered chargee if the charge is of a kind which is also registrable in a specialist register the rules of which give a registered charge priority over an

unregistered charge and the subsequent chargee effects registration first. roo See below, paras 5-29 et seq.

189

V FIXED AND FLOATING CHARGES: SOME PROBLEMS OF PRIORITY

systems priority is determined by the order of registration. 101 Further, other means of giving public notice can operate as a priority point. Thus under the rule in Dearle v Hall the priority of successive assigmnents of a chose in action is governed by the order in which notice of assignment is given to the debtor. 102 Where a security interest involves the possession of the security holder, for example, a pledge, one might say that the giving of public notice was a priority point. However, in fact, priority between a pledge and an interest perfected by registration in the Companies Register is detemined by the normal priority rules. If the other interest is legal, the nemo dat rule applies. If the other interest is equitable, either the pledge predates the other interest, in which case the nemo dat rule applies, or if the registered interest predates the pledge, the pledgee, who has a legal interest, takes free of the equitable interest as a legal purchaser for value without notice, 103 or, if the pledgee has actual or constructi"e notice of the registered interest, 104 it will

5-29 temporary protection for his prospective security interest by one or both of two protective devices, the priorl'ly notice and the pre-completion search.

(1) Priority notice

The priority notice procedure allows the intending secured creditor to obtain 5-30 priority for his prospective security interest by registering a priority notice and then taking and perfecting his security interest within a specified period (renewable for successive periods before each period has expired), priority then dating back, under some rules, to the time of registration of the (latest) priority notice105 and, under others, to the time of creation of the security

interest. 106

,.

101See abOve para.S-16 and below paras·-j_;,29-5.31.

102Subject· to the qualification that the secbnd assignee had no notice of the prior assignment.

There ·are various exceptions to the rule in Dearle v Hall, see above, para.5-08.

103 ...

104 Constructive notice would depend on whether he would be expected to search the register,

';which is a matter of some dispute, see Beale, Bridge, Gullifer and Lomnicka, The Law of

·~Personal Property Security 13.06.

105''As in the case of ship mortgages;;(Merchant Shipping Act 1995 Sch.l para.B and Merchant Shipping (Registration of Ships) Regulations 1993, SI 1993/3138, reg.59 and aircraft mortgages (Mortgaging of Aircraft Qrder 1972, SI 1972/971, art.l4(2)(iii). For aircraft mortgages the priority is lost unless the mortgage is made and registered within 14 days. There is no time limit for ship mortgages, although the priority notice will lapse after thirty days if not renewed. Merchant Shipping (Registration of Ships) Regulations 1993, SI

1993/3138, reg.59(6) and (7).

106As in the case of land charge over unregistered land (Land Charges Act 1972 s.ll). But the charge must be taken and registered within 30 days.

190

V FIXED AND FLOATING CHARGES: SOME PROBLEMS OF PRIORITY

does not affect SCl 's right to look to asset A, 113 either on its own or at the same time as resorting to asset B, but it protects SC2 by allowing him to resort to asset B to the extent to which he has been deprived of his own security by reason of SC1 's recourse to asset A.

Effect of priorities on enforcement by a secured creditor

5--34 If mortgages are granted in succession to SP1 and SP2 and there are no factors to displace SP 1's priority, he may realise his security, take what is due to him and then account for any surplus to SP2, who will in turn deduct what is due to him and hand over any remaining surplus to the mortgagor. Where there are three or more incumbrancers it would seem that SP1 's duty is to

hand over the whole of any surplus to SP2, leaving it to him to take what is due to him and pass any bala11c~ to SP3, rather than SP1 being responsible

for distribution among all intirested parties in order of priority, 114

However, it is not only the' senior mortgagee who can enforce. Sp2 may realise his security, but if he is'~selling free from SP1's mortgage he must

obtain SP1's consent and must apply the proceeds in discharge of that mortgage before taking what is due to him. If, however, SP2 is selling subject to SP1's mortgage SP1 is not affected by the sale and his consent is not required. His mortgage continues to attach to the property and SP2 is not accountable to him for any part of the proceeds, but must take what is due to him and then pass any surplus to the next mortgagee, if any, or, if none, to the debtor. Where SPl has himself become entitled to enforce his mortgage and chooses to do so after SP2 has initiated steps to enforce his own mortgage, SP1 is entitled to take control in priority to SP2.

5. COMPETITION BETWEEN A FIXED CONSENSUAL SECURITY

INTEREST AND OTHER TYPES OF INTEREST

Secured creditor versus outright buyer

5-35 A legal. mortgagee has priority .:pver a subsequent buyer to whom the mortgagor wrongfully sells the charged asset. 115 An equitable mortgagee or

11~· Manks v Whiteley [1911] 2 Ch. 448, per Parker J. at 466; Chase Corporation (Australia) Pty

~;Ltd v North Sydney Brick and Tile Co Ltd (1994) A.C.S.R. 586, per Cohen J. at 1008-1009.

For a detailed discussion of the topic see the monograph by P.A.U. Ali, Marshalling of Securities (Oxford: Oxford University: Press, 1999).

114Re Thomson's Mortgage Trusts [1920] f',Ch.508; Fisher & Lightwood's Law of Mortgage 12th edn (London: Butterworths Law, 2006) 'para.30.47. See also s.l05 Law of Property Act 1925, which obliges a mortgagee or receiver appointed by him to account to 'the person entitled to the mortgaged property' on sale or other realisation of the mortgaged assets.

115There are certain exceptions, such as estoppel, which are not discussed here. S.24 of the Sale of Goods Act 1979 does not apply here, because s.62(4) of that Act prevents the provisions of the Act applying to a mOrtgage or other security. However, there are good policy reasons

192

COMPETITION BETWEEN A FIXED CONSENSUAL SECURITY INTEREST

chargee is postponed to a subsequent buyer who acquires the legal title in good faith and without notice of the prior equitable mortgage or charge. The extent to which registration constitutes notice has been discussed earlier. 116

There is one oddity. While a charge not duly registered under s.860 of the Companies Act is void as against a subsequent chargee, the section says nothing about a subsequent buyer. Accordingly failure to register does not invalidate the unregistered charge against the buyer, and priorities will be determined by the common law rules. A legal mortgagee will retain its priority under the first-in-time rule; an equitable mortgagee or chargee will be postponed to a buyer who takes the legal title for value and without notice but prevails against any other kind of buyer, for example, the purchaser of charged debts who has not given notice to the debtor, if the unregistered chargee has given notice.

Secured creditor versus holder of non-consensual right or interest

A consensual security interest may come into conflict with a right or interest 5-36 created by law. If the non-consensual right is purely personal or is ad rem

rather than in rem,117 the security interest usually prevails. There are, however, statutory exceptions.. A landlord is entitled to distrain for rent on any goods on the demised premises, whether or not the property of the tenant, though if distress is levied on goods the subject of a fixed charge the chargee may perhaps be able to procure their release by service of a notice under s.l of the Law of Distress Amendment Act 1908.118 A statutory right to arrest an aircraft for non-payment of airport dues has priority over a security interest in the aircraft. 119 ,,

Where the consensual security interest comes into conflict with a non- consensual right in rem, such an equitable tracing right, the principles governing priority between competing consensual interests apply, Suppose, for example, that B, in the possession of O's goods, wrongfully sells them on credit, and assigns the proceeds, in the shape of the debt due from the purchaser for the price, to M by way of mortgage under a statutory assignment in conformity with s.l36 of the Law of Property Act 1925. 0 asserts an equitable tracing claim to the debt as proceeds of its asset, 120 while M claims as mortgagee, In this situation M cannot simply rely on his legal title, even if he took without notice of O's equitable interest, because even a statutory assignee takes subject to equities, which for this purpose includes O's equitable

why this is unsatisfactory, see M. Bridge, "The Sale of Goods" (1997) 453; The Diamond Report para.l3.2.9.

11 6 See above, para.2-29.

117See above, para.l-17.

118See below, para.S-52.

11 9 See Channel Airways Ltd v City of Manchester [1974] 2 Lloyd's Rep. 456,per Forbes J. at 461.

120 See above, para.l-60.

193