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

11 ATTACHMENT AND PERFECTION OF A SECURITY INTEREST

The Law Commission's initial recommendation that a security interest registrable in a specialist register180 should not be registrable under s.395 of the Companies Act181 was changed in relation to charges over personal property in the final report. The consultation revealed the strong view that the costs of double registration were considered worthwhile for the peace of mind it brought, given that some interests were not registered in the specialist registers, and that it was convenient to have all the information about a company's charges in one place. 182 Statutory rules governing the priority of such interests were to apply in place of the 'first to file' rule. 183 The same applied to charges over unregistered land and floating charges over registered land. However, it was proposed that fixed charges over registered land did not have to be registered twice, and that the information about charges registered at the Land Registry should be forwarded to the Company Security Register and made avaiable with other information about company charges. 184

The Law Commssion's pro.posals in its final report were limited to

traditional types of security185 and did not include quasi-security interests,

-

since proposals to include the l11tter in the scheme had met with a great deal of dissent. Despite this, the pr0posals in the final report were thought by some to be controversiaF86 and it now seems unlikely that the proposals will be the subject of legislation in the near future. The Government issued a consultation document in July 2005 and has not yet made a final decision on the matter. Howeve1; no reforms were included in the Companies Act 2006, which re-enacted the provisions in the Companies Act 1985 without significant change, although the Secretary of State has very limited power to make small changes. 187

1so See above para.2-30.

181Consultative Report No.l76 (2004), Company.Security Interests, paras 3.309, 3.322, 3.333,

3.342.

1s2 Report 296 (2005), Company Security Interests, para.3.39-3.41. 1s~ ibid. para.3.235.

18'~ -ibid. para.3.38. The Companies {\et 2006 contains a power in s.893 enabling the Secretary of

State to make provision for 'information sharing' arrangements between specialist registers and the Companies House register, :,and consequentially for charges registered in such specialist registers not to be registrable at Companies House. This power may be used in relation to charges over land in connection with electronic convenyancing.

185Although some outright assignments of receivables were also included.

186See, for example, the comments of the Financial Law Committee of the City of London Law Society (August 31, 2005).

187s.894 Companies Act 2006.

94

Ill

Attachment, Perfe,etion and Effocts of

Fixed Security in Non-Documentary

Receivables

6.Legal Impediments to the Creation of Security over a

1. INTRODUCTION

Intangible property is today the most valuable object of security for the ~1 financier, and pure intangibles1 possess several advantages over tangible

assets. They are not susceptible to physical loss, damage or deterioration; they can be stored on and transferred by computer and turned over in huge volumes without constraints of size or physical delivery requirements; and they may be notionally shifted from one country to another at the press of a button. This does not mean that they are free from risk. Intellectual property rights may be attacked as invalid or lose their value because of superior competing products; debtors may become insolvent; and supposed debtors may assert against a mortgagee or chargee defences based on nonperformance or defective performance by the mortgagor or chargor or rights of set-off in respect of cross-claims against the mortgagor or chargor.2 But the ease with which intangibles may be given in security makes them an ideal form of collateral.

95

lll ATTACHMEKT, PERFECTI0:-1 AND EFFECTS OF FIXED SECURITY

Intangibles are also distinctive in that, depending on their nature, they may be mortgaged in up to three different ways: by assignment, by novation, and by negotiation 3

The particular form of intangible examined in the present chapter is the account receivable (abbreviated to "receivable"), by which is meant the right to payment of a sum of money, whether presently or in the future, for goods supplied, services rendered or facilities made available, being a right not embedied in a negotiable instrument.4 The discussion is concerned with fixed security interests, 5 Floating charges, and the particular problems of distinguishing a fixed charge of receivables from a floating charge, are analysed in Ch.IV Priority issues are the subject of Ch.V The special problems arising in connection with security interests in investment securities, and particularly in investments securities held indirectly with an intermediary, are examined in Ch. VL

3-02 Receivables financing cannot'be viewed in isolation but must be seen in the context of a life cycle of assets. Money is invested in raw materials which are made up into the finished product, becoming stock in trade. The stock is sold, producing receivables. The recel!vables crystallise into cash which is reinvested in new raw materials. Security may be taken over an asset at any stage in its life cvcl.,..,frorn chrysalis to butterfly-and since, as we have seen,6 security in a~ asset carries through to products resulting from commingling of the proceeds, it not uncommonly happens that one party lays claim to a receivable as original security-i.e. security in the form in which he bargained for it at the outset-whilst another claims security rights over it as the product or proceeds of another asset featuring earlier in the cycle, For example, a manufacturer sells goods to a distributor, reserving title until payment but authorising the distributor to resell the goods provided that he accounts for the proceeds-the typical Romalpa clause. The distributor has previously arranged a line of credit with its bank, secured by a charge on its book debts. When. the goods are resold by the distributor on 28-day credit, the resulting receivable is claimed by the l;>ank as original security and by the manufacturer as the traceable pro~'ceds of goods to which it had reserved

··········· -- ··------------ """"" -

~See below, paras 3~03 et seq. as to a;~s.ignment and novation.

In other words, debts. But "receivables" is a convenient term, fir.stly, because it makes it clear

that the perspective is that of the cnktitor, not the debtor, and secondly, because it. ~voids confusion with book debts, whkh constitute a narrower category. See also the defimtton of

'receivables' in reg.2(3} of the draft Regulations_included in the Law Commission Report 1\o. 296 on Company Security Interests (2005). For :i romprehens.lve treatment of the subject, see

INTRODUCTION

title.l This type of problem will be discussed in a later chapter when discussing some typical priority problems.

Bnt first, some preliminary remarks about characteristics of security over receivables.

2. CHARACTERISATION AND FORMS OF SECURITY

Mortgage .by assignment and mortgage by novation

It is necessary to draw a clear distinction between a mortgage by assignment 3-03 and a mortgage by novation, A mortgage by assignment does not change the identity of the contracting parties; the mortgagor retains his contractual relationship with the account debtor, 8 and the account rerruuns in the mortgagor's name. The assignment merely entitles the assignee to payment in

place of the mortgagor upon giving notice of the assignment to the account debtor. Accordingly an assignment does not in principle require the consent of the account debtor. By contrast a mortgage by novation entails a change of parties through a transfer of funds which are to be held by the mortgagee as a segregated fund, separate from the mortgagee's own moneys, to which the mortgagee may resort in the event of default but must otherwise hold on trust for the mortgagor9 and return to him if the debt for which the fund is security is discharged from other sources. 10 The provision of such cash co11ateral11 is an everyday occurrence, for example, to provide margin deposits to a broker or cash cover to a bank by its customer for an anticipated liability to be incurred by the bank to a third party on the customer's behalf. So in contrast to an assignment, which preserves the original debt and results in the mortgagee taking over whatever claim the assignor had against the debtor, a novation replaces an existing debt in which the creditor was the mortgagor with a new debt which is owed not to the mortgagee in his own right, not as assignee. 12 Novation produces a change of parties and requires

7 On the present state of the authorities, it is unlikely that the manufacturer will have a valid claim to the proceeds of sale, unless he has registered his interest as a charge, See above para. 1-31.

_;; The account debtor is the debtor of the person assigning or charging the debt by way of security< The assignor is, of course, himself a debtor to the assignee. To avoid confusion the term "debtor" wiU be used to refer to the account debtor, his creditor as the mortgagof' or intending mortgagor and the latter's creditor or intended creditor 8$ the mortgagee or intended mortgagee,

9The mortgagee is not, of course, a trustee to the extent that he holds for an interest of his own, but he ls a trustee to the extent of the mortgagor's equHy of re-demption.

10It is thus to be distinguished from an outright funds transfer by way of payment, which is by far the more common type of funds transfer, where the transferee becomes outright owner of the claim on its bank

u "Cash" here refers not to physical notes or coin but, typically, to the chose in action represented by a daim on a bank.

12 It follows that a mere charge, which creates no new debt, cannot be created by novation.

Ill ATTACHMENT, PERFECTION AND EFFECTS OF FIXED SECURITY

the consent of all parties involved.D In the straightforward case where mortgagor and mortgagee bank with same bank, all that is involved is an inhouse transfer in the books of the bank, so that there is a novation solely by change of creditor. In the more complex case where the mortgagor and mortgagee hold their accounts with different banks the novation is not direct but takes place through the books of a higher-tier bank with whom the banks of both parties hold their accounts and transfer funds by an in-house transfer. 14 In this case there is a change of both creditor and debtor; the debtor's claim against its bank as paying bank is replaced pro tanto by the creditor's claim against its bank as the transferee bank. The same principle applies where the funds provided as cash collateral come not from the debtor directly but from a !bird party at the debtor's direction, including a third party buying goods from the debtor and paying them into the creditor's account. 15

Both methods of mortgage, &ssignment and novation, allow of tracing. 16 The difference between them 'inay, however, be significant in that as assignee the mortgagee takes subject to, equities, including any rights of set-off the debtor may have against the mi'Jrtgagor, whereas as recipient of a new right by way of novation the mortgagee is not concerned with equities available to the debtor against the assignor, only with those available against the mortgagee himself, e.g. a right of set-off against the mortgagee's credit balance, and then only if the debtor is not on notice tbat its creditor holds the credit balance as mortgagee. 17 The rest of this chapter is devoted to security transfers by assignment except where otherwise stated.

Security distinguished from purchase

3-04 It is necessary at the outset to distinguish a loan on the security of receivables from a purchase of receivables. A transaction described by the parties purchase and sale may be characterised as a secured loan either because the

13The same novation technique is utilised in relation to shares, whether held directly from the issuer (in which case the mortgagee replaces the mortgagor on the share register) or indirectly

through a securities account with a b_ank or other securities intermediary, in which case there will be a book-entry transfer in the b'O.qks.of the intermediary if common to the parties 01~ if not, in:'the books of a common higher-tier intermediary. See further below, para.6-02.

14If the· parties' banks themselves hold their accounts with different higher-tier banks, it is

necessary to go further up the chain until one rea_ches a common bank, which in the case of the clearing banks is the Bank of England.

~~~For an example of such a fact situation, see Palmer v Carey [1926] A.C. 703. See above, "J_para.l-26.

16-'See above, para.l-60; below, paql..3-36.

17Thus where the mortgage is effected by transfer of funds from the mortgagor's bank account

to an account in the name of the mortgagee the bank may exercise a. right of set-off in respect of moneys due from the mortgagee onanother account so -long as it is not on notice that the mortgagee is a mortgagee and not the beneficial owner of the account. But if it is on notice the bank cannot, it is thought, exercise a right of set-off even for the amount of the mortgagor's indebtedness in respect of which the mortgagee has a right of recourse to the credit balance, for this would erode the mortgagor's equity of redemption if it were to discharge its indebtedness from other sources. See further above, para.l-69; below.

CHARACTERISATION AND FORMS OF SECURITY

document evidencing the transaction is a sham in that it does not represent the true intention of the parties or because, though it is genuine, its provisions viewed as a whole show that, contrary to the description given by the parties, its legal effect is that of a mortgage or charge. 18 A loan on security postulates a repayment obligation and a right to redeem the security by repayment. A purchase involves an outright transfer, in which the transferor has no duty to repay and no right to redeem. In practice, the distinction is not always so clear cut. The following deserve particular mention.

(I) Sale with recourse

The transferor of receivables (who is referred to hereafter as tbe assignor, to 3-05 distinguish him from the account debtor) may dispose of them by way of sale

but guarantee payment by the debtors and, by way of convenient implementation of his guarantee, furnish an instalment note, or series of bills of exchange, covering the amount of his recourse liability. In this type of transaction, there is an exchange of money for money, so that in terms of cash flow and economic effect it is virtually indistinguishable from a mortgage of receivables. Yet in law the character of the transaction as a sale is not altered by the giving of the guarantee, for the assignor's liability is not to repay an advance but to pay a sum in discharge of a recourse obligation. 19 Provided that the transaction is genuine and not a sham,20 the courts will uphold it as a sale, even if the parties use commercial language which to the legal mind would suggest a loan on security. 21

(2) Outright transfer of debt with creditor's personal obligation to ;epay excess of proceeds over amount of debt

Again, an agreement by which a debtor assigns to his creditor a debt 3-06 exceeding the amount he owes the creditor, the latter agreeing to repay any

excess he receives, is not a security agreement, for the debtor has parted with the debt due to him unconditionally and with no right of redemption."

18Re Curtain Dream plc [1990] B.C.L.C. 925; Re Welsh Development Agency v Export Finance Co Ltd [1992] B.C.L.C. 148 (where the transaction was upheld as producing its intended legal effect). See generally H. Beale, M. Bridge, L. Gullifer and E. Lomnicka, The Law of Personal Property Security (Oxford: Oxford University Press, 2007) Ch.2.

19Olds Discount Co Ltd v John Playfair Ltd [1938]1 All E.R. 275; Chow Yoong Hong v Choong Fah Rubber Manufactory [1962] A.C. 209; Lloyds & Scottish Finance Ltd v Cyril Lord Carpet Sales Ltd [1982] B.C.L.C. 609.

20There appears to be no reported case in which a purported sale of receivables has been struck down as a disguised loan on security, but the cases on chattel mortgages disguised as outright sales would be equally in point here. See, for example, Polsky vS. & A. Services [1951]1 All E.R. 185, affirmed [1951] 1 All E.R. 1062; North Central Wagon Finance Co Ltd v Brailsford

[1962]1 All E.R. 502. For an analysis of the authorities, seeR. M. Goode, Hire-Purchase Law and Practice 2nd edn (London: Butterworths, 1970), Chs 4 and 5.

21Lloyds & Scottish Finance Ltd v Cyril Lord Carpet Sales Ltd, above.

22See above, para.3-04.

n Mathew v Blackmore (1857) l H. & N. 762; De Vigier v Inland Revenue Commissioners [1964]

2 All E.R. 907; Levett v Batclays .Bank plc [19.95] 2 All E.R. 615; Chitty on Contracts

para.39~228.

14.·Re Curtain Dream plc [1990] B.C,LC. 925.

2'"\See generally H. Beale, M. Bridge, L. Gullifer and E: Lomnicka, The Law of Personal Property

:<security (2007} 5.56~5.69. There 4re international standard-term master agreements for repos, such as the Master Agreement of TBMA and IS!'viA. See further below, paras 6-17 and 6-18.

Ut The- selllbuy-back produces effects similar to the classic repo but difiers from it in instead of a sale back at the original purchase price plus a charge or interest the resale is at a forward price which is higher jn order ro cover what would otherwise ha~t-e been interest There are also other differences which need not be discussed here" See generally M. Choudhry. The Repo Handbook, (Oxford: Butterworth~Hememann, 2002) pp.99 et seq. See further below, para.6-17.

;;1 Beconwood Securities Pt;'' Ltd v Australia and New Zealand Banking Group Ltd [2008]

FCA594.

by Financial Reporting Standard 5 which requires accounts to reflect the 'substance' of the transaction. However, for the purpose of value added tax there is no distinction between a sale of receivables and a mortgage of receivables; both are exempt supplies within item 1 of Group

5 of the 9th Schedule to the Value Added Tax Ac-t 1994,

31There are, however, exceptions, For example, a company cannot be affected by notice of a trust or mortgage of its shares, so that to obtain priority against other incumbrancers and purchasers the secured creditor need<;: to be registered as the holder of the shares. Since this requires a transfer, an equitable chargee who becomes the registered holder is necessarily

converted Jnto a legal mortgagee, See below para.6-23.

:u It may well be that the provision of such remedies means that the charge is actually an equitable mortgage, see J. Armour and A. Waiters, "Fundjng Liquidation: a functional view" (2006) 122 L,Q,R, 295, 303. However, this makes very litHe difference in practice, see H. Beale, M. Bridg\"; L GuUifer and E. Lomnicka, "The Lmv of Personal Property 0'ecurit/' {2007)

4.20-4.33.

Ill ATTACHMENT, PERFECTION AND EFFECTS OF FIXED SECURITY

Existing and future debts

3--11 Security may be given over existing debts, future debts or both. The difference between existing and future debts is legally material in that a mortgage of the latter can take effect only in equity, whereas a present debt can be assigned under s.l36 of the Law of Property Act 1925 so as to take effect at law. However, the distinction between a legal and an equitable assignment has little practical impact, beyond the fact that a statutory assignee can sue in his own name33 whereas an equitable assignee may be required to join the assignor.34 A sum growing due under an existing contract is regarded in law as a present debt, even though the right to payment has not yet matured, e.g. because this is dependent on performance of the work which is to generate the payment obligation.35

3--12 In the first two editions of this l!>ook Professor Goode argued that the giving of security over receivables necessarily involved three parties, the debtor, the creditor and the creditor's assignee or other encumbrancer and that it was conceptually impossible for the debtor to be given a security interest over his own obligation to his creditor, e.g. for a bank to take security over its own customer's credit balance. The reason was that as between creditor and debtor a debt is not a species of property, merely an obligation, and since the creditor purporting to take the security interest cannot sue himself, appoint a receiver to collect from himself or sell his own obligation the so-called security interest is in reality a contractual set-off. That view, which divided the legal profession, was adopted by Millet! J. in Re Charge Card Services

and by the Court of Appeal in Re Bank of Credit and Commerce International SA (No.8),37 but when the latter decision was appealed to the House of Lords, Lord Hoffmann opined that there was no conceptual reason why a bank should not be able to take a charge over its own customer's credit balance, which a charge like any other except that it was enforceable only by book-entry38 Lord Hoffmann's statement, though obviously of great

33Law of Property Act 1925 s.136(1).

34A reqUirement which was frequently ignored in practice. Non~joinder of the assignor was not a ground for dismissing the action (R.S.C. Ord,l5, r.6(1)). The effect of the Civil Procedure Rules 1998 is that the assignee may bring.proceedings in his own name and the assignor may be added as a party if this is desirable to resolve the issues in dispute (CPR, Pt 19, r.2). The

\irequirement of joinder is seen as a rule of practice, which will not be insisted upon where

·there is no need: Sim Swee Jqo Shipping Sdn Bhd v Shirlstar Container Transport Ltd (unreported) February 17, 1994; Raifftisen Zentralbank 6sterr~ich AG v Five Star Trading

LLC[2001] 1 Q.B. 825; [2001] EWCA C,iv 68 [60]. For a view that the difference between a legal and equitable assignment is substantive rather than procedural, see G. Tolhurst, The Assignment of Contractual Rights (Oxford: Hart Publishing, 2006) Ch.S.

35G. & T. Earle Ltd v Hemsworth R.D.C. (1928) 140 L.T. 69.

36[1987] Ch. 150.

37[1996] Ch. 245.

38[1998] A.C. 214 at 226-228.

102

CHARACTERISATION AND FORMS OF SECURITY

persuasive value, was obiter, so that the point remains open. It is also unclear whether Lord Hoffmann's reasoning can apply to an equitable mortgage39

Professor Goode has addressed elsewhere40 both the conceptual problems of charge-backs and the policy issues which deserved consideration but appear never to have been argued.41 But the force of business practice cannot be denied. Lord Hoffmann himself drew attention to legislation in Hong Kong and Singapore giving statutory effect to charge-backs. There was in fact a good example at home in the shape of s.215(2)(a) of the Insolvency Act 1986, which empowers the court, v,:hen making a declaration of wrongful trading under s.214 of the Act, to direct that the defendant's liability be charged on any debt or obligation due to him from the company. Article 9 of the American Uniform Commercial Code provides for perfection of a security interest in a deposit account by control,42 and states that a secured party has control of a deposit account if (inter alia) it is the bank with which the deposit account is maintained.43 Finally, art.4 of the EC Directive on financial collateral arrangements44 requires Member States to ensure that on the occurrence of an enforcement event cash collateral may be realised by setting off the amount against or applying it in discharge of the relevant financial obligations.45 This provision has now been enacted as reg.l7 of the Financial Collateral Arrangements (No.2) Regulations 2003. This provides that a collateral taker can exercise a right of appropriation of collateral without applying to the court, but only if there is a power to do so in the security agreement.46 The provision of cash collateral to banks and brokers is commonplace. Accordingly conceptual problems such as the blurring of the distinction between property and obligation, and policy problems such as the fact that the only method of distinguishing a charge-back from a contractual set-off is by the label given to the transaction by the parties, must yield to business practice and legislative developments designed to acconllnodate it.

39See discussion in Beale, Bridge, Gullifer and Lomnicka, The Law of Personal Property Security 4.28. It is therefore advisable for a charge~back to be drafted as a mere charge, without the provisions as to enforcement referred to in para.3-10 above, which would, in any

event, be unecessary since the charge can be enforced by book entry, Re BCCI (No.B) [1998]

A.C. 214 at 226-227.

4°Commercial Law in the Next Millennium (the 1997 Hamlyn Lectures), pp.69-7L-

41Indeed, Lord Hoffmann expressly stated (at 228) that there was no objection of public policy.

42§9-312(b)(1).

43§9-104(a)(I).

44Directive 2002/47 dated June 6, 2002.

45Similarly, UCC § 8-106 provides for a securities entitlement to be given in security to the securities intermediary with whom the securities account is maintained and art.1(2)(b) of the 2002 Hague Convention on the Law Applicable to Certain Rights in respect of Securities held with an Intermediary expressly covers a disposition in favour of the account holder's intermediary. See also the draft UNIDROIT Convention on Substantive Rules Regarding Intermediated Securities, Art.lO (1)(2)(a) (grant of an interest in intermediated securities to the relevant intermediary) and Art.30 (l)(a)(ii) (collateral taker's right of appropriation).

46Although the power does not need to be express, it is clearly safer to include such a power in the documentation. The Regulation only applies where the security interest created is a legal or equitable mortgage (and does not appear to include a charge). This appears to be one of the rare situations in which the distinction between a charge and a mortgage is important, and if it is wished to exercise a power of appropriation it would be wise to provide expfessly that a mortgage is created.

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Ill ATTACHMENT, PERFECTION AND EFFECTS OF FIXED SECURITY

3. ATTACHMENT OF SECURITY INTEREST IN RECEIVABLES

Mortgage

3--13 As stated above a mortgage of receivables is effected either by assignment or by novation. An assignment may be a statutory assignment taking effect at law or an equitable assignment. The difference between the two is of little practical significance, since the normal rule giving priority to a subsequent purchaser of a legal title in good faith and without notice of a prior equitable does not apply to successive dealings in receivables, which are governed by the rule in Dearle v Ha/1.47 Of more importance is the fact that where the receivable is a book debt it is registrable and registration displaces the rule in Dearle v Hall as regards a competing post-registration assignment,48 whereas dealings in a receivable which is'not a book debt are governed by the rule.

3-14 To constitute a statutory assignment, so as to vest the receivable in the assignee at law and enable him to sue solely in his own name, the assignment must be effected in accordance with the requirements of s.l36 of the Law of Property Act 1925. The assignment itself must be in writing under the hand of the assignor, it must be absolute and not by way of charge,49 it must relate to the whole of the debt50 and it must be notified to the debtor in writing. 51 As mentioned above, 52 only present debts can be assigned by statutory assignment. An assignment which fails to meet any of these conditions takes effect in equity only. A statutory assignment is not possible where the account debtor or other counterparty is not obliged, and may not even be entitled, to

5°Forste'r v Baker [1910] 2 K.B. 636; Re·s,teel Wing Co Ltd [1921] l Ch. 349.

51The nOtice of the assignment is not required to contain any explicit direction to the debtor to pay th'e assignee. He is expected to infer this from the fact that the debt has bec:ome vested in the assignee. All that is required for a valid nd!ice is one which tells the debtor that the

assignment has been made, which identifies thedebt and which sufficiently identifies the

'iassignee (Van Lynn Developments Ltd v Pelias Construction Co Ltd [1969] 1 Q.B. 607, 615. !:1There is much to be said for a rule along the lines of ss.9-318(3) of the Uniform Commercial ·Code authorising the debtor to make payment to the assignor unless the notice to him requires payment to the assignee. Art.8(l)(b) of the 1988 UNIDROIT Convention on International Factoring is to the same effect. It is by .l)o means uncommon for the purchaser of a receivable, e.g. a factor, to agree with his assignor'that despite notice of the assignment to the debtor the assignor will continue to collect, as agent of the assignee, until otherwise directed. It is important that the debtor should be left in no doubt as to whom payment is to be made, and notice of the assignment, though sufficient under s.l36 of the Law of Property Act, is not

necessarily informative enough to achieve its commercial purpose. 52 Para.3-11.

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ATTACHMENT OF SECURITY INTERESTS IN RECEIVABLES

receive notice of the assignment-for example, (a) on a transfer of shares,53 which to take effect in law must be done by novation, i.e. substitution of the transferee for the transferor in the books of the issuer; or (b) where the claim is embodied in a negotiable instrument, in which case the acceptor's duty is to pay the holder on presentation, regardless of notice of assignment from someone else54 ; or (c) where the contract to which the assignment relates prohibits assignment.

where the intending mortgagor undertakes to account to the intended mortgagee for sums paid by the debtor to the intending mortgagor. 58 Such an undertaking is common in a master invoice discounting agreement, where a

53 See below, para. 5-0S.

54See below para.5-08.

55If the assignor becomes bankrupt, his trustee in bankruptcy stands in his shoes. It follows that the trustee cannot secure priority over the assignee by being the first to give notice to the debtor (Re Wallis [1902]1 K.B. 719: Re Anderson [1911]1 K.B. 896).

56See above, paras 2-12 et seq.

57William Brandt's Son & Co v Dunlop Rubber Co [1905] A.C. 454.

58GE. Crane Sales Pty Ltd v Commissioner of Taxation (1971) 126 C.L.R. 177, 183. This case equates a declaration of trust with an assignment, but this seems wrong, as pointed out by Waller L.J. in Barbados Trust Co Ltd v Bank of Zambia [2007] EWCA Civ. 148 [43], since an equitable assignment in writing can be converted into a statutory assignment, and this is not true of a declaration of trust although see Rix L.J. in the same case at [111], who says that he

105

to make payment to the intended mortgagee. But this by itself is not enough. 60 In order for the direction to be effective it must either be given pursuant to prior agreement between the intending mortgagor and the intended mortgagee61 or be communicated to the latter afterwards. 62 A direction to the debtor which has neither been previously arranged with the intended mortgagee nor subsequently communicated to him is merely a revocable authority to pay, even if it is expressed to be irrevocable.63 Moreover, the direction itself must be couched in such language as to convey to the debtor that he is required to pay the intended mortgagee not merely as a matter of convenience to the intending mortgagor but because the right to receive payment has become vested in the mortgagee. If the direction does not make this clear, the debtor will be entitled to assume that the intending mortgagor is still entitled to receive payment.64

recognises that a declaration of trust ~~frights of suit under a contract is akin to an equitable assignment of those rights. Despite this,;-the view of Wailer L.J. appears to be settled law. For further 'discussion see G. Tolhurst, "Prohibitions on Assignment and Declarations of Trust" [2007]' L.M.C.L.Q. 278, 285. See also M. Smith, The Law of Assignment (London: Sweet &

Maxwell, 2001) Ch.6. Smith's view is that an equit!!ble assignment by contract takes place by a constructive trust (para.6.12) and this is contraSted with a transfer by way of express trust

(paras 6.33-6.45).

59\;nternational Factors Ltd v Rodriguez [1979] 1 Q.B. 351. However, in that case, and in most agreements, there is an agreement;,. to assign the relevant debts.

60 Bell v London & North Western Ry Co (1852) 15 Beav. 248; CmTan v Newpark Cinemas Ltd

61As in Re Kent & Sussex Sawmills Ltd [1947] Ch. 177; and Winn v Burgess, The Times, July 8,

1986.

62Curran v Newpark Cinemas Ltd, above; Alexander v Steinhardt, Walker & Co [1903] 2 K.B.

208.

63ibid.

64James Talcott Ltd v John Lewis & Co Ltd [1940] 3 All E.R. 592.

106

creditor, either at law or in equity, a charge is a mere encumbrance.

Nevertheless, most of the effects of a mortgage apply to a charge. Notice of the charge to the debtor precludes him from making payment to the chargor, preserves the chargee's priority against subsequent incumbrancers and cuts off the debtor's right of set-off in respect of cross-claims arisingfrom future dealings with the chargor.66 The one major difference, in theory at least, relates to enforcement. A charge (otherwise than on land) is purely the creation of equity; it does not exist at common law, nor does it come within s.l36 of the Law of Property Act 1925 so as to be capable of conferring on the chargee a right of action solely in his own name against the debtor. Accordingly the chargor may need to be joined as a party to any proceedings by the chargee for recovery of the debt, and a chargee has no power of sale otherwise than under an order of the court.67 In practice a well-drawn charge over receivables will confer on the chargee all the powers it needs, including power to convert the charge into a mortgage, for which purpose the charge should incorporate a power of attorney to the chargee to execute an assignment in the name of the chargor.68 ,

Since a charge leaves ownership of the debt with the chargor it cannot be effected by novation. All that is required for attachment is an agreement for a charge.

4. PERFECTION OF SECURITY INTEREST IN RECEIVABLES

Hitherto we have been concerned with attachment of a security interest in 3-22 receivables, that is, its efficacy as between assignor and assignee. It is now necessary to see what steps have to be taken to make the security assignment enforceable against third parties. As discussed in Ch.2,69 the giving of public

65See above. para.3-03.

66See Business Computers Ltd v Anglo-African Leasing Ltd [1977] 2 All E.R. 741 and below, para.7-66.

67See above, para.1-51, fn.184.

68It is possible that the inclusion of such a power, together with the right to appoint a receiver, and for that receiver to have power to take possession of and sell the charged assets, means that the security interest is an equitable mortgage anyway, see fn.26 above.

69Above para.2-16 et seq.

107

Ill ATTACHMENT, PERFECT!Ol' AND EFFECTS OF FIXED SECURITY

notice of a security interest can be done by a number of different methods, and has a number of different consequences. The following discussion will consider both the methods and the consequences, some of which retate to the validity of the security interest in the debtor's insolvency, and some of which relate to the priority of the security interest over other incumbrancers and purchasers.

Perfection by registration under the Companies Act 2006

3-23 A charge on receivables is registrable under s.860 of the Companies Act 2006 if the receivables constitute book debts. No separate act is necessary to perfect a mortgage or charge of a receivables that is not a book debt.70

Several points arise.

·l

(!) The registration requiremerzt

3-24 Section 860 applies only to chai71!es created by the company, not to charges arising by operation of law71 Accordingly, a security interest in book debts which arises not by agreement but by virtue of an equitable tracing right- e.g. as the proceeds of a disposition of stock or equipment-is not registrable. The same applies wbere the agreement, though specifying a duty to account for receivables as proceeds, is merely spelling out rights which would in any event vest in the chargee in equity.72 The position is otherwise where it is apparent from the security instrument that the receivables resulting as proceeds of other security are to be regarded as the property of the chargor, but subject to a charge created by the instrument.

(2) What is a charge?

3-25 The term "charge" includes a mortgage." The registration requirement applies whether the mortgage is effected by assignment or by novation.

;o See above, para.2~21; below, para.3~4Q.__This statement is restrlcted to fixed security: floating

71 CapitafFinance Co Ltd v Stokes [1969} Ch. 261.

nIn relation to clauses covering the proceeds of goods sold on retention of title~ the position is riot clear. At first instance in Aluminium Industt~e Vaassen BV 11 Romalpa Aluminium Ltd

[1976] 1 WL.R, 676) 68~3, Mocatta I held that the interest of the sellers in the proceeds was

:not registrable, The question of registration was not argued in the Court of Appeal, and \?viocatta J.'s view was doubted in by Phillips J. in Tatung (UK) Ltd v Galex Telesure Ltd (1989}

5_--B.C.C. 325, 335~6. A concessioj'l to the opposite effect, however, was made by the floating chargee in Compaq Computers Ltd v Abercorn Group Ltd [1993] B.C.L.C. 602, 613, A trust recei pr by which pledged documents of title to goods are released by the pledgee to the pledgor to enable him to sell them as the pledgee's trustee-agent upon terms that the proceeds are to be held in trust for the pledgee does not constitute a charge over those proceeds as book debts, since these are vested in the pledgee in equity from the beginning as the proceeds of his original secunty (Re DaYid Ailester Ltdll922] 2 Ch. 211), see above para.2~!19 and fn.ll3.

73 Companies Act 2006 s.861(5). But it would seem that for the purposes of s.670 of the Companies Act 2006 "charge» bears its narrower meaning. See below, para.~23.

108

PERFECTION OF SECI.iRITY INTEREST IN RECEIVABLES

(3) What is a book debt?

A book debt is a debt arising in the course of a trader's business which is of 3-26 such of a kind that it would ordinarily be entered in a trader's books (or the modern equivalent of books),74 whether in fact so entered or not.75 It is generally considered that money deposited by a trader with his bank does not

give rise to a book debt, since although the banker is the trader's debtor the debt does not arise in the way of trade but is merely a consequence of the deposit of surplus funds. Certainly the general accounting view is that such deposits do not fall to be treated as book debts, and this view was adopted by Hoffmann J. in Re Brightlife Ltd,76 though in subsequent eases he has suggested that this is not always the case and is a matter on which banks should make up their own minds.77 Sums deposited as part of a company's trading activity, for example, as a dealer in the money market, might well be considered book debts. Debts embodied in securities issued on a market, do not, it is thought, constitute book debts, whether the securities are registered securities or bearer securities,78 but the position as regards declared dividends is unclear. For that reason it is common to register charges on shares even though these are not in themselves a registrable category. In the case of indirect holdings of securities by book-entry in the records of a securities intermediary, the securities entitlement is not a book debt as regards the securities themselves, nor does a declaration of dividend by the issuer give rise to a charge on book debt, because the company's indebtedness is owed to the registered shareholders, not to lower-tier intermediaries of their customers. But the position may be otherwise as regards dividends or other cash received by the securities intermediary, who thus becomes a debtor to his customer, so that if cash is included in a charge of the customeljs securities entitlement the charge could perhaps constitute a charge on a book debt.79 Interests in a money fund are not book debts, since these are proprietary in character and therefore not debts at al1.80

A liquidation creditor's entitlement to dividend, charged to a senior creditor under a turnover subordination," is not a book debt. In the first place, the book debt is that which produced the dividend, not the dividend itself. Secondly, a dividend entitlement is not a debt at all, for while the liquidator who declares a dividend has statutory duties to perform he is not

?4 e.g. computer records,

Collateral Arrangements (No.2) Regulations SI 2003/3226 reg.4, discussed below, para.6--39.

8t} Sec above, para.l-55. 81 See above, para.l-8L

109

lll ATTACHMENT, PERFECITON AND EFFFC1S OF FIXED SECI!RITY

a debtor in respect of a dividend declared by him and no action lies against him for payment of the dividend82

(4) Negotiable instruments

:l--27 The monetary obligation embodied in a negotiable instrument is a book debt, at any rate if the instrument is held by way of conditional payment of the underlying obligation.sJ However, tbe deposit of negotiable instruments given to secure payment of a book debt84 is exempt from registration," in order to avoid interfering with the concept of negotiability. Thus negotiable instruments taken from a debtor in respect of a book debt may be pledged by the creditor without attracting any registration requirement. As stated above, money obligations embodied in a negotiable bond i<>sue, though debts, would not appear to constitute bo.ok debts.

(

(5) The effect of registration

:l--28 Registration perfects tbe security and constitutes notice to tbose who could reasonably be expected to search, but not otherwise."

(6) The effect of.failure to register

:l--29 Failure to register a charge on book debts renders the charge void against a liquidator or administrator and creditors,87 by which is meant creditors in a winding up or administration and secured creditors,88 as opposed to unsecured creditors where no winding up or administration has occurred. Non-registration does not avoid the charge as against a next line purchaser of tbe debt, but if he acquires the legal title without notice of the unregistered charge be has priority under the normal priority rules.89

The effect of non-registration is exhausted if the debts are collected before anyone has acquired a locus standi to complain of non-registration, i.e. before winding up or administration or the grant of .specific security."' 'Wben

1>2 Spence/V Coleman [1901] 2 KB. 199, applying to 'A<inding up a similar rule enunciated in bankruptcy in Prout v Gugory (1889) 24 Q.B.D. 281 and now enshrined in s.325(2) of the

Insolvency Act 1986.

SJ Dawson v Isle, above.

M .In this context security means personal security in the shape of the payment obligations of the

sa i.e. secured creditors whose interests are created after that of the non~registering chargee. See further above, para.2-22; below, para.S-23.

tw This is subject to the application of the rule in Dearle v Hall. See below paraS·OB.

90l'tfercamile Bank of India Ltd v Chartered Banfc ofIndia. Australia and Chilla and Strr.mss & Co

(m liquidation) [1937] 1 All E,R, 231; Re Row Da/ Constructions Pty Ltd[t966J V.R. 249; NV

Slavenlmrg's Bank v Intercontinental lv'atural Resources Ltd[1980J 1 W.LR. 1076.

PERFECTION OF SECCR!IY INTEREST I!> RECEIVABLES

a charge becomes void under s.874 the money secured by it immediately becomes payable.'1

Registration of assignment of book debts by unincorporated trader

(1)to prevent him from making payment to the assignor. If he does so

despite the notice of assignment, he can be made to pay again, to the assignee98;

"Companies Act 2006 s.874(l).

92Which are excluded from the defmition of "personal chattels" in s.4 of the Bills of Sale Act 1878.

93i.e. under the procedure in the Bills of Sale Act 1878, not the Bills of Sale (1878) Amendment

Act 1882, which applies to security bills,

"Insolvency Act 1986 s.344(l){b). " Insolvency Act 1986 s.344(l)(a).

96See cases cited fnJ03, below, Registration could, howe>-er, constitute constructive notice to those expected to search the register., which might be re!evant to the operation of the second

limb of Dearle v llall (see below). Priority of other registered bills of sale is by date of registration (s.l 0 Bills of Sale Act I878).

91 That is. the debtor's debtor.

':B Brice v Bannister (l878) 3 Q.RD, 569.

Ill ATTACHMENT, PERFECTION AND EFFECTS OF FIXED SECURITY

(2)to stop new equities arising iu favour of the debtor99;

(3)to prevent modification of the agreement between assignor and debtor under which the debt arose«JO;

(4)to secure priority over another encumbrancer. Under the rule in Dearle v Hall, 101 a later encumbrancer taking without notice of the earlier assignment and giving notice to the debtor first would obtain priority; and

(5)to obtain the benefit of a statutory assignment, and thus the right to sue for the debt in the assignee's own name without joining the assignor. 102

It should be observed that registration of the assignment, assuming it to be registrable, does not dispense wit-h the need to give notice to the debtor, for he is not required to search a,tegister for encumbrances before settling the debt, lOl although registration does have the effect of preserving priority over subsequent assignees who are i:r<pected to search the register, under the sec.ond limb of Dearle v !Ia/1. 104 Giving notice to the debtor has no effecrt where the debtor or other obligor is not obliged to have regard to the notice, for example, where it relates to a non-assignable debt or to registered shares or negotiable instruments.105

Novation

3-32 As an alternative to assignment, a receivable may be mortgaged by novation, that is by transfer of the receivable into an account in the name of the mortgagee.106 This has the effect of givng public notice of the mortgagee's interest in the receivable, although registration is still required if the receivable is a book debt.

~9 Roxburghe v C.ox (1881) li Ch.D. 520. By contrast, defences arising out of the transaction giving rise to the debt (e.g. where the debt is for goods sold, that they are defective) are available regardless of the date of receipt of the notice of assignment, for the assignee cannot acquir~ greater contractual rights thail.·those possessed by his assignor.

too Brice v Bannister, above. In practic~ aii assignee usually finds it necessary to allow some leeway to the assignor in regard to modifications, particularly in the cat-.-e of a contract involving continuing performance, such as a -C,enstruction contract. Art 11:308 of the

, Principles of European Contract Law provides th<it a modification made without the consent ,1 of the assignee after notice of assignment does not bind the assignee "unless the modification f_is provjded for in the assignment agreement or is one which is made in good faith and is of a n-ature to which the assignee oouid not reasonably object" A construction contract is given

as an illustration in Comment E to artll:204 of the Principles. "' (!828) 3 Russ. l. See above, para.3~!3;.below, para.S.-08.

1

" Law of Property Acll925 s.l36(l).

JOJ Snyder's Ltd v FUrniture Finance Corp (1930) 66 D.L.R. 79; Re Royal Bank of Canada (1979)

94 D.L.R. (3d) 692.

104 See below para.5-08.

ws See further below, paras 3-39, 5-08 and 5-28.

106 See above, para.3-03.

ll2

PERFECTION OF SECURITY INTEREST IN RECEIVABLES

---

Attornment

If a third party receiving a fund as trustee of the debtor acknowledges the 3-33 creditor's interest and agrees that until that interest has been discharged the

third party will act in accordance with the instructions of the creditor, not the debtor, the creditor can enforce his interest against the third party.w' The effect of this attornment is to give the creditor control of the accountios and therefore gives a sort of public notice of the creditor's interest. Since this can only properly be done by agreement of the debtor the charge is to be treated as created. by the debtor, and differs from an ordinary charge only in that the third party's attornment produces the same effect as receipt of a notice of assignment, the third party in both cases becoming bound to respect the creditor's interest in the fund. However, the charge is probably not a registrable charge, since the third party is not merely a debtor but holds the

securities intermediary, a common method of setting up the control is by transfer of the required amount of cash or securities to a "pledge" or escrow account in the name of the debtor but under the control of a third party, such as an escrow agent.'""

5. RIGHTS ACQUIRED BY THE ASSIGNEE

Assignee takes subject to equities

The assignee of a receivable takes subject to equities, i.e. to ~11 defences 3-34 available by the debtor against the assignor and all rights of set-off open to

the debtor against the assignor in respect of claims arising prior to the debtor's receipt of notice of assignment. uo

'" G'iffm v Weatherby (!868) L.R. 3 Q.B. 753, 758.

!M The concept of control is an important featw;e of arts 8 and 9 of the Uniform Commercial

Code. See§§ 8~106, 9-104 to 9-107, where it constitutes automatic perfection, so that no flling is required, The nearest English law equivalent is attornment. Under English law, if tlte char~ is otherwise registrable it will have to be registered, However, control by a chargee of fmancrnl collateral has the ciTed that the charge ls not registrable, see paras 6--38---6-39.

109As to escrow balances in CREST account~ see below, paraJ>···26.

110Roxburghe v Cox (1881) !7 Ch.D 520; Re Plnto Leue & Nephews [1929] l Ch. 221; Law of Property Act 1925 s.l36{1). See further below, para.?-66, However, if the receivable is embodied in a docW!lent which provldes that·it is to be transferrable free from equities the court will give effect to this provision (Hdger Analytical Ltd v Rank Precision Industries Ltd

[!984) B.C.L.C.lOl).

!13