Reforming the law of security—what is the state of play?

Reforming the law of security—what is the state of play?  

The LexisPSL Banking & Finance team attended the Secured Transactions Conference on the 6 November 2019 held at University College London. This News Analysis discusses some key points to emerge from the conference and next steps.

What was the purpose of the conference?

Academics, practitioners and industry representatives came together on 6 November 2019 to discuss the most recent version of the Secured Transactions Code (Code) at a conference organised by the Secured Transactions Law Reform Project and the City of London Law Society (CLLS).

The Code was initially drafted, along with a commentary, by the CLLS in 2016 and a revised version was circulated for discussion in September 2019 following comments from the market. The Code sets out a vision of a clearer and simpler system of taking security under English law that is easily comprehensible to everyone involved in giving and taking security, including those based overseas. It is hoped that this will enhance the UK's reputation as a place to do business globally.

The conference was split into four separate sessions. The first focused on participants’ comments on the Code. This was followed by a session looking in detail on the continuing relevance of the legal/equitable distinction. The third session looked at whether law and practice in relation to title-based financing needed to be reformed and the final session looked at possible next steps for secured transactions law reform.

What are the key changes envisaged by the Code?

Key points of departure from the existing law as envisaged in the current draft of the Code include:

  • mortgages, pledges, security assignments, charges and contractual liens are replaced by one type of security interest only, described in the Code as a charge 
  • the distinction between fixed and floating charges is abolished, though a distinction is drawn between current and fixed assets for the purposes of setting out a chargee’s rights following an unauthorised disposal of charged assets 
  • a registrable charge is not created until it has been registered (though contractual rights and obligations can still arise under the charge document)—the current ‘invisibility period’ in which later chargees are unaware that a charge has been created that may rank ahead is therefore removed

  • the requirement to register charges is extended from companies within the meaning of the Companies Act 2006 and LLPs, to partnerships, sole traders and companies incorporated by statute or created by Royal Charter

  • a priority notice may be delivered to Companies House to notify anyone looking at the register that the business intends to enter into a charge in the near future (the aim is to protect the chargee’s priority for the period between execution and registration) 
  • the priority rules are simplified so that priority of charges is determined by order of creation, unless priority is determined by registration in a particular asset registry or the parties agree otherwise—the priority advantage of legal over equitable security and in serving of notice in the case of intangibles, as well as the restrictions on tacking, are abolished

Should an unregistered charge be a charge?

The first session provided participants with an opportunity to comment generally on the revised draft of the Code. Much of the discussion centred around the proposal under the Code that a registrable charge is not created until it is actually registered at Companies House. This would be a departure from existing law in which registration is required for effectiveness against third parties rather than actual creation of the charge. The rationale for this is to improve visibility for subsequent chargees and provide clarity to the law.

Concerns were raised that a chargee whose charge had not been registered would find its purported charge ineffective as against a solvent debtor, though some participants commented that this situation did not commonly arise in practice. It was suggested that a way to address this issue may be for the charge to take effect as an ‘agreement to charge’ prior to registration—this would potentially provide the chargee with certain equitable remedies.

Another key issue raised on the Code was whether or not electronic bills of lading should be exempt from registration at Companies House and if so how the relevant interest could be notified to third parties. A suggestion was put forward that these should be exempt provided the interest was noted on the electronic bill of lading itself. However, progress on this issue is, it was felt, dependent on how the industry itself decides to deal with the move away from paper to electronic bills of lading.

The legal and equitable distinction—what does it add?

The second session focused on whether the distinction between legal and equitable security interests should be abolished in the new secured transactions regime.

The Code provides that the charge created first in time takes priority (whether legal or equitable), unless otherwise agreed between the parties or unless priority is to be dictated by registration at an asset register. It therefore does away with the current priority advantage of having a legal interest. However, the Code currently does retain the distinction between legal and equitable interests for security created under the Code, listing out those that constitute legal interests, as the distinction will still be relevant for priority disputes that lie outside the ambit of the Code, for example in relation to liens or outright proprietary interests such as ownership or leases.

The question, therefore, is whether the legal/ equitable distinction is the best way to resolve priority disputes with interests that arise outside the ambit of the Code.

It was noted that following the reform of their laws on security, the Canadian court decided that a registered interest under their code should be treated as a legal interest for priority disputes outside its ambit. Including a statement to this effect was suggested as an option, as was setting out when interests created under the Code should be considered legal and when equitable in the context of disputes involving non-Code interests. It was felt that the broader the scope of the code, the fewer problems that would be likely to arise.

Should title-based financing be reformed?

The third session looked at whether there would be any merit in reforming title-based financing (eg leases and hire-purchase agreements). Key issues with the current law include:

  • buyers and others dealing with the finance taker, eg the lessees or hirer, are generally bound by the proprietary interests of the finance provider, eg the lessor, and have no easy way to check whether what they buy is free from liabilities that would bind them—the private registers available are not necessarily comprehensive or reliable

  • finance providers can lose their proprietary interests in certain circumstances, eg the extent of their interest in insurance proceeds following destruction of the asset is not clear

It was proposed that a central register of title-based financing interests, with loss of priority for unregistered interests, may address the current issues. A representative from the Finance Leasing Association attended and expressed doubt as to whether there was any appetite for change in the market. The difficulty of finding a foolproof identifier for certain types of assets was seen as another obstacle.

What are the next steps for the secured transactions law reform project?

The final session focused on how best to take the project forward. Additional comments were invited from conference participants and will be taken into consideration when putting together the next draft and updating the accompanying commentary. A revised draft will be made publicly available in due course.

Various areas of the Code as currently drafted need further consideration. One key issue is that certain aspects of the Code, for example the abolition of the concept of floating charges, would have significant implications for insolvency law (for example sections relating to avoidance of floating charges and the prescribed part). It was also felt that a conflicts of laws section would be helpful given that one aim of the reforms is to facilitate cross-border transactions. 

Ensuring industry bodies are up to speed on the proposals would be helpful at this stage and it is intended that this be progressed at the same time as the redrafting. 

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About the author:

Miranda is a solicitor specialising in leveraged and acquisition finance. She trained at Hogan Lovells International LLP and qualified into the international banking and finance team. During her time at Hogan Lovells she worked on a variety of domestic and cross-border transactions, acting for both borrowers and lenders. She also experienced secondments to Barclays Bank PLC and Kaupthing Bank hf.