Part E Guarantees and Security, 27 Security—Characterization, Formalities, and Registration
- Regulation of banks — Security interest — Security issuer
Contractual Nature of Security
27.02 In general terms, it must be borne in mind that, so far as English law is concerned, the creation of security is of an essentially contractual character. It is important to retain sight of this fundamental feature, even though it is overlaid and obscured by numerous statutory provisions designed for the protection of creditors. The result is that security documents must be construed with a view to ascertaining the intention of the parties from the words which they have used. The security will thus extend to the class of assets agreed between the parties, as evidenced by the relevant document. The nature and extent of that class is to be ascertained by ordinary processes of contractual interpretation.
27.03 The contractual nature of security also means that the arrangement must be supported by consideration although, in practice, the point is often avoided by requiring that the security document should be executed as a deed.1
What is a Security Interest?
27.04 When should a particular arrangement be characterized as a security interest? This may seem to be a highly theoretical question, especially to the practising lawyer. Yet the nature (p. 564) of a transaction as a security interest or as a charge can be a matter of some moment in a variety of contexts. For example:
(a) as will be seen, a ‘charge’ created by a company requires registration under section 859A of the Companies Act 2006, and it will become void against creditors and insolvency officials if this requirement is not met. It thus becomes necessary to consider whether a particular arrangement amounts to a ‘charge’ for these purposes;
(b) an equity of redemption only arises in relation to any assets if they are subject to a charge. Thus, if X has transferred assets to Y for cash, X can reclaim the asset if the cash transfer was intended to be a secured loan, but not if the transaction was intended as an outright sale and purchase of the assets concerned. These statements may seem to be obvious but modern financing techniques have occasionally clouded the distinction between the two types of transaction. The distinction matters because, as noted above, the correct characterization of a transaction may affect the application of registration or other requirements.
(a) A executes a transfer of freehold property in favour of B. B immediately executes a lease of the property back to A, and grants him an option to repurchase the property in five years’ time. Is this a genuine sale and purchase transaction—in which case no security registration requirements can apply—or is it in reality a loan secured on the property, to which registration requirements would apply?
(b) A enters into an agreement with B under which A agrees to transfer securities to B to cover A’s mark-to-market exposure under a derivatives contract.2 This arrangement is plainly designed to cover B against potential losses in the event of a subsequent payment default by A. Nevertheless, the transfer of the securities is expressed to be unconditional, and B is free to use those securities in the course of its own business. In the event that the mark-to-market exposure is reduced or eliminated, B’s obligation is to return to A equivalent securities of the same, fungible class. Again, is the purported outright transfer genuine, or does the arrangement really amount to the creation of a security interest?
27.06 Obviously, the correct approach to these transactions is important to both parties, but especially to the side which has parted with his money and is relying on the legal efficacy of the arrangements.3 The English courts generally favour the certainty of transactions and—at least in the absence of fraud or some other form of evasion4—have shown themselves to be reluctant to recharacterize transactions. They have usually taken the view that parties should be able to structure their transactions in the manner selected by them in the confidence that their expectations will be met. Nevertheless, cases involving proprietary or security issues have an unpleasant habit of coming to the fore when one of the parties has become insolvent, with the result that the position of unsecured creditors or other third parties may be affected by the outcome.
(p. 565) 27.07 Even in such situations, however, it is fair to say that the English courts have been reluctant to recharacterize transactions so that they have the legal consequences of an unregistered security interest. By way of examples:
(a) In Re George Inglefield Ltd,5 a furniture dealer sold the benefit of hire purchase agreements to a finance company. Payment by the hirers was effectively guaranteed by the furniture, which accepted bills drawn on it by the financier for the discounted value of the receivables. Despite the personal liability of the dealer itself, the court found that the transaction was a genuine sale of the receivables; it was not a disguised loan and (unregistered) charge over the book debts. The decision was influenced by the fact that the dealer had no right to pay off the financier and to demand the re-transfer of the receivables.6 Nevertheless, whilst it is possible to sell receivables, it is equally possible to create security over them. Thus, the court must look to the overall language and effect of the documentation to determine the intention of the parties. Accordingly, where the documents included language such as ‘…as security for its obligations hereunder…’, ‘…such security…’ and similar expressions, the structure was found to be a charge rather than an outright sale, with the result that it was void for want of registration.7
(b) A transaction will not be recharacterized merely because the parties have structured it in a manner designed to avoid impediments standing in the way of the route which they may otherwise have originally intended. For example, in one case,8 financiers had intended to make a loan of £30,000 against a charge over rolling stock. However, it was then discovered that the proposed facility would result in a breach of the borrowing restrictions applicable under the private Act of Parliament which had incorporated the borrower. The transaction was accordingly structured as a ‘sale and leaseback’, so that the obligations of the company would not be ‘borrowings’ for the purposes of the statutory calculation. The rolling stock was transferred to the financiers, the company still received £30,000 and the payments under the lease were structured such that the financial return to the financiers was identical; the company had the right to repurchase the rolling stock for £1.00 at the end of the lease term. The economic effect of the transaction was thus effectively identical to the original (and abortive) secured loan. The company defaulted and, when sued on their personal guarantees, the directors argued that the underlying transaction was a sham. The court rejected (p. 566) this argument on the basis that there had been no attempt to disguise the true nature of the transaction. The fact that the arrangements could not lawfully be implemented as a secured loan did not necessarily prevent them from being implemented on an alternative basis.9
(c) There may be cases where a provision in the ‘small print’ of a contract creates a security interest where the parties have not really turned their minds to the matter. For example, in Smith (Administrator of Cosslett (Contractors) Ltd v Bridgend County Council,10 a standard form construction contract allowed the employer council, in the event of an insolvency of the contractor ‘…at any time [to] sell any of the constructional plant, temporary works and unused goods and materials and apply the proceeds of sale in or towards the satisfaction of any sums due or which may become due to [it] from the contractor under the contract…’. Although this was a remote clause in a standard contract, it was hard to see ‘…how a right to sell an asset belonging to a debtor and appropriate the proceeds in payment of a debt can be anything other than a charge…’.11 The security was construed as a floating charge, because it referred to classes of assets which would be turning over during the course of the contract (‘unused goods and materials’), and the language of the contract did not suggest a fixed charge even in the context of larger or more permanent items which might remain on site for the entire contract period.12
(d) In many collateral and security documents in use in the financial markets, provision is made for the ‘security’ to be provided by means of an outright transfer of bonds or other securities.13 There will be no equity of redemption in the normal sense—the collateral-taker will merely be obliged to return ‘equivalent’ securities at a later stage. It has recently been argued before the Federal Court of Australia in Beconwood Securities Pty Ltd v Australia and New Zealand Banking Group14 that such an arrangement involves a security interest. Unusually, the argument was not advanced by an unsecured creditor against the liquidator (as would be the normal case), but by the alleged provider of the security itself (although, as will become apparent, the court did not accept that status). The reason was that the transferee of the of the securities had become insolvent, and the transferor sought to argue that (i) the original transfer had been by way of security and (ii) upon payment of the monies owing to the transferee, the transferor would be entitled to the return of its securities by virtue of its equity of redemption, with the result that the body of unsecured creditors would have no claim on these assets. However, the assertion that the arrangements amounted to a security interest were simply not tenable. The original transfer of the securities had been effected under a securities lending agreement, where the outright transfer of title was a vital feature, since the transferee wished to use the securities as a means of settling its own delivery (p. 567) obligations in favour of third parties. This objective could not be met if the transferee’s status were effectively ‘downgraded’ from that of an owner to a mere chargee. The terminology and commercial objectives of the agreement, coupled with the obligation to redeliver equivalent (rather than identical) securities reinforced the view that no charge or security arrangement was intended.15
(e) The foregoing remarks dealt with the danger that a transaction intended by the parties to take effect as a particular structure (eg sale/purchase, sale/leaseback) might be recharacterized as a security arrangement and hence found to be void for want of registration or other formality. But—at least until recent times—recharacterization could occur even within a transaction that is intended to take effect as security, with results that can also be catastrophic for the financier. For example, the parties may have intended to create security over assets by way of fixed charge, under circumstances where no registration would be required but, if the charge were later recharacterized as a floating security, then it would be void for want of registration. The danger and consequences of such a recharacterization of security interests is, however, now of limited concern in this particular sphere, since nearly all forms of security created by an English company now require registration under Part 25 of the 2006 Act.16
The Scope and Extent of the Security
27.08 It is common to focus on the nature of security as it applies to particular assets, applicable registration requirements, and similar matters. But it is also sometimes necessary to focus on the precise extent of the security, ie what is the extent of the indebtedness which has the benefit of the security?
27.09 In the normal course, this will not cause great difficulty; a standard debenture or other security document will secure all monies from time to time owing by the customer.17 But there may be occasions when the security is limited to a particular facility. This will inevitably be the case with syndicated transactions,18 where the security package will cover only that particular facility and will not be intended to be available for separate and independent loans made available to the borrower on a bilateral basis by the individual syndicate members. But this necessary limitation of the security can cause practical difficulties. Unforeseen events may mean that the underlying facility has to be varied or extended, or additional funds have (p. 568) to be provided to assist the borrower with cash flow problems. The difficulty is: to what extent will the security continue to apply notwithstanding such variations or amendments?
27.10 Lawyers responsible for the preparation of such security documents are, of course, alive to these problems and—seeking to take advantage of the contractual and, hence, flexible nature of English security arrangements—will seek to provide that the security document extends to any additional or supplemental documentation executed between the parties with respect to the same facility. Yet provisions of this kind cannot operate without limit, since they have the potential to operate to the detriment of unsecured creditors in the event of a later insolvency.
27.11 A provision to the effect that the security document will also extend to the facility agreement ‘as from time to time varied, extended, amended or replaced’ will be sufficient—and hence the original security will continue to be effective—if the maturity date of the underlying facility is extended, or if the interest rate is increased by an amount appropriate to reflect the borrower’s deteriorating credit quality. It may even be that amendments to the facility agreement providing for a modest level of additional advances may also be covered, at least provided that these are made for purposes consistent with the original facility itself. But if the facility agreement is amended to provide extra funding for other purposes, then it is doubtful that the security would extend to the additional amounts so made available. Questions of degree will no doubt be involved in each case.
27.12 The difficulties involved in seeking to extend security documents to cover future amendments and variations have recently been illustrated in Public Trustee of Queensland v Octaviar Ltd.19 In that case, a guarantee and supporting charge was given by Octaviar to secure ‘…all monies, obligations and liabilities of any kind that are or may in the future become due, owing or payable, whether actually, contingently or prospectively by [Octaviar] in relation to any Transaction Document…’. The expression ‘Transaction Document’ referred to (i) an A$250 million facility agreement executed between the lender and Octaviar Castle Pty Ltd, a subsidiary of Octaviar and (ii) any document designated by the parties as a ‘Transaction Document’ for the purposes of the facility agreement. Octaviar had previously provided a guarantee (‘YVE guarantee’) to the same lender in respect of a facility granted to another of its subsidiaries, Young Village Estates (YVE), but no specific security had been granted in relation to the YVE guarantee. The facilities granted to Octaviar Castle and to YVE were clearly intended to be separate transactions, at least as at the date of their inception. However, no doubt in the light of a deteriorating financial situation, Octaviar and the other relevant parties executed an agreement to the effect that the YVE guarantee should also be regarded as a ‘Transaction Document’ and, hence, brought within the scope of the charge originally given by Octaviar in respect of the Octaviar Castle facility.
27.13 On the construction of the documentation, the Queensland Supreme Court held that it was open to the parties to agree that the YVE guarantee would be a ‘Transaction Document’, and there was no sufficient reason to limit this expression to documents associated with the Octaviar castle facility itself. However, the agreement designating the YVE guarantee as a Transaction Document had the effect of increasing the amount secured or creating a new security interest over the assets concerned. Given that the relevant agreement had not (p. 569) been filed, the attempt to extend the charge to cover the YVE guarantee was ineffective as against a liquidator or administrator of Octaviar. It should be said that this decision depended to a significant extent on the specific language of the registration provisions contained in the Australian Corporations Act, and that these differ in material respects from the corresponding English rules.20 It should also be said that the first instance decision was subsequently overturned by the Queensland Court of Appeal, on the basis that the relevant provisions of the legislation were directed to variations in the terms of the charge itself, and not at increases in liability which were imposed consistently with the original provisions of the charge.21 Nevertheless, this particular saga illustrates the need for great care in ensuring that the security document does indeed extend to all of the liabilities which are intended to be secured, and that a cautious drafting approach is required.
27.14 The prudent course for the lenders in such a case is to take a further security document to cover the increased or extended facility, thus placing the issue beyond doubt. The difficulty is that this may not always be practicable or may involve negotiations with holders of other security and who may have different interests.
27.15 On the whole, modern commercial law sets its face against excessive formal requirements, preferring instead to ascertain the intentions of the parties and to give effect to them where appropriate. It is for this reason that, for the most part, English law will enforce contracts which have been concluded orally, provided that the necessary evidence is available.22
27.16 This relatively relaxed approach is both acceptable and justifiable when dealing with arrangements of a purely contractual character as between the parties concerned. However, the creation of security clearly has an impact on third parties; the effect of a security interest is to establish rights of a proprietary nature, which will plainly have an impact on the rights of other creditors in the event of insolvency.
(a) Requirements of writing. In many cases, a security interest will only be effective if created in writing. Regardless of particular statutory requirements, this is a natural precaution in any event, but the applicable rules will be noted against each category of security.23
(p. 570) (b) Registration or notice requirements. The essential validity of security as against third parties may be made dependent on the completion of registration requirements, so that third parties dealing with the chargor may have the opportunity to discover the existence of the security. Once again, the requirements applicable to each particular category of security will be considered in the relevant section, although some general commentary is also set out below.
Part 25 of the Companies Act 2006
27.18 Although registration requirements are discussed in relation to particular categories of security, the regime applicable to the registration of charges by companies applies in a number of contexts and it is therefore felt appropriate to include some general commentary on this subject. This is especially the case given that this whole area has recently been the subject of significant reform. The application of the section to particular types of security will then be considered under the appropriate heading, below.
27.19 It should, of course, be appreciated that the relevant provisions apply only to companies. They are extended to security given by limited liability partnerships—a form of body corporate,24 but they do not apply to security created by individuals or general partnerships.25
27.20 A new statutory framework for the registration of charges was introduced by sections 860–894 (Part 25) of the Companies Act 2006.26 This replaced Part XII (sections 395–409) of the Companies Act 1985 (‘the 1985 Act’). Subject to a few minor exceptions, the regime introduced at that time mirrored the corresponding provisions of the 1985 Act, and most of the variations reflected a change in drafting approach.27 However, the system for the registration of security interests was slated for an early review—indeed the 2006 Act explicitly allowed the government to revise Part 25 by means of delegated legislation.28 A fairly lengthy consultation process29 ultimately led to the Companies Act 2006 (Amendment of Part 25) Regulations 2013.30 These regulations insert a new Part 25 into the 2006 Act and, from here on, references to sections within Part 25 are to the revised version set out in Schedule 1 to the 2013 Regulations.
27.21 The starting point is section 859A(2) of the 2006 Act, which provides that: ‘The Registrar [of companies] must register the charge if, before the end of the period allowed for delivery, the company or any other person interested in the charge delivers to the registrar for registration a section 859D statement of particulars.’
27.22 Where, as will almost invariably be the case, the charge is created by a written document, then the registrar is only required to register the charge if a certified copy of that document is delivered along with a statement of particulars.31 The required statement of particulars (p. 571) must include details of the chargor company, the nature and extent of the security and identity of the chargee. In a departure from the earlier provision, the statement of particulars must also include a description of any ‘negative pledge’ undertakings that may affect the security.32 The ‘period allowed for delivery’ is 21 days from the date of creation of the charge, and the ‘date of creation of the charge’ will generally be the date on which the document is delivered to the charge and intended to take effect.33
27.23 It was formerly the case that only specified categories of charge—including a charge over land, a charge over a ship or aircraft and a floating charge—fell within the scope of the registration requirement. Charges falling outside the ambit of the registration requirement, and this distinction occasionally led to difficulties of definition and characterization. In addition, this meant that the register might not disclose information that might be useful or relevant to those inspecting the register.
27.24 As a result, every charge created by a UK-registered company is now subject to the registration requirement, unless it falls within the scope of a specific exemption.34 The expression ‘charge’ is defined inclusively (as opposed to exhaustively), and the term includes a mortgage and various forms of security created under the laws of Scotland.35 The 2006 Act creates only three specific exemptions from the registration requirement, namely:
(a) a charge over a cash deposit in favour of a landlord to secure the tenant’s obligations under a lease of land;36
(b) a charge created by a member of Lloyds to secure its obligations in respect of underwriting business;37 and
(c) a charge excluded from the registration requirement under the provisions of any other Act.38
27.25 The regime for registration of company charges is thus now very wide-ranging and banks will be advised to register all forms of security interest that they may take in the course of their business. The available exemptions are very narrow and, in any event, will rarely be applicable in a banking context.
(a) it will be noted that the registration requirement applies only to charges created by a company. This seems to refer to security created as a result of a voluntary act undertaken by the company concerned. Thus, to the extent that a right of set-off arises over a bank deposit by operation of law, it would appear that this does not require registration as a security interest created by the company;39
(b) an instrument will only require registration if it constitutes a ‘charge’ for the purposes of section 859A. This question of characterization will have to be determined by reference to the definitions of that expression which have been adopted by the courts from time to time. For example, a charge has been defined as40 ‘…a security whereby real or personal property is appropriated for the discharge of a debt or other obligation, but which does not pass either an absolute or a special property in the subject matter of the security to the creditor, nor any right to possession. In the event of non-payment of the debt, the creditor’s right of realisation is by judicial process. …’ This definition has been judicially approved41 and perhaps offers a suitable starting point for these purposes. It is, however, necessary to note a few reservations. First of all, the definition was adopted specifically in the context of an equitable charge. Section 859A is clearly intended to be broader than this and is intended to catch legal mortgages as well.42 Secondly, the emphasis placed on judicial process as a means of enforcement43 will not always be appropriate. For example, a charge over a bank deposit will be enforced by the simple act of appropriation. A charge over receivables will be enforced by giving notice of the charge to the debtors (if that has not previously been done) and collecting payment from them. Taking all of these factors into account it is submitted that the expression ‘charge’ as used in section 859A is apt to refer to any voluntary arrangement44 designed to provide to the lender priority over particular assets of the chargor in the event of its insolvency and which includes powers of realization, appropriation, or sale, whether by virtue of the terms of the arrangement or by law. Marginal cases will inevitably arise. For example, if a bank takes a contractual right of set-off over deposits, this may well amount to a charge because it seeks to ring fence certain assets of the customer in the event of its insolvency and allows the bank a right of appropriation by way of enforcement.45 On the other hand, if the customer merely agrees that certain deposits will not be repayable until a particular facility has been discharged, then the bank has no right of appropriation, but merely a right of retention. Such a structure (commonly referred (p. 573) to as a ‘flawed asset’ arrangement) therefore lacks one of the key indicia of a ‘charge’ and hence should not require registration under section 859A;46
(c) a common feature of statutory requirements for the registration of security is that they are designed for the protection of other creditors of the chargor, and not for the protection of the chargor itself. This principle is reflected in section 859H of the 2006 Act, which renders an unregistered47 charge void against the liquidator, administrator, and creditors of the chargor. It is implicit in this formulation that the security remains valid as against the chargor company itself,48 and the chargee may enforce its security in accordance with its terms until a liquidator, administrator, or creditor intervenes;49
(d) whilst the section may render the security void in stated circumstances, it does not vitiate the contractual obligation to repay money which was intended to be secured by the charge. Indeed, section 859H(4) confirms that the avoidance of the charge ‘…is without prejudice to any contract or obligation for repayment of the money secured by the charge; and when a charge becomes void under this section, the money secured by it becomes immediately payable…’. Although the point does not seem to have been decided, it is submitted that this provision does not operate to accelerate the date on which a non-monetary obligation is required to be performed, nor would it require the chargor to make immediate payment in respect of a monetary obligation which is subject to a contingency;50
(e) it should be noted that the 21-day period for registration of the charge runs from the date after the date on which the charge was created. This expression does not necessarily coincide with the date which has been inserted into the document and, of course, there may be cases in which a document which is intended to create security has been delivered—perhaps through oversight—without any date written on it at all. The 2006 Act provides a series of rules to ascertain the date of creation of a charge but, in essence, this will be the date of delivery of the document concerned;51
(f) the court has a discretion to extend the 21-day period if (i) non-registration was due to inadvertence and does not prejudice creditors or (ii) it is otherwise just and equitable to do so.52 The discretion can be exercised even though the chargor has become insolvent, (p. 574) although permission to register the charge will not normally be given if a winding-up petition has been presented;53
(g) it should be appreciated that registration under section 859A only prevents a security from becoming void as against the liquidator, administrator, and creditors. So far as the secured lender is concerned, registration under this section has no further purpose or advantage. Thus, if the security document itself is invalid for some reason, registration under section 859A will not serve to validate it;54
(h) it should be noted that—in contrast to previous versions of the registration requirements—section 859A of the 2006 Act now applies only to UK-incorporated companies.55 Whilst the definition of the affected companies is thus limited, it should be appreciated that no such limitation applies to the location of the charged assets. As a result, the registration requirement will apply to assets situated outside the United Kingdom. Consequently, any security over foreign assets which has not been registered in this country will equally be void against the liquidator, administrator, and creditors of the chargor in accordance with the rules described above. It may, however, be noted that the security will—if otherwise valid—be regarded as effective in England even though it has not been registered or perfected under the relevant local law. This point is of some significance and is discussed in other contexts, below;
(i) on occasion, a company may acquire property which is subject to a pre-existing charge, without requiring that security to be released on the completion of the purchase.56 In such a case, the acquiring company must lodge the charge document and the required particulars within the requisite 21-day period following completion of the acquisition.57 It should be noted, however, that failure to register the charge in this particular case does not render the security void against a liquidator or any other person. No doubt this would be unfairly prejudicial to the creditor, who may not always be aware that the charged asset has been transferred;58
(j) in some ‘financial market’ cases in which the registration requirements would otherwise apply, their application is excluded by specific rules relating to financial collateral;59
(k) the Registrar is required to issue a certificate of registration in respect of charges delivered to him, and that certificate will be conclusive evidence that the requisite documents have been delivered to him within the required period for delivery.60 This provision is commercially convenient (at least to lenders) for it means that honest mistakes made in the completion of the registration process will not vitiate the security or limit its scope; any such challenge is foreclosed by the issue of the certificate,61 even if the amount secured by the charge is incorrectly reproduced in the prescribed (p. 575) particulars.62 This principle would appear only to give way in the face of fraud on the part of the person presenting the particulars for registration.63 More recent cases have tended to re-confirm the difficulties of challenging or ‘going behind’ a certificate of registration;64
(l) it may be added that, if an existing charge is amended so as to increase the liabilities secured by it or so as to widen the scope of the assets within its ambit, it is the writer’s view that this involves the creation of a new charge that would require registration under section 859A of the 2006 Act, and which would become void in the absence of such registration. Beyond this, however, it may be noted that other variations to a charge that introduce a restriction against the creation of further security or seek to regulate the priority of security interests may also be registered under section 859O of the Act. However, such registration appears to be voluntary, in the sense that the relevant document remains valid even in the absence of such registration;
(m) finally, it may be noted that further documents may have to be lodged with the Registrar of Companies if the lender appoints a receiver or manager by way of enforcement of its security.65
27.27 It should be noted that the registration requirements discussed above generally apply because the chargor company is incorporated in the United Kingdom. Given that the place of incorporation operates as the jurisdictional nexus, the duty to register security applies regardless of the geographical location of the assets to which the security applies. This is logical because a person searching the charges register of a UK company would be concerned to know about security subsisting over assets anywhere in the world.66
27.28 Where appropriate, comments will be made about foreign elements in the later parts of this section which address security over specific asset classes. But a few broader and more general comments may be helpful at this stage.
27.30 Secondly, registration will be required irrespective of the law applicable to the document which creates the security.67 This point may seem obvious, since section 859A merely refers (p. 576) generally to a ‘charge’, without discrimination as to the law applicable to the arrangement. Yet this, in turn, creates questions of its own—when does a foreign law document create a ‘charge’ for these purposes? A question of characterization is necessarily involved. Whether or not the document constitutes a ‘charge’ must strictly be a matter of English law, since it is necessary to give meaning to that expression in the context of an English statute. The meaning of ‘charge’ has already been discussed.68 It would thus be necessary to examine the nature of the rights and remedies conferred by the foreign security and consider whether these ‘match’ the criteria (priority and realization) which have been noted.69 If they do, then the arrangement will require registration under section 859A of the 2006 Act, unless one of the limited categories of exemption applies.
An English debenture purporting to charge by way of floating security all the English company’s property and assets does amount, where the English company possesses land abroad, to an agreement to charge that land, and is a valid equitable security according to English law; and the debenture holders, upon any winding up of that company would rank as secured creditors in respect of the foreign land, and upon a winding up in England they would be paid in full out of the proceeds of sale of that land, before any distribution of the proceeds of it was made among ordinary unsecured creditors. The law on this point is correctly stated in Palmers Company Law 5th Edn p 236: ‘Even without complying with the formalities required by the local law in relation to transfers or mortgages, it is competent to a company to create an effective charge on property belonging to it in a foreign country, for the court, in virtue of its Chancery jurisdiction in personam, enforces equities in relation to foreign land where the mortgagor is within the jurisdiction…and in determining whether there is an equity the court regards English, not foreign, law and if according to English law there is an equity, e.g., if for valuable consideration a company agrees to give a charge on foreign property, the court will enforce it, although the equity may be one not recognised by the lex loci rei sitae…’.
27.32 This statement has been accepted on subsequent occasions. Thus, where an English company executed a floating charge over all of its assets, the proceeds of sale of a property in Scotland fell within the scope of the floating charge even though the security had not been perfected in Scotland and even though the very concept of a floating charge was not at that time recognized in Scotland.71
(p. 577) 27.33 In every case, the practical difficulty for the secured creditor will lie in the realization of the charged asset. He will be unable directly to enforce his security in the foreign country if it has not been registered, or otherwise does not comply with the formalities prescribed by the local law.72 As a result, he only has an effective claim against the proceeds of sale of the property when they are received by the administrator or liquidator in the United Kingdom.73 The existence and the amount of those proceeds will be diminished by action taken by creditors against the property through local proceedings, since the local courts will ignore the security interest. Furthermore, the English courts will not attempt to restrain unsecured creditors from taking any such proceedings, since it would be inappropriate to do so in the face of the jurisdiction of the local court over the land concerned.74
27.35 As a final point, it will be obvious that the failure to comply with applicable foreign registration requirements or other formalities will not be taken into account by the English courts in this context. The equitable charge arises under English law by virtue of the chargor’s promise to give the security. The validity of that charge thus cannot be challenged by reference to any other system of law.
27.36 It used to be the case that charges created by foreign companies required registration in England if (i) the foreign company had a place of business in England and (ii) the charged assets were located in England. Both aspects of this formulation gave rise to significant difficulties and generated a certain amount of case law. However, since the replacement of Part 25 of the Companies Act 2006, the requirement to register charges created by foreign companies was abolished in its entirety. It is accordingly no longer necessary for a bank providing facilities to a foreign company to consider the need for registration of the security under the Companies Act 2006.75 It should be appreciated, however, that separate registration requirements in relation to land, ships, and aircraft76 will continue to apply even though the chargor is a foreign company.
27.37 It remains to consider the attitude which the English courts should adopt when considering a security interest created by a foreign company over assets situate in England where any necessary English formalities have been met so that the security is in principle valid in this country, but the company has failed to comply with applicable registration requirements in its home jurisdiction.77 Although there seems to be no case law which directly decides these issues, it is submitted that the position is as follows:
(a) If the security document is governed by English law,78 then the English courts should enforce that security at the behest of the creditor, regardless of non-compliance with formalities in the chargor’s jurisdiction of incorporation.79 Some inferential support for this view may be drawn from the decision in Arthur D Little Ltd (in administration) v Ableco Finance LLC80 where a Scottish company had executed a charge over shares in its English subsidiary pursuant to a security document governed by English law. The charge had not been registered in Scotland and it was argued that (i) the security took effect as a floating charge and (ii) the English court should hold the charge to be void against the administrator on the basis that it had not been registered under the corresponding registration requirements relating to companies incorporated in Scotland. The court seems to have worked on the basis that a foreign law registration requirement would not affect the validity of a charge over English property and governed by English law.81
(b) Where the security is governed by the laws of the chargor’s home jurisdiction and that law invalidates the security as a result of non-compliance with registration formalities, then the English courts should likewise hold the security to be void. This reflects the fact that an arrangement which is invalid under its applicable law will be treated as invalid in England to the same extent.82
1 It should, however, be appreciated that security which is given for no ‘real’ consideration in the sense of new money advanced at the time the security is given—may later be vulnerable to attack as a transaction at an undervalue under s 238 of the Insolvency Act 1986: see para 39.04 below. Execution as a deed will be required in certain cases in any event—for example where the security package comprises real estate.
2 On these contracts, see Chapter 23 above.
6 ie the transaction did not include an equity of redemption, which is a key feature of a security arrangement. The factoring of debts in this way is a common method of financing and the arrangements have been categorized as a genuine sale (as opposed to a disguised, secured loan) on a number of occasions. See, for example, Olds Discount Co Ltd v John Playfair Ltd  3 All ER 275; Olds Discount Co Ltd v Cohen  3 All ER 281n; Lloyds & Scottish Finance Ltd v Cyril Lord Carpet Sales Ltd  BCLC 609 (HL); and Welsh Development Agency v Export Finance Co Ltd  BCLC 148 (CA). A clause designed to retain title to goods pending payment to the seller may be effective for so long as the goods remain in the physical possession of the buyer (see Clough Mill Ltd v Martin  BCLC 64). However, to the extent that the retention seeks to extend to the proceeds of sale of those goods, the relevant contractual provision is likely to be characterized as a charge over book debts (ie an asset of the company), and will be void if unregistered: see, for example, E Pfeiffer Weinkellerei-Weinkauf GmbH & Co v Arbuthnot Factors Ltd  BCLC 522; Tatung (UK) Ltd v Galex Telesure Ltd (1988) 5 BCC 325; Re Weldtech Ltd  BCLC 393; and Compaq Computers Ltd v Abercorn Group Ltd  BCLC 602.
7 Orion Finance Ltd v Crown Financial Management Ltd  2 BCLC 78. For a further case in which a disputed assignment was held to be by way of security, see Coakley v Argent Credit Corporation plc, 4 June 1998 (Ch).
9 As Lord Devlin remarked in Chow Yoong Hong v Choong Fah Rubber Manufactory  AC 209 (at p 216), ‘…there are many ways of raising cash besides borrowing—if it is not in form a loan it is not to the point to say that its object was to raise money for one of them or that the parties would have produced the same result by borrowing and lending money…’.
12 The House applied the decision in Agnew v Commissioner of Inland Revenue  AC 714 (PC). The decision is further noted at para 30.04 below.
15 As the Federal Court pointed out, the US Supreme Court has adopted the same approach in giving effect to the intention of the parties: see Provost v United States 269 US 443 (1926). The simple position is that the stock lender receives a fee for the loan of the securities and takes the risk that the borrower will be unable to redeliver equivalent securities on the contracted date. In essence, the stock lender takes a risk which, in credit and economic terms, are very similar to those which apply in the context of an ordinary, monetary loan. For another case which has sought to adhere to the intention of the parties rather than attempt a recharacterization exercise, see Granite Partners LP v Bear Sterns & Co Inc 175 F Supp 275 (SDNY, 1998). The US courts have also been sensitive to the need to uphold market standard documentation in the manner expected by market participants in order to avoid prejudice to the proper functioning of those markets: see, for example, Re County of Orange 31 F Supp 2d 768 (1998 CD Cal).
16 On this subject, see the discussion at para 27.18 below.
17 Note, however, the question of interpretation which arose in Bank of Scotland v Wright  BCLC 244, noted at para 26.31 above in the context of guarantees. For a case in which a third-party legal charge executed by a company was interpreted to extend not only to a £27,000,000 facility made available to the borrower itself but also to further facilities made available both to the borrower itself and its related companies, see Ashwood Enterprises Ltd v Governor and Company of Bank of Ireland  EWHC 2624 (Ch).
18 On syndicated facilities generally, see Chapter 21 above.
20 On these rules, see paras 27.18–27.35 below.
22 For a notable exception, see Statute of Frauds 1677, s 4 insofar as it relates to guarantees. The subject has been discussed at para 26.20 above.
23 Where, as in the case of transactions involving land, there is a requirement for execution of the relevant instrument as a deed, it has been suggested that s 1(3) of the Law of Property (Miscellaneous Provisions) Act 1989 requires a deed to be executed in its full text, and that the mortgagor cannot simply leave executed, blank pages in the possession of his advisors for use at the completion: see R (on the application of Mercury Tax Group and another) v HM Revenue and Customs Commissioners  EWHC 2721. This view appears to proceed on the basis that s 1(3) would thereby offer a safeguard against fraud. Earlier authority suggests that a signed contract can be altered or completed at a later stage provided that the amendment or completion is authorized by the parties concerned: see Koeningsblatt v Sweet  2 Ch 314; United Dominions Trust Ltd v Western  QB 513. However that may be, it may be appropriate to adopt a cautious approach to the execution of documents and insist that they should be executed in their final and completed form.
27 Act 2006, s 1052 considered at paras 27.33–27.44 below.
29 The process was begun on 12 March 2010 through the publication by the Department for Business Innovation and Skills of its consultation paper, ‘Registration of Charges created by Companies and Limited Liability Partnerships—Proposals to amend the current scheme and relating to specialist regimes’.
32 See s 859D of the 2006 Act. This may mean that a subsequent charge of the same assets may be deemed to have notice of both the existing security and the restriction against the creation of further charges. A later security interest created in the face of such a restriction may be regarded as ineffective.
34 Where the company creating the charge holds the relevant assets as trustee for a third party, it is now possible to enter a notice to that effect on the register: see s 859J of the 2006 Act. If the beneficiary itself is a UK company, then the question may arise whether the charge should also be registered against that company under s 859A of the Act. Such a requirement would be consistent with the overall objectives of the registration regime, but the charge is not created by the beneficiary company, with the result that registration would not seem to be required.
36 See s 895A(6)(a) of the 2006 Act. Note that the exemption only applies to a lease of land, and not to other assets. Consequently, a charge over a cash deposit placed with the lessor of an aircraft or other equipment would remain within the scope of the registration requirement. This specific exemption is unlikely to be of great significance to banks, because the exemption favours lessors of real estate, rather than financial institutions.
38 See s 895A(6)(c) of the 2006 Act. This would refer, for example, to financial collateral arrangements of the type discussed in Chapter 35 below.
39 On the banker’s right of set-off, see the discussion in Chapter 36 below.
43 The emphasis on the need for judicial enforcement proceedings is present in other cases: see, for example, National Provincial and Union Bank of England v Charnley  1 KB 431, approved in Re Bank of Credit and Commerce International SA (No 8)  AC 214. However, in Re Charge Card Services Ltd  Ch 150, emphasis was instead placed on the creditor’s general ‘right to resort’ to the property, rather than judicial proceedings.
44 On the need for the arrangement to be voluntary, see para 27.26(a) above. The word ‘arrangement’ is used advisedly because—save in specialized cases—there is no necessary requirement that the charge should be created in writing: see the discussion in para 27.17 above. However, security in unwritten form will be very rare in practice, and security over land must be created in writing in any event.
45 Such a set-off arrangement may not necessarily be subject to registration on the basis that the security does not fall within the prescribed categories. On rights of set-off generally, see Chapter 36 below.
46 A right to retain an asset and use it for a particular purpose (but without any power of sale or realization) does not amount to a charge: Fisher and Lightwood, para 6.1. See also the decision in Online Catering Ltd v Acton  EWCA Civ (CA).
47 Expressions such as ‘registration’ and ‘unregistered’ are used for convenience. It should, however, be appreciated that there is no positive obligation on the company or the chargee to procure that the charge is actually registered; s 859A merely imposes an obligation to deliver the charge (together with the prescribed particulars) for registration within the 21-day time limit. If that has been done, then s 859H) cannot apply to strike down the security even if, for some reason, the security is not subsequently entered on the register.
49 This point may appear to be largely theoretical, since the availability of security usually only becomes material at the point of insolvency. However, the point could become relevant in other circumstances, for example where the borrower is solvent but is refusing to perform some of its other obligations under the facility agreement.
50 This may occur where, for example, the bank issues a performance bond at the request of the company, and the company’s obligation to reimburse the bank is secured by a charge over the company’s assets. It is submitted that the quoted language from s 874(3) is apt to convert a future obligation into a present one, but it does not convert a contingent obligation into an immediate obligation where the relevant contingency (in this case, a demand against the bank under the performance bond) has not occurred.
59 On these rules, see paras 35.22–35.34 below.
62 Re Mechanisations (Eaglescliffe) Ltd  Ch 20. A certificate cannot be challenged even if it was issued following an application for late registration in accordance with the procedure described at para 27.23(i) above: Exeter Trust Ltd v Screenways Ltd  BCC 477 (CA).
63 See the commentary in Sun Tai Cheung Credits Ltd v AG of Hong Kong  1 WLR 948 (PC). This could conceivably occur, for example, if the charge had been dated (and created on) ‘1 December’ but the creditor altered this to ‘10 December’ in order to enable him to lodge the particulars and the charge on 23 December.
66 At the risk of a simplistic comparison, the company’s financial statements will show the company’s assets on a worldwide basis. It is therefore legitimate to expect easy access to details of the extent to which those assets have been encumbered in favour of third parties.
67 This point is made here since it will primarily be of relevance to foreign assets, but this will not invariably be the case. For example, a UK company might create a charge over its receivables by means of a New York law assignment executed in favour of its American financier. Some of the receivables may be situate in the United Kingdom. But even if they are not, the foreign law document will still constitute a charge over assets of the company and will hence require registration under s 859A of the 2006 Act.
68 See para 27.04 above.
69 For a case in which the problems of categorization of a foreign security instrument for these purposes were discussed (but not resolved) in the context of a factoring agreement governed by French law, see Cofacredit SA v Morris  EWHC 353 (Ch), para 120.
75 For a discussion of the problems that formerly arose in this area, see paras 27.33–27.42 of the first edition of this work.
77 This is in some respects the converse of the situation which arose in the British South Africa case, discussed at para 27.28 above.
79 This follows from the fact that foreign laws cannot generally affect questions of title to assets situate in the UK: see Bank voor Handel en Scheepvaart NV v Administrator of Hungarian Property  AC 584 (HL); Williams & Humbert Ltd v W&H Trade Marks (Jersey) Ltd  AC 368 (HL).
81 In the event, the provisions for registration of charges created by Scottish companies were held to form a part of the law of England as well as Scotland and, hence, were not a registration requirement imposed by a ‘foreign’ law for these purposes. However, that line of reasoning plainly could not be applied to jurisdictions outside the United Kingdom.