CL 9: Security interests

What are Security interests?

Security interests help businesses to convince finance providers (creditors) to lend them
money. How?
- The business grants the finance provider (creditor) proprietary rights over assets owned
by the business
- If the business does not repay the loan granted by the finance provider, the finance
provider (creditor) can sell such assets

Consider the following example

- Toni’s company needs a cash flow injection.
- Bank agrees to lend Toni’s company money if she secures the loan.
- Toni’s company owns an expensive industrial computer.
- Toni decides to grant the bank proprietary rights over the computer:
– She grants the bank the right to sell the computer if she does not repay the loan

1. What are security interests?

Definition: A person with absolute proprietary rights (the debtor/borrower) grants a finance
provider (the creditor/lender) limited proprietary rights over his assets.

In our example:
- Toni’s company owns a computer, i.e. the company has absolute proprietary rights over
the computer
- To secure a loan with the bank, Toni gives the bank the right to sell the computer if she
does not repay the loan.
- The bank’s right to sell the computer is a security interest, i.e. a limited proprietary right

1. What are security interests?

Business (debtor/borrower) ----------- finance provider (creditor/lender)
The business owns an asset The finance provider is granted
that it uses to secure a loan limited proprietary rights (such as
the right to sell the secured asset) if
the business fails to pay the loan

 There are 4 types of security interests over personal property in English law
- Pledges
- Liens
- Mortgages
- Charges
 Why is this important?
- Benefits for businesses…
- Benefits for finance providers – provides them security when lending

Security & ownership

 To secure a loan, a debtor (borrower) grants a creditor (lender) proprietary right over the
debtor’s assets. If the debtor does not repay the loan the creditor has the right to sell the
asset.
 The debtor has ownership title over the asset they are using to secure a loan with the bank
 Once the security transaction has been celebrated with the bank, ownership title over the
asset remains with the debtor*, but the creditor is given limited proprietary rights such as
the right to sell the debtor’s assets if the debtor fails to repay the loan
* There is one exception only

Distinguishing security from quasi-security

Security
- To secure a loan, a debtor (borrower) grants a creditor (lender) proprietary right over
his assets. If the debtor does not repay the loan the creditor has the right to sell the
asset.
- Security: Ownership title over the asset is with the debtor (but the creditor is given the
right to sell the debtor’s assets if the debtor fails to repay the loan)

Quasi-security – e.g. Retention of title clauses

The creditor (seller) retains ownership title to the goods until the debtor (buyer) has completed
payment.
- Quasi-security: Ownership title over the asset is on the creditor (seller) until the debtor
(buyer) has completed payment

Types of security interests over personal property:

- Pledges Possessory: creditor required

- Liens to take possession

- Mortgages Non-possessory: creditor not

- Charges required to take possession

2. Attachment and Perfection

Attachment
 Refers to the creation (attach) of a security interest
 The process of “attaching” the security interest to the property to which it relates
 Requirements:
- Agreement between the parties + identifying the property
- Debtor must have ownership title over the asset
 - Security interests can be created over present or future property
Perfection
 Refers to the process of making security interests effective towards third parties, binding
third parties
 Perfection allows third parties to know that property has been used to secure a payment

Perfection by possession
- With pledges and liens: the creditor must take possession of the property for the
security interest to get perfected, binding third parties

Perfection by registration
- Mortgages and charges created by companies must be registered
- otherwise void towards third parties (Companies Act 2006, s 859 H (3))
- The creditor is not required to take possession

Summary: attachment and perfection

 Attachment: creates the security interest. The debtor must have title to property
 Perfection: for the security interest to bind third parties,
- The creditor must take possession of the property if pledges or liens have been created
- Mortgages and charges created by companies must be registered in the Registrar of
Companies (otherwise they are void)

3. Pledges
Definition:
 Pledges are contractual securities
 Under a pledge agreement, the business/debtor agrees to part with possession of assets it
owns in order to create a security interest for the creditor.
 Ownership of the asset remains with the debtor

Rights and obligations

 The creditor must take possession of the asset (pledges are possessory security interests).
Possession can be physical or constructive
 Under a pledge, the creditor has the right to retain the asset until the debtor has paid
 The creditor is also entitled to sell the asset it the debtor defaults

4. Liens
Definition
 Possessory liens arise as a common law right; they can also be contractual.
 Liens give the creditor the right to detain debtor’s assets as security until payment has
been completed
 The debtor remains the owner of the asset

Rights and obligations

 The creditor must take possession
 The creditor can detain the asset until payment

5. Mortgages
Definition
 A mortgage transfers ownership of the property to the creditor (mortgagee) by the debtor
(mortgagor) for the purpose of providing security for an underlying obligation.
 Once the debtor has repaid the debt (redemption), the creditor will retransfer ownership
of the asset back to the debtor

Rights and obligations

 In a mortgage, there is a transfer of title to the creditor
- but the creditor gets limited proprietary rights as they will have to give the
property back to the debtor if the debtor pays the debt
 The creditor is not required to take possession, usually the debtor remains in possession
 Transfer of title to the creditor is either legal or beneficial

Perfection: mortgages created by companies are void unless registered (Companies Act 2006,
s 859)

Legal mortgages
 There is a transfer of legal title with an obligation to retransfer the title back if the debtor
pays the underlying obligation (redemption)
 Involve the present transfer of property

Equitable mortgages
 There is a transfer of equitable title with an obligation to retransfer the title back if the
debtor pays the underlying obligation (redemption)
 An agreement to mortgage future property is an equitable mortgage (Holroyd v Marshall
(1862) 11 ER 999 HL)

How does a mortgage terminate?

1) Debt is paid ownership of the asset is retransferred back to the debtor
2) The debtor defaults - creditor can either (a) take ownership (foreclosure) or (b) sell
the asset:

(a) Foreclosure: (b) Power of sale:

• Creditor takes the property in • Express power of sale in the
satisfaction of the debt, which agreement (or implied) once debtor
extinguishes the debtor’s right to has defaulted.
recover title to the property upon • A receiver will be appointed to sell
payment –requires a court order the asset – to ensure that the debt
• The creditor becomes the absolute is paid, and the costs are met
owner (i.e. if the creditor sells the • If surplus in sale, this will be for the
property and there is a surplus in benefit of the debtor
sale, this will be for the benefit of
creditor)
 6. Charges
Definition:
- The debtor secures a debt with a finance provider by granting the finance provider
(creditor) the right to sell the asset.
- Charges do not transfer ownership title over the charged asset, neither legal nor
beneficial. The debtor remains the owner.
- The debtor remains in possession of the asset

What does the creditor get?

- An equitable proprietary interest => if debtor defaults, the creditor can sell the asset by
judicial process

Perfection: Charges created by companies are void unless registered (Companies Act 2006,
s859)
Termination: Debtor pays: charge terminates
Debtor pays: creditor sells the assest

Fixed charges
 Charges over specific, existing assets, usually permanent: plants and machinery, vehicles,
computers etc.
 The debtor can:
- use the charged asset but
- cannot dispose of it (i.e. cannot sell it) in the course of business

Fixed charges => the creditor keeps control of the asset

Floating charges
 Charges over a class of items that fluctuate goods, small items of equipment, raw
materials etc.
 Two different periods have to be distinguished:

Floating charge: the debtor can use the asset and From crystallization onwards: the charge becomes
n
Crystallisatio

dispose of it (i.e. sell it) in the course of business a fixed charge

=> the creditor is not in control of the charged => the creditor is in control of the charged asset
assets
Re Spectrum Plus Ltd [2005] UKHL 41.

 Crystallisation: Event agreed by the parties, usually, debtor’s failure to pay conservative
payments

Priorities on insolvency/bankrupt
1. Creditors holding fixed and floating charges are both secured: they have priority over
 ordinary creditors
2. Creditors holding a fixed charge are satisfied first
3. Then preferential creditors (employees) are paid
4. A proportion of the debtor’s assets is then taken to pay unsecured creditors
5. Creditors with floating charges come next

Assignment of receivables by way of charge

A business can also assign the debt to the finance provider by way of security, charging the
debts.
- The business remains the owner of the debt and retains possession
- If the business collects the debts from its customers but puts the money aside without using
the proceeds, this would be a fixed charge
- If the business collects the debts and is free to use the proceeds in the course of its
business (i.e. can use the money), this would be a floating charge =>very common
Re Spectrum Plus Ltd [2005] UKHL 41.

RECAP - final
PLEDGES:
Ownership: with the debtor
Possession: the creditor must take possession
Rights: Creditor granted the right to retain possession of asset until debt paid; or right to sell
Perfection: merely by creditor taking possession of the asset
LIENS
Ownership: with the debtor
Possession: the creditor takes possession
Rights: creditor granted the right to detain possession of asset until debt paid
Perfection: merely by creditor taking possession of asset
MORTGAGES
Ownership: transferred to the creditor; once debtor repays, the creditor will retransfer
ownership back to the debtor. Transfer of title can be either legal or beneficial
Possession: debtor in possession usually
Perfection: needs to be registered (Companies Act 2006)
CHARGES
Ownership with the debtor – no transfer of title, neither legal nor beneficial.
- If fixed: the debtor is not free to sell the charged asset
- If floating: the debtor can sell the charged asset
Possession: with the debtor
Perfection: needs to be registered (Companies Act 2006)