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Security Rights in Respect of
What is a security right?
Security, in the paradigm case, is an interest in land or chattels which secures payment for performance of an obligation.
Security rights (proprietary) can be compared with purely personal rights to recover debt
It is possible to distinguish between true security rights and those that have the same function but are not true security rights.
True security rights arise where the creditor acquires a property right that he/she did not have before. They acquire a new property right in order to secure the performance of the obligation.
A number of important concerns affect the way in which the basic structure applies to security rights:
1. Weighing the interests of different types of financiers/creditors
2. Notice to the world (registration)
o Preventing unfair surprise
3. Preventing sham transactions from taking effect
4. Commercial certainty
Channelling function: making sure that following certain steps will lead to a legal transaction form being in existence
5. Bargaining flexibility
6. There is a need to protect A (the person giving the security to B). In situations where B is extending credit to A, there is a risk that B will exploit A's need for the money by imposing harsh terms on A.
Thus, statutory rules applying to consumer credit agreements extend to the context of securities.
7. There is a need to protect B. If the property law system makes it difficult for B to acquire security there is a risk that the flow of credit will be impacted. Credit is important in our society.
8. There is the need to protect C (the 3 rd party). B's right he acquires as security may be hard to discover.
We need to be aware of the basic tension between the needs of A, B and C as the above policy considerations can often conflict.
In assessing the formal vs functional debate, we can't take that inquiry in a vacuum: we have to look at the extent to which each approach achieves the underlying policy objectives of secured transactions law discussed above. A. The Formal Approach
Under a formal approach, the law follows the requirements of the legal form. All the legal effects of that form will follow. Therefore, if something is not a true security interest it will not be treated as such.
Note that the formal approach imposes objective requirements for a particular form.
Labelling something is a security interest will not suffice if it does not follow the prescribed form of that interest (Re Spectrum)
It is arguable that if the forms of the security interests are good, we don't need functionalism.
Strengths of formalism:
Greatest advantage is legal certainty
Very clear boundaries between concepts
Channelling function: knowing that you can achieve certain legal effects if the form is satisfied
Formalism does not mean limited options in English Law: there are many legal forms of security
Sophisticated commercial parties have a very specific idea of where they want risks to lie, and the better (and the greater the number of) legal forms, the greater the bargaining flexibility to achieve that precise risk allocation
Ask whether this is facilitated by what English law offers today?
Reduces the risk of 'unfair surprise' under the functional approach where a party may not realise that a transaction is registrable and incurs loss as a result of non-registration
Weaknesses of formal approach:
Might not give effect to the necessary policy objectives
But, do we need the functional approach to cure the weakness of the formal approach?
o Judges shouldn't recharacterize transactions easily because certainty in commercial transactions is paramount and certainty is what is achieved by the formal approach
Better approach may be to use legislative carveouts for specific areas worthy of intervention: e.g. Hire-purchase of cars
A more targeted anti-abuse regime may well be better (can be a mixture of statute and existing doctrine):
Sham doctrine (trusts)
Requiring certain forms of 'subsequent conduct' before a charge can be characterised as fixed
The 'cloak' doctrine
Hire-purchase Act for cars (to mitigate the 'apparent ownership' problem)
B. The Functional Approach
By contrast, a functional approach treats all devices intended to provide a security as true security interests. It looks at the economic substance of a transaction as opposed to the form.
So long as the security device denotes some interest in the item of personal property it may amount to a security interest regardless of its form
There is a focus on what the transaction seeks to accomplish (secure payment for performance of an obligation) rather than legal form
Another view of the functional approach is that it denotes all devices intended to secure payment for goods.
Under this definition, the legal forms of pledge, lien, mortgage and charge are not just formally but also functionally security interests
So under this approach the law does take a functional approach to a large extent (but not completely, as it excludes things like retention of title and hire purchase)
Strengths of functionalism
Does not look at metaphysical property constructs but is concerned with the interests of the parties
Cures unfairness to debtor that can be caused by formalism
Moves the definitional question: instead of having to ask whether a transaction prescribes to a particular legal form, we have to ask whether it is a 'security interest' in the functional sense
Security interest is not always easy to define and has fuzzy edges. We will still have to determine the boundaries of that concept
E.g. the Quistclose trust is difficult to characterise with certainty. It functions as a security interest is the purpose is not satisfied but is no longer a security if the purpose is satisfied.
o Sometimes a transaction will have multiple purposes- one security and another.
What do we do in these circumstances?
If it goes too far it can blur the distinction between ownership and security as property rights
Worry that it disrespects the institution of 'ownership' which entails a power to do whatever you want with it, and not have it subject to an encumbrance against your will
Sacrifices certainty in pursuance of 'justice' objectives
Functional approach liable to disrupt parties' bargains too much by imposing registration requirements where they don't reasonably expect them to be imposed
English law is generally very lenient when it comes to artificial transactions with freedom of contract reigning. For example, the success of hire-purchase (it is a very artificial way of achieving a sale by instalments). However, it does not allow 'sham' transactions. A sham transaction is one where an apparent legal consequence is not one that is actually intended by the parties.
We must question whether these really involve 'security rights' in their proper sense at all. The approach taken by English law seems to be to look at the form rather than the function of security transactions: something is not a security right unless the creditor has acquired a new right from the debtor. This is so even if the function of the transaction is to secure the debt in some way.
The distinguishing features between true and quasi-securities are:
A. On true security, the creditor holds the surplus on trust for the debtor, whereas he doesn't with quasi
B. With a quasi security interest the creditor obtains a property right in something that the debtor owns. A. Retention of Title
What is it?
In some situations, a creditor who is the owner of a moveable thing may retain ownership until he is paid in full. This does not truly involve the acquisition of a security right.
E.g. In Armour, the creditor retained title, rather than acquired a new property right on security
This interest is not a security interest by nature, and the transaction is not a security transaction by its nature. But ownership can function economically as a security interest. This causes problems of apparent ownership.
Enforcement- benefits and detriments
Since a creditor has legal title to the property he can take any steps that a legal owner can take to enforce his interest (e.g. take possession, sell).
The retention of title is controversial because the seller gets super-priority over secured creditors by having a legal interest. But there is a balance in that it only extends until the product is manufactured (see Romalpa clauses below). The limitations that the courts have laid down in these extended cases shows them taking account of the security aspect of the transaction.
Armour v Thyssen Edelstahlwerke AG - HoL (Scotland)
Facts: D, manufacturers of steel, sold steel to C for use in its manufacturing process. The contract of sale contained a retention of title clause (that the steel remained the property of the sellers after delivery until all debts were paid). Receivers were appointed to C and a dispute arose as to the ownership of a quantity of steel at C's works.
Held (Lord Keith): By virtue of S17 and 19 of the SGA 2979, the property remained with the sellers until that condition was complied with. This was not by way of 'security', however.
"I am, however, unable to regard a provision reserving title to the seller until payment of all debts due to him by the buyer as amounting to the creation by the buyer of a right of security in favour of the seller. Such a provision does in a sense give the seller security for the unpaid debts of the buyer. But it does so by way of a legitimate retention of title, not by virtue of any right over his own property conferred by the buyer."
In Romalpa and Re Peachdart, we see extended retention of title clauses where the seller purports to retain title not only to the goods themselves but also to the proceeds of sale and products of manufacture. These cases cannot truly be said to involve 'retention' of title- we know from the law on manufacture that a new title is created.
Nevertheless, there may be ways in which the owner can entitle himself to the proceeds of sale/products of manufacture:
(a) By trust
Romalpa: there is an implied obligation to account for the proceeds which resulted in a fiduciary relationship which gave rise to an equitable property right in the proceeds which gave them the ability to trace
But is there really an intention to create a trust over the proceeds of the sale?
(b) By way of charge (Re Peachdart)
o Parties in these cases to do not wish to create a charge outright since this would require registration (in the case of companies)
The sale is often in relation to low value goods by companies who make many transactions in a day. It is therefore not practical for them to have to register.
Nevertheless, in cases where the processing leads to the creation of a completely new chattel then the court will often have to reach the conclusion that a charge was created
Aluminium Industrie Vaassen BV v Romalpa Aluminium Ltd - CoA
Facts: C agreed to sell aluminium foil to D on the condition that ownership of the goods would not be transferred to D until D had paid the price to C, and that ownership of items made by D out of the material would also remain in C as "surety" for D's indebtedness but that D should have power to sell such items to 3 rd parties in the normal course of their business. D went into liquidation while owing money to C. C argued that they were entitled to trace the proceeds of sub-sales into the bank account in the receiver's name.
Held (Lord Roskill): In order to give effect to the purpose of the clause, there must be an implied obligation to account for the proceeds, giving rise to a fiduciary relationship. This gave rise to an equitable property right in the proceeds and ability to trace.
Re Peachdart Ltd - Ch Div
Facts: F supplied P with leather for the manufacture of handbags. The contract for sale provided that property in the leather should remain with F until payment was received in full, and that F
should retain the right to resell the leather upon payment becoming overdue (the date of delivery in the event of sale of the goods manufactured from unpaid-for leather). P went into receivership with bills from F unpaid.
Held (Vinelott J): the parties must be presumed to have intended that once P had appropriated the goods so that they became unrecognisable or valueless, a charge over the goods thereby manufactured or their proceeds should arise. In this case such a charge arose in relation to partly completed and completed handbags and the proceeds of completed handbags which had been sold.
The hire-purchase agreement takes the form of a period of hire (lease) followed by an option to purchase at the end of the lease. It takes this form for a specific purpose:
To avoid the fact that if there was an outright sale in instalments then the bona fide purchaser rules would apply under the SGA buyer in possession. It is therefore safer for seller if there is a hire which the SGA does not apply to.
It also avoids the bills of sale legislation
Parliament has intervened with targeted legislation through the Hire Purchase Act to avoid some of these legal effects.
Is hire-purchase a true security right?
No- the seller does not acquire any new property rights
Confirmed in Wagon case:
o D claimed that the condition was void under the Bills of Sale Acts
S9 of the Act provides that it must be in prescribe form if given by way of security
Held that it did not involve a security interest so did not fall under the Act
Manchester, Sheffield and Lincolnshire Rlwy Co v North Central Wagon Co (1888)-HoL
Facts: B wanted some money. R agreed to buy wagons from B for £1000. At the same time the R
leased the wagons to the B for 3 years, at a yearly rent and calculated to replace the £1000 with
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