USER GUIDE for SECURED TRANSACTIONS CODE
Contents
1. broadly reflects the existing law on charged assets but it does make certain important changes to the current law BD 23762705 v1 2 20 21 22 There is an attempt in section 12 3 to regulate when an asset which is received by the chargor after it enters into insolvency proceedings falls within the scope of a charge and when it is available to the insolvency officer This will need discussion An attempt has been made to clarify and sometimes to improve some of the more technical aspects of the existing law So for instance section 14 goes further than the current law by setting broad default rules on the extent to which a charge over an asset includes connected assets There is a specific section section 15 which deals with receivables which is broadly intended to reflect the current law One of things which we want to explore is the possibility of adding other sections in this part to deal with the particularities of various types of asset for instance land or particular categories of goods and intangibles such as registered land ships and aircraft and intellectual property This part also contains rules to deal with contractual restrictions on charging assets These are broadly intended to reflect the current law We considered whether it would be appropriate to tackle the issue of contractual restrictions on charging receivables Because this is currently the subject of proposals for change under the Small Busines2. of the interpretation of the charge itself It will specify the extent to which the chargor has the ability to sell assets free from the charge In a properly drafted charge this will normally be all that is required But there will inevitably be cases where a purchaser will need to buy an asset from a company without checking the terms of the charge A company cannot sensibly carry on business if its purchasers are always required to check its charges register before doing business with it In dealing with this problem the Code draws on the well known distinction between fixed and current assets A person should generally be able to buy a current asset BD 23762705 v1 7 from a company without checking what charges it has created But in the case of a fixed asset the purchaser would be expected to check The distinction is not always easy to draw particularly because it depends so much on the business of the company concerned But then it does reflect the realities of the commercial situation Part 9 Enforcement 53 54 55 56 In practice most powers of enforcement are set out in the charge itself The default powers of enforcement in legislation and case law are complicated confusing and out of date The Code assumes that powers of enforcement will continue to be set out in the charge documents but it establishes default powers which are more in line with current commercial practices It also sets out the duties of
3. requirement for all individuals to register most charges they create is unlikely to be cost effective particularly as it could be applied to short term financial BD 23762705 v1 5 38 39 40 41 42 43 44 transactions leading to a high volume of registrations against the tens of millions of adults in the UK most of which experience elsewhere suggests will remain on the register long after all the secured payments have been made making the register increasingly expensive to maintain and increasingly misleading for users What is needed is to draw a line between commercial and consumer transactions and to require registration only in relation to commercial transactions The simplest way to do that is to require registration by companies and not by individuals although charges created by individuals will continue to be registrable in the asset registries The Code broadly follows this line but adds certain other categories of person to a list of those who need to register These include LLPs companies incorporated by statute or by royal charter partnerships limited partnerships and sole traders The thought behind the Code is to enable partnerships limited partnerships and sole traders to register at Companies House if they want to create a charge What needs to be considered is whether the benefits which would be obtained from registration justify the cost of requiring it But one of the key points here is that this wo
4. those enforcing security which are broadly intended to reflect the current position One issue for discussion is whether a system should be introduced to enable the chargee to retain the asset on enforcement if there are suitable protections for the chargor Foreclosure is not available under the current law without a court order although appropriation of financial collateral serves a similar purpose and does not require a court order Is it possible to establish appropriate safeguards for the chargor to establish a general out of court procedure Part 10 Insolvency proceedings 57 58 It would be possible for the Code not to deal with insolvency proceedings at all But because security is rarely enforced outside an insolvency proceeding it was thought important to refer to them and to set out the key ways in which an insolvency proceeding impinges upon the enforcement of security Insolvency law currently draws a distinction between fixed and floating charges The Code does not draw this distinction Whether or not a purchaser takes free of the charge depends on the terms of the charge and the provisions of part 8 of the Code The Code does not yet contain a provision to deal with what if any liabilities should rank ahead of charges on an insolvency It is the subject of the Discussion Paper issued by the CLLS in February 2014 BD 23762705 v1 8 59 The Code also raises the question of how to deal with the current claw back provisi
5. SFER Scope of this part This part applies to transfers of assets not just to charges For this purpose a transfer of an asset is a the transfer of all or any part of the asset or b the creation of a proprietary interest of any kind over all or any part of the asset by one person the transferor in favour of another person the transferee whether it is outright or by way of security A transfer of an asset therefore includes not only a charge but also an assignment and a trust Contractual restrictions on transferring receivables A transfer of a receivable is effective even if it is prohibited in the contract by which the receivable is created The transferee therefore obtains a valid proprietary interest in the receivable in spite of the prohibition Subject to part nsolvency Proceedings that proprietary interest remains effective if the transferor enters into insolvency proceedings But if it is prohibited by the contract the transfer does not affect the rights liberties powers and immunities of the payer The payer can deal with the transferor as if the transfer did not exist In particular the transferor cannot be required to pay a greater amount or to pay to a different person or in any other way to pay on different terms than are provided for in the contract On an insolvency set off will continue to apply as if there had been no transfer Contractual restrictions on transferring other
6. USER GUIDE for SECURED TRANSACTIONS CODE July 2015 BD 23762705 v1 1 The purpose of this User Guide is briefly to explain what we have put in the Code and why 2 The important point to stress is that the Code is a starting point for discussion We want to prompt a dialogue about whether a Code is useful and if it is what it should contain The current text is a starting point for that discussion Part 1 What is a charge 3 This part contains the power to create a charge and explains what a charge is and how it differs from an outright interest 4 Our starting point is the current law because we believe that charges work well in practice but we have tried to simplify and modernise the law where possible 5 The intention is that there should be a single security interest the charge with a single set of rules But the Code will only apply to secured transactions and therefore the underlying property law principles relating to outright transactions will continue in their current form For that reason it has been thought necessary to provide for legal charges as well as equitable ones This is not intended to affect the position between the chargor and the chargee that will be the same whether the charge is legal or equitable But the distinction is necessary when dealing with priority issues see part 8 below Part 2 Creation and effectiveness 6 In section 5 a distinction is drawn between the creation
7. and the effectiveness of a charge The reason for this is to deal with registrable charges 7 Under the current law the chargee has twenty one days within which to register the charge and this creates what has been described as the twenty one day invisibility period This has not created material problems in practice but the introduction of a Code would enable it to be overcome The Code therefore draws a distinction between the creation and effectiveness of a charge A charge is created in the normal way at which time the personal rights and duties arise between the parties But if the charge is registrable it only becomes effective as a proprietary interest on registration This avoids the invisibility period 8 We envisage that registration will be electronic and automatic but it would be possible to introduce a priority search system if that were thought necessary Since the BD 23762705 v1 1 effectiveness of a charge will be dependent on registration the system will need to be robust The other major change introduced in part 2 is that it provides that the charge is the only form of security interest which will be available Mortgages security assignments pledges and contractual liens are abolished This is not as dramatic as it sounds The main difference between charges and other types of security interest particularly legal interests like legal mortgages and pledges is that the priority rules are different Priori
8. ay be liable for If the transferee takes the transfer with actual knowledge of a contractual prohibition on the transfer and it deliberately encouraged the transfer to breach that provision the transferee is liable in tort for the loss suffered by the person in whose favour the prohibition was given The transferee has no other liability of any kind for instance in tort or in equity if it takes a transfer in breach of a contractual restriction of this kind BD 23762705 v1 11
9. d are intractable and there is a general consensus that they should be simplified and improved The problem with simplifying the priority rules is that it has to be done in relation to all types of interest in all types of property A comprehensive reform of priority rules cannot be achieved within the context of Secured Transactions Code So what the Code tries to do is to deal with certain key priority issues which are relevant in relation to charges whilst at the same time allowing the existing rules to apply where the Code does not The Code regulates the priority of charges amongst themselves and also priorities between receivables financing agreements and between charges and receivables financing agreements One of the issues we have grappled with is the extent to which legal interests should continue to be given priority over equitable ones Where the priority dispute is between a chargee and a third party which is not a chargee the existing rules will inevitably apply and the law equity divide will therefore be relevant But to what extent should it be preserved in the priority rules between chargees We have inserted a Rule 4 which does preserve the law equity divide in relation to financial collateral but not otherwise These are difficult areas and we look forward to a discussion of them It also deals with the circumstances in which an outright purchaser of an asset will take free of a charge This will generally be a matter
10. intangible assets Except for a transfer of receivables the benefit of an intangible asset for instance a contract cannot be transferred if it is prohibited by the terms on which the asset is created for instance the terms of the contract BD 23762705 v1 10 3 2 3 3 3 4 4 1 4 2 4 3 4 4 This is the case even if the prospective transferee is unaware of the restriction Whether or not the particular type of transfer concerned is prohibited by the terms of a contract is a matter of interpretation of the contract concerned The question is whether it is the object common intention of the parties that a transfer of that type is prohibited If the terms of a contract do prohibit the particular type of transfer concerned then a except for any transfer of receivables any purported transfer is to the extent of the prohibition invalid b the purported transfer is not of itself a breach of the contract by the transferor and c if the transferor has agreed to effect the transfer the invalidity of the transfer may result in a personal claim by the intended transferee against the transferor for breach of contract Contractual restrictions on transferring other assets The validity of a transfer is not affected by any other contractual restriction on transfer This is the case even if the transferee is aware of the restriction This does not affect any personal claim for breach of contract which the transferor m
11. moneys clause is also a matter of interpretation but section 20 contains another broad default rule which can also be contracted out of which is intended to give all moneys a broad meaning Part 5 The parties to a charge 28 29 The key point in part 5 is a limitation on the extent to which natural persons can create charges over their goods The Law Commission is currently conducting a review of the Bills of Sale legislation and this may therefore be overtaken by events On the assumption that it is recognised that consumers should not be able to create security over absolutely all of their assets the Code contains a suggested approach to charges over goods Again it is intended as a starting point for discussion The description of a chargee in section 24 reflects the current understanding and practice that the chargee can either be a creditor or a person such as a trustee who BD 23762705 v1 4 30 holds the charged asset on behalf of the creditor and this works well in practice In the so called extended liens case as part of the Lehman Brothers litigation Briggs J adopted a wider formulation This has not been adopted because of the uncertainties which it might create but it is something which is open for discussion It may be worth describing in the Code the default rules as to when if a debt is transferred the security transfers with it Part 6 The terms of a charge 31 32 The underlying pri
12. nciple must be that the parties should be free to determine the terms of their charge The only exception should be consumer cases This brief part therefore sets out skeletal default provisions in the expectation that these will invariably be amended by agreement Section 27 preserves the concept of the equity of redemption but does away with the doctrine of clogs on the equity of redemption which is an unnecessary extension of the concept which can create practical problems in commercial transactions Part 7 Registration 33 34 35 36 37 It is generally accepted in the profession that the registration of charges is worthwhile and effective The problem comes in trying to extend the current registration system from companies to other persons The approach which has been adopted under the PPSAs is that registration should apply to all chargors This has an appealing logical simplicity but it has meant the creation of new stand alone registration systems which can be complicated and expensive to establish and maintain The current company registration system works well in practice and the Code has been built around this The starting point of the Code is that registration of charges is important in commercial transactions and that it should be required unless there is a very good reason not to have to register But it accepts that what is required in a commercial context is not necessarily required outside it A
13. ons in section 245 of the Insolvency Act 1986 This only applies to floating charges and would therefore need to be reconsidered Cross border transactions 60 Cross border transactions are very important in practice and we think it is important that a Code should state the English conflict of laws rules on the validity of security 61 The issues here are complex not least the relationship with EU law and it has been decided not to put forward drafting at this stage but first to see if it is possible to reach a consensus on what is both feasible and desirable 62 The discussion will provide an opportunity to test the utility of the current rules and to see whether they can be improved For instance To what extent is the lex situs still an appropriate rule for goods Is the law of the place of registration a better test for goods which are the subject of an asset registry As a general principle should the law governing an intangible asset be the law which determines the validity and priority of security over that asset To what extent should failure to register a charge in the place of incorporation of a chargor affect security in other jurisdictions 63 EU law impinges on this area and any rules which are established would need to be compatible with the EU rules We look forward to a discussion of these issues BD 23762705 v1 9 2 1 2 2 2 3 3 1 ANNEXURE PART CONTRACTUAL RESTRICTIONS ON TRAN
14. ow to deal with this important practical issue Part 4 Secured obligations 24 25 26 27 Secured obligations are drafted broadly to include any obligation or liability of any kind One issue to be considered is whether this should be restricted to monetary liabilities not just primary obligations to pay debts of all kinds including future and contingent debts but also secondary obligations to pay damages The question is whether it is practicable to secure an obligation which is ultimately to do something other than to pay money In such a case it is not possible to establish the extent to which the secured assets are required in order to discharge the secured liability They would not be commensurable to use an expression coined in relation to the law of set off When you come to enforce how much do you enforce for In practice one of the most difficult issues concerning secured obligations is the extent to which a charge granted to secure a particular facility will extend to that facility as amended in a fundamental way This is ultimately a matter of interpretation but section 19 attempts to establish a broad default rule which can be contracted out of that the charge does extend even to fundamental amendments This is intended to benefit chargors as much as chargees In our experience the wish to avoid more documentation comes from chargors because they would generally have to pay for it The extent of an all
15. s Enterprise and Employment Act 2015 we decided not to do so but we have included some suggested drafting as an Annexure to this User Guide There is a tension under the current law between on the one hand giving effect to contractual restrictions on assignment which have been agreed by the parties and on the other allowing security to be created over valuable receivables Our suggested wording in the Annexure deals with this problem in two ways It allows a charge to be created even though there is a prohibition in the relevant contract But it also makes it clear that this will not affect the rights of the counterparty to the contract What the charge does is to give the chargee a proprietary interest in the event of the chargor s insolvency This is something with which the counterparty should not be concerned But where the counterparty is concerned for instance whom to pay how much and when the existence of the charge does not affect the counterparty at all It would be perfectly possible as now for the chargor to direct the counterparty to pay into an account with the chargee where the contract with the counterparty allows for such directions but this would not affect for example set off rights of the counterparty BD 23762705 v1 3 23 This is intended as a practical compromise solution to a problem which arises all the time in practice It is put forward for discussion to see if any consensus can emerge about h
16. ties are dealt with in part 8 and as has been mentioned above the distinction between legal and equitable interests has been retained and can therefore be used as a priority device to the extent it is thought appropriate The purpose of the Code is to simplify and clarify the existing law Charges are ubiquitous and that is the model which has been used Legal mortgages are used commonly for assets such as land ships and aircraft and the key distinction here is that registration in the asset registry determines priority That will not change The key distinction between pledges and charges is that the latter are generally registrable and the former are not This distinction is reflected in part 7 which is concerned with registration It would logically be possible to create a new form of charge which would sit alongside the existing security interests But that would not simplify the law it would complicate it If we are to have a Code we have taken the view that it needs to provide for one type of security interest The Code eschews formalities but accepts that other legislation may impose them In practice security arrangements are written down but we have not required this The reasons are practical as anyone having to deal in practice with the formal requirements for the creation of guarantees will understand It also continues to allow chargors to grant informal possessory security Part 3 Charged assets 15 This part
17. uld be an addition to an existing system of registration not the creation of a wholly new one The registration system which is described in part 7 is based on the current system of registration at Companies House with suggested improvements and simplifications There has been discussion of whether rent charges should continue to be registrable If it were thought appropriate to exclude them that could be dealt with in the Code Part 7 does one other thing In section 37 it enables but does not require the registration of receivables financing agreements such as factoring and invoice discounting agreements These are not treated in the same way as charges Registration is not a requirement of validity It would be voluntary system of registration which could be used by receivables financiers in order to improve their priority position which is discussed under part 8 below This is an issue which has been discussed for some time The purpose of section 37 is to enable us to assess its practicality The Code is mostly concerned just with the law of England and Wales But since the registration provisions of the Companies Act apply throughout the United Kingdom it BD 23762705 v1 6 would be necessary to ensure that the changes are compatible with the laws in Scotland and Northern Ireland and acceptable in those jurisdictions Part 8 Priorities 45 46 47 48 49 50 51 52 The current priority rules in Englan
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