Part IX

Security interests created by non-corporate debtors: the need for reform

                    9.1               In Part III we considered the need for reform to the company charges registration scheme, and discussed a number of factors that we considered to be weaknesses, including the failure of the current scheme to fulfil efficiently the functions that are now attributed to it. This Part considers whether there is a need to reform the law relating to the creation and registration of security interests over property other than land by non-corporate debtors. It is our provisional conclusion that there is such a need. Although we are able to set out the problems quite shortly, we are of the view that they are significant ones. Some of them are similar to criticisms we made in the context of company charge registration (such as the ‘invisibility’ to third parties of the existence of certain transactions).

Complexity of the existing law

                    9.2               We have noted that the granting of security by non-corporate debtors is in many cases covered by the Bills of Sale Acts. As can be seen from Part VIII, even a brief consideration of this legislation reveals it to contain a complex mass of technical requirements, failure to comply with which results in severe consequences for the creditor, who will find its security avoided. The problems may be exacerbated by the fact that the Bills of Sale Acts relate not just to registration (as with the scheme under the Companies Act 1985) but also to the form the bill is required to take.

                    9.3               There has been criticism of the way the Bills of Sale Acts operate for many years. Even within just a few years of the introduction of the 1882 Act the legislation was drawing adverse judicial comment:

to say that ‘the Bills of Sale Act (1878) Amendment Act (1882)’ is well-drawn, or that its meaning is reasonably clear, would be to affirm a proposition to which I think few lawyers would subscribe, and which seems to be contradicted by the mass of litigation which the Act has produced and is producing every day. For my own part, the more I have occasion to study the Act the more convinced I am that it is beset with difficulties which can only be removed by legislation.[1]

                    9.4               Over 80 years later the Crowther report was equally critical:

It is difficult to imagine any legislation possessing more technical pitfalls than the Bills of Sale Acts, particularly in relation to security bills of sale.[2]

To have strict, detailed requirements as to form, and a registration system needing the presentation of attestations and affidavits, all upon pain of the avoidance of the bill in the case of error not only as between grantor and third parties but also grantor and grantee is, in our view, far too complicated an approach to be compatible with a modern economy. It is not necessary to achieve what we indicated in Part III should be the aims of a modern registration system.[3] It is our clear provisional view that the criticisms outlined in the courts and in the Crowther report have much force, and would in themselves justify giving serious consideration to reform.

Compatibility with the ECHR

                    9.5               We noted in Part III that one of the concerns the Steering Group expressed in its Final Report was whether the sanction of invalidity under the scheme of registration of company charges was compatible with the Convention rights given under the ECHR and applicable to the scheme of registration by virtue of the Human Rights Act 1998.[4] We expressed doubts in that case as to whether such criticism was justified. However, a similar - but more serious - question mark hangs over the provisions of the Bills of Sale Acts that result in a security bill being void absolutely in the case of non-compliance with the statutory requirements. It is very hard to see how invalidating an incorrectly registered security agreement as against the debtor (and not just as against third parties) is proportionate to the risk that a third party might have been prejudiced by an incorrect registration, or even a complete failure to register. This is particularly so where the requirements of the registration process are complicated and detailed, and thus more easy to get wrong, as with the Bills of Sale Acts.

Difficulty in obtaining finance for unincorporated businesses

                    9.6               Criticism of the existing law under the Bills of Sale Acts is not merely a question of inaccessibility. The complexity of the current law has more serious consequences. It is our understanding that bills of sale are seldom used:[5] this is almost certainly the result of the technical difficulties that we have referred to.[6] The result is that sole traders, partnerships and other unincorporated businesses are in practice unable to create fixed charges over goods they own.

                    9.7               Moreover, the impossibility of taking a bill of sale over after-acquired property[7] prevents any unincorporated business from creating a floating charge, whichis an additional handicap to the raising of finance.

                    9.8               Thus it can be said that the need to comply with the rigid and complicated system set out by the Bills of Sale Acts, together with the draconian consequences (for the lender) of non-compliance, means that there are difficulties for sole traders or unincorporated businesses in obtaining finance.[8] In New Zealand at least it has been suggested that the result of the old law was that lenders put pressure on businesses to incorporate:

many banks require sole traders to incorporate, so that the debtor is able to give the bank a debenture creating fixed and floating charges, which unnecessarily increases the number of companies on the register.[9]

                    9.9               In considering the question of whether the difficulty in raising finance facing non-corporate debtors is something that would justify reform, we need to separate the position of consumers from that of businesses.

Consumers

                9.10               The 1882 Act, which is responsible for at least some of the technicalities in registration and for the ban on bills covering after-acquired property, was conceived as what would now be called a consumer protection measure.[10] It was designed to prevent persons of modest means from improvident arrangements by, amongst other things, mortgaging goods they do not yet own. This restriction may well have contributed to the growth of other types of agreement such as hire-purchase, but these are considered to be less harmful to consumers, as the supplier’s rights are normally in goods supplied on credit (that is, purchase-money credit)[11] and, secondly, are limited to those goods.[12]

                9.11               Some of the protection given by the1882 Act has been eroded by inflation: the ban on bills of sale for under £30 is now practically meaningless.[13] However the ban on charging after-acquired property remains and, as far as consumers are concerned, probably should continue to do so. Some of the schemes adopted or proposed overseas either prevent consumers charging after-acquired personal property or prevent such security interests attaching without specific appropriation.[14] We therefore do not regard the ban on charging after-acquired property to be unduly restrictive in the case of consumers. Whether the law should be even more restrictive and prevent consumers from creating security interests over existing personal property is a question to which we return in Part X.

Sole traders and partners

                9.12               In contrast to consumers, we see no case for excluding sole traders, partners or other non-corporate borrowers from creating charges over either existing or after-acquired property, or from creating floating charges over their property. The Cork Committee[15] recommended in 1982 that, if reforms to floating charges were made in the way advocated in its report, individuals should be able to create floating charges. However, it recommended that such a floating charge should not extend to the whole of the debtor’s property and assets (so as to include even those that would be retained by the debtor on an insolvency): the power of an individual to create a floating charge should not be greater than that necessary to enable a trader to charge the whole of his business undertaking. Consequently, such a charge should not be capable of extending to any property or assets not used or acquired for use in connection with the debtor’s business, trade or profession.[16]

                9.13               It seems particularly anomalous that partnerships, which may now in some cases be of unlimited size,[17] are unable to create floating charges and practically unable to create fixed charges over goods.[18] It is true that partnerships of professionals will not hold goods as stock-in-trade, and that goods that they are using can effectively be made the subject of quasi-security interests by obtaining them under finance leases or on hire-purchase. However, it seems to us that there is no reason why other forms of business that do have capital locked up in goods should not be able to use the partnership form and yet use those goods as security. The law of security should be neutral as between business forms.[19]

Invisibility of charges and quasi-security

                9.14               We noted in Part III that one of the problems of the registration scheme for companies was that only those charges that were on the list set out in the Companies Act 1985 had to be registered. A security interest that was taken in a form not on the list did not have to be registered, which consequently meant that third parties might not be able to find out about the existence of that interest from a public source. Outside the scope of traditional securities, most quasi-securities are also not registrable, and thus risk being ‘invisible’ to other possible creditors or purchasers.

                9.15               Similar criticisms can be made in the case of security interests created by non-corporate debtors. The Bills of Sale Acts apply in the case of goods and general assignments of book debts, and in theory should give public notice of the securities concerned;[20] but though a non-corporate debtor is able to create a fixed charge over receivables, the charge may not be registrable, and it is thus hard for subsequent creditors to discover its existence.

                9.16               The criticisms that we made of the lack of a functional approach to registration of company charges also apply in the case of non-corporate debtors. Quasi-securities (with the exception of general assignments of book debts) are not registrable against a non-corporate debtor any more than they are against a company. We are not aware of complaints that this presents a misleading picture of the financial position of non-corporate debtors in particular. However, the information that certain apparent assets of an unincorporated business are subject to security interests in favour of third parties seems just as useful to potential creditors as it is in the case of a company. A charge over goods owned by a non-corporate debtor to secure an overdraft would need registration as a bill of sale, a sale and lease-back of the same goods would not. The secured nature of the latter transaction would again be invisible to someone searching the bills of sale register.

                9.17               In some cases it is of course possible to discover whether a non-corporate debtor has created a security interest, in the broad sense, over some specified assets.[21] Thus hire-purchase and conditional sale agreements over vehicles will normally be registered with HPI. A similar scheme now also covers caravans, motorhomes and boats.[22] Security interests over ships and aircraft, however, are registrable only if they amount to charges.

conclusion

                9.18               It is our clear provisional view that the current law relating to security interests created by non-corporate debtors is in need of reform. The combination of a complicated and restrictive scheme of registration with the draconian consequences for non-compliance seems to us to be out of date and unfair. In addition, the current law unnecessarily fetters the ability of unincorporated businesses to raise finance. Provided safeguards are put in place to protect consumers (which we discuss in Part X), there seems to be no reason why the ability of a partnership or a sole trader to raise secured finance should be significantly more restricted by the law than that of a company.

                9.19               We ask whether consultees agree that the existing law applying to the registration of security and quasi-security interests by individuals and unincorporated businesses is in need of reform because it:

                                                   (1)       is unnecessarily complex;

                                                   (2)       is potentially in compatible with the ECHR;

                                                   (3)       makes it difficult for businesses and individuals to create fixed charges;

                                                   (4)       makes it impossible for unincorporated businesses to create floating charges; and

                                                   (5)       fails to give adequate public notice of security and quasi-security interests created by unincorporated debtors.

Where they do not so agree, we ask them to explain why.