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You are here: BAILII >> Databases >> The Law Commission >> Company Security Interests (Report) [2005] EWLC 296(Exp_Notes) (August 2005) URL: http://www.bailii.org/ew/other/EWLC/2005/296(Exp_Notes).html Cite as: [2005] EWLC 296(Exp_Notes)

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EXPLANATORY NOTES

PART 1 INTRODUCTION

Citation and Commencement

Regulation 1 Citation and Commencement

The title 'Company Security Regulations' reflects the fact that the Regulations apply not only to charges but also to pledges (dealing with their priority as against charges) and to sales of receivables.

Scope of the Regulations

Regulations 2-4 deal with the scope of the Regulations.

Regulation 2 Companies registered in England and Wales

The scheme applies to charges over the assets of a company registered in England and Wales, and to sales of its receivables.

It is immaterial whether a charge that is created by a company secures its own obligation or those of a third person (regulation 6(5) 'debtor'). It is equally immaterial whether or not the chargee is a company. For the purposes of the Regulations, a person who holds security as trustee for a number of others is treated as the chargee (regulation 6(5) 'chargee').

The Regulations apply wherever the asset is situated (whether physically or, with intangible assets, according to the rules of private international law). In this the Regulations follow the Companies Act 1985, section 395. However regulation 2(2) reflects the position in practice that interests recognised by the law of the place where the asset is 'situated' will be frequently be given effect by that law regardless of whether the charge should have been registered in England and Wales. (Under current law this is required when article 5 of the Insolvency Regulation^[1] applies.) Note that the Regulations are subject to various exceptions set out in regulation 4.

This regulation includes the definition of 'receivables', since the sales of receivables by companies registered in England and Wales will need to be registered to be effective (regulation 20). Priority will depend on date of registration (regulation 24.) The definition is a deliberately narrow one. The requirement to register sales of receivables applies only to the kinds of monetary obligations that are commonly sold by companies to factors or discounters. It does not apply, for example, to rent or payments under mortgages or credit card loans. However, a charge over any form of receivable is within the scheme.

Regulation 3 Other companies

Charges created by a company registered outside Great Britain over assets in England and Wales will come within the scheme whether or not the company has a branch or a place of business in England and Wales. Such charges will need to be registered in order to be effective in insolvency (unless exempted from registration). Similarly, their priority as against other security and as against a person who buys the property subject to the charge will be governed by the scheme. There will be special provisions for goods that are subject to a charge when they are brought into England and Wales (regulation 21). However, to reduce the uncertainty over aircraft and ships that are likely to move in and out of the country frequently, special rules apply to registered aircraft and registered ships. They will be regarded as situated in England and Wales if they are registered in the UK, and as not situated here if they are registered abroad, regardless of their physical location.

Implementation of the Scottish Law Commission Report on Registration of Rights in Security by Companies (Scot Law Com No 197, 2004) will mean that, under Scots law, the text of floating charge deeds must be registered in a Register of Floating Charges. Charges created by Scottish companies will not be registered with the Registrar of Companies. Under regulation 3, to enable those dealing with the company's assets in England and Wales to discover whether the assets are subject to a charge, the charge will be registrable in the same way as a charge created by a company registered outside Great Britain.

The provisions on sales of receivables do not apply to a company registered outside England and Wales, whether or not the company has registered a branch or place of business in Great Britain.

Regulation 4 Exceptions

With the introduction of electronic conveyancing, it will become unnecessary for registered charges over registered land to be registered also at Companies House. The Land Registry already has the power to forward information about such charges to Companies House. Under the scheme, information will be forwarded routinely and made be available to those searching the Company Security Register. The scheme applies to such charges only to the extent that it deals with competing priorities between these and other charges over the land (regulation 25).

Liens and charges created by operation of law (regulation 4(1)(a)) are also outside the scheme, save that their priority as against other charges is dealt with by regulation 31.

The scheme contains a special exemption for Lloyd's Trust Deeds (see regulation 4(1)(g)). When a corporate member joins Lloyd's it is obliged to enter into several categories of trust deed to ensure that funds are available to pay policy-holders, and these are currently registrable as charges although most of the registrations serve little useful purpose.

Under the Regulations, the "Lloyd's Deposit Trust Deed" or "Lloyd's Security and Trust Deed" created by each corporate member will continue to be registrable. This will serve as a warning to all concerned that the company is a corporate member of Lloyd's and will probably have entered other trust deeds. Other trusts deeds will cease to registrable. Charges other than trust deeds created by corporate members will need to be registered in the normal way.

Regulation 4(1)(b)-(e) exempt from the scheme various types of sale of receivable that are not connected to receivables financing.

PART 2 REGISTRATION OF CHARGES AND SALES OF RECEIVABLES

Regulation 5 The Register

Regulation 5, with the remainder of Part 2, sets up a register for company charges and sales of receivables that can be wholly electronic. Part 2 will be supplemented by Rules to be made by the Registrar under powers to be conferred by the Company Law Reform Bill.

Registration will be effected by 'filing' a 'financing statement'. The way that this will work is described below.

Regulation 6 Financing statement

It is envisaged that the Rules will require a person wishing to register a charge or sale of receivables (who will normally be the chargee or buyer, or its agent) to contact Companies House to be authorised to use the system, if it has not done so before. (This may involve, for example, setting up payment arrangements and giving an email address that the Registrar may use for communicating with the person.)

The person will then 'file' a 'financing statement' on-line (either via the Company Security Register's website or under direct arrangements made by the Registrar and the filing party). The financing statement must contain information in each of the fields listed in regulation 6(2) and the confirmation required by regulation 5(3) must be given. It is envisaged that the system will provide an automatic check that both the name of the debtor and its registered number are given and that they match each other. If they do not, or if no number is given, the filing will not be accepted until the party filing either enters a matching name and number or confirms that the company is an oversea company that has not registered a branch or place of business in Great Britain.

Once this is done and arrangements have been made for payment of the fees, the system will accept the filing. The date and time will be recorded on the financing statement and it will be given a number. From that moment, the financing statement will be 'registered' (regulation 7(1)). Subject to regulation 9, the charge or sale will then be registered unless the registration ceases to be effective because it was for a limited period that has expired or because it has been discharged.

A filing may be made before the charge agreement or sale agreement has been made. This enables a financier engaged in negotiations with the company to protect its priority. It also makes it unnecessary to file more than once for repeated transactions with the same company over similar collateral. This is important in receivables financing, where there may be many separate sales under a single agreement that does not itself constitute a sale.

A party filing will be required to confirm that either there is a charge or sale agreement or the company has consented to the filing. An incorrect confirmation will expose the filing party to liability in damages to the company for any loss it suffers as a result, unless the party filing can show that it had a reasonable excuse for its mistake. A filing made without an honest belief that there is an agreement or that the company has consented to the filing will lead to criminal liability under general provisions envisaged in the Companies Bill. The company named as debtor will be able to secure the removal of any incorrectly-made filing under regulation 16.

Regulation 7 When registration is effective

The financing statement is registered at the moment that the system assigns a number to it; the date and time will also be recorded. The date, time and (if necessary) the number will often determine questions of priority (for example, regulation 24).

Regulation 8 Verification statement

Once the financing statement has been registered, a verification statement will be sent to the person filing at the address given, and to the company identified as the debtor in the financing statement. In the case of a company registered in Great Britain or that has registered a branch or place of business in Great Britain, the 'verification statement' will be sent by the Registrar, either by email or by post, to the company's registered address (or such other address as the company may have provide for the purpose). In the case of other companies, the party filing will be obliged to send a copy of the verification statement to the company, and will be liable in damages to the company for any failure to do so (regulation 17(2)).

Regulation 9 Errors in financing statement

The system will check that the name and number given for the debtor company match (see above). However, it will not check the accuracy of any other information on the financing statement. If the financing statement has identified the wrong company, it will not be effective to register the charge or sale of receivables. This is because a search using the correct name and number would not reveal it.

With oversea companies that have not registered a branch or place of business in Great Britain, it is envisaged that those searching the register will be able to ask for 'near misses'. A registered financing statement that gave an incorrect name will be effective to register the charge unless a search using the 'near miss' facility would not have revealed the financing statement.

A mistake in the other fields will not invalidate the registration save that the charge will not be effectively registered in respect of collateral that was omitted from the description of the collateral.

Regulation 10 Additional statements

Subsequent changes to a financing statement (such as to add or delete collateral or to discharge it altogether) will be made by filing an 'additional statement'. This will have to contain the number allocated to the financing statement that is being amended. A search will then reveal not just the original statement but any additional statements that have amended it. It is assumed that, after a while, discharged financing statements will be removed to an 'archive' file so that a search will not reveal them unless the searcher specifically asks for 'archived' material.

It is envisaged that the party who files will be issued with a personal identification number that will enable it to access the system to file additional statements. Where a party attempts to extend the period of registration or add to the security, it will be asked to confirm that this is in accordance with an existing security agreement or that the debtor has consented to the change. The sanctions will be as described under regulation 6, above.

In certain circumstances the debtor will also be able to effect changes by means of an additional statement (regulation 16).

Regulation 11 Extension or discharge of registration

Registration of a financing statement that was limited to run only until a particular date may be extended by the party who filed by means of an additional statement.

Regulation 12 Amendment of financing statement

See regulation 10, above.

Regulation 13 Notice of transfer

Where a charge is assigned by the chargee to another person, it is not necessary to file an additional statement. However, it may be convenient for all concerned that the new assignee is recorded as the chargee so that enquiries and notices are sent direct to it. The same is true if the benefit of an agreement to sell receivables is assigned, for example by one factor to another. It is therefore provided that the transfer may be recorded.

Regulation 14 Notice of subordination

The same is provided where the parties enter a subordination agreement.

Regulation 15 Searches

Regulation 15 provides for searches, including the criteria by which searching must be made possible. For the significance of this see regulation 9, above.

Regulation 16 Debtor etc may require additional statement

If the information shown in a registered financing statement is inaccurate (for example it refers to collateral not covered by the charge agreement), the debtor may demand that it be corrected. Similarly if the secured obligations have been discharged, the debtor may demand that the financing statement be discharged. If the company shown as the debtor has not entered a charge agreement with the person who is named as the chargee, or on whose behalf the financing statement was filed, it can demand that the registration be removed. Where the person was incorrectly identified as one of several debtors, the person wrongly identified can have its name removed, leaving in place the registration against other parties who were correctly named as debtors.

It is envisaged that in most cases the debtor will make its demand by entering on the system a 'requirement' notice, setting out what change is required. This will be sent to the party shown as chargee, or its agent, on the financing statement at the address shown. Within 15 days the recipient must either file an additional statement in accordance with the requirement notice or commence court proceedings and notify the Registrar that it has done so. Failing that, the debtor will be empowered to make the change demanded in the requirement notice. If proceedings have been commenced, the Registrar will mark the financing statement as contested. The financing statement will remain registered until the Registrar is notified of the court's order. However, where 90 days (or such longer period as the court may order) elapses without an order being obtained or the proceedings are dismissed or discontinued, the debtor will be empowered to make the change demanded.

Where the chargee is merely a trustee for others (for example, for a group of lenders), the procedure will not apply, because an oversight by the trustee might lead to the beneficiaries losing their security through no fault of their own. If the financing statement indicates that the chargee is a trustee (which will be optional), the person named as debtor will need to obtain a court order to have the financing statement amended or discharged.

Regulation 17 Entitlement to damages for incorrect filing, etc

If a financing statement has been filed when there is no relevant agreement or the debtor has not consented to the filing, and the party filing had no reasonable excuse, the party who filed will be liable in damages to the company identified as the debtor.

A party who files a financing statement against a company that is not registered, and has not registered a branch or place of business in Great Britain, must forward the verification statement to the company (regulation 8). If it fails to do so without a reasonable excuse it will be liable in damages to the company.

Regulation 18 Requirement to notify Registrar about appointment of a receiver

This provision replicates the effect of the Companies Act 1985, section 405.

Regulation 19 Filing is not notice

Some provisions (regulations 21, 24, 28, 29, 35 and 38) refer to whether a party knew of a fact. Regulation 19 has the effect that registration of a financing statement does not give anyone 'constructive' notice of the existence of any charge to which it refers, or of the contents of the financing statement. Under the regulations, the priority of a registered charge against another registered charge or a pledge, for example, generally depends on the date of registration. Its effect against a buyer depends on whether it was registered and on the buyer's knowledge. In neither case does the outcome depend on 'constructive notice' of what has been registered.

PART 3 EFFECTIVENESS OF CHARGES, ETC

Regulation 20 Effectiveness of a charge or a sale of receivables in insolvency proceedings

Unless a charge is exempt from registration, it will not be effective against the company's administrator or liquidator unless it has been registered before the onset of insolvency (regulation 20(1)). The charge will also be ineffective as against execution creditors (regulation 20(4)). (It will also be at risk of loss of priority to subsequent charges and pledges and ineffective against a buyer who does not know of it, see regulations 24 and 28. On charges that are registered in the 'run-up to insolvency', see regulation 45.)

A charge of any description and over any type of property falls within this regulation unless specifically exempted. The principal exemptions are for charges over:

financial collateral of which the chargee has 'control' (see regulation 36);

registered land where the charge has been registered at the Land Registry (see regulation 4); and

'supporting obligations' such as guarantees and letters of credit, which will be treated as if they are registered when the charge over the principal obligation has been registered.

If as the result of the debtor company disposing of the collateral the chargee becomes entitled to the proceeds of disposition, its rights to the proceeds will be effective without separate registration (unless its right arises only because of the terms of a floating charge). The same applies if the collateral is damaged or destroyed and the chargee is entitled to the insurance proceeds (regulation 20(1)(c)).

The scheme extends the same treatment to sales of receivables. (For the definition of receivables see regulation 2.) There is one exception, to guard against accidental oversight by those not regularly engaged in receivables financing. Under regulation 20(2) it is not necessary to register a sale of receivables that is of such a small proportion of the company's receivables that its sale will not be significant to the decision of a subsequent receivables financier or unsecured creditor as to the extent of funds or credit that should be advanced to the company.

Regulation 21 Charges over imported goods

Under regulation 3, charges created by Scottish and oversea companies over their assets in England and Wales will be subject to the scheme. When goods that are subject to a charge are brought into the jurisdiction, the charge will need to be registered if they remain here for more than 60 days. Otherwise it will be ineffective in the Scottish or oversea company's insolvency. Until the charge has been registered, it will be vulnerable to loss of priority and will be ineffective against a buyer who does not know of it (regulations 24 and 28). Special treatment is accorded to registered aircraft and registered ships (regulation 3).

Regulation 22 Pledge treated as charge if collateral made available to debtor

Although generally a pledge requires that the pledgee retain possession of the pledged property, it has been held that if the property is released to the debtor under a 'trust receipt' or similar arrangement (for instance to allow the debtor to sell the property) the pledge continues. The pledgee is also entitled to the proceeds of any disposition the property. Regulation 22 treats such arrangements as a charge which, if it is to be effective in the debtor company's insolvency, must be registered within 15 days (unless the property is returned to the pledgee within that time). Until the charge has been registered (which may be done in advance of the arrangement, see regulation 6), a buyer who does not know of it will take free of it (regulation 28) and it will be vulnerable to loss of priority (see regulation 24).

Regulation 23 Attornment by debtor

A pledgee may take 'possession' of property that is in the physical possession or custody of a third person (for example, a warehousing company) if the third person agrees with the pledgee to hold to its order ('attorns' to the pledgee). There is authority that there may be a pledge where the debtor itself has physical possession or custody and attorns to the pledgee. (If the arrangement is in writing it is registrable as a bill of sale.) The arrangement may mislead others dealing with the debtor into believing that the property in the debtor's possession is unencumbered and under these Regulations it is treated as a charge.

PART 4 PRIORITY

Priority rules

Regulation 24 Residual rules

Regulation 24 sets out the rules that govern priority between charges and pledges over property other than financial collateral (regulation 36) and sums due under letters of credit (regulation 26). The rules also apply to the priority of sales of receivables. The fundamental principles are that priority of a charge or a sale of receivables dates from the date of registration of a financing statement covering the charge or sale. This may be before the charge has been created or the sale has taken place (regulation 6). The priority of a pledge dates from when it was created, which requires that the pledgee has possession (regulations 22 and 23). For this purpose, a contractual lien is considered to be a pledge (regulation 42). Charges over supporting obligations that have not been registered separately will have the same priority as the charge over the principal obligation.

The priority of a charge will apply to all advances made under the charge, including those made after the chargee has notice of a subsequent charge. This is not confined to advances that the chargee is under an obligation to make. However advances made without any obligation to do so after the chargee has notice of the interests of an execution creditor will not have priority over the interests of the execution creditor (regulation 24(11)).

Priority from date of registration of the financing statement will apply to floating charges as well as fixed charges, so that it will no longer be necessary to employ negative pledge clauses to protect the priority of a floating charge. Consequential amendments will be made to Insolvency Act 1986 to clarify the effect on preferential creditors and the fund for unsecured creditors (see regulation 45).

Regulation 25 Conflict with transactions registered in specialist registers

Charges over certain types of asset may be registered in specialist registers. These include:

registered aircraft

registered ships

unregistered land (for registered land, see below)

patents

registered designs

registered trademarks.

Registration in the specialist register is not required to preserve the effectiveness of the charge in the debtor company's insolvency. However, it may be needed to create a legal mortgage or to preserve the priority of an equitable mortgage or charge against a subsequent purchaser or chargee. In these cases, the charge will also have to registered in the Company Security Register if it is to be effective in the debtor company's insolvency. Regulation 25 provides that the priority of charges over such assets will be governed by any rules set out in the relevant enactment rather than by the date of registration in the Company Security Register.

Regulation 25 applies the same rule to charges over registered land registered in the Land Register, which do not require registration in the Company Security Register (regulation 4).

In some cases the enactment establishing the specialist registry does not lay down rules governing the priority of charges registered in it but leaves it to general law. For example, the priority of equitable charges over registered land is not affected by registration at the Land Registry. Here the rules of the Company Security Regulations will apply. Thus as between two equitable charges over registered land, if neither charge is registered at the Land Register, priority will depend on which financing statement was first registered in the Company Security Register. If one is covered by a financing statement registered in the Company Security Register and the other is registered in the Land Register, priority will depend on which registration took place first.

Regulation 26 Sums due under letters of credit

A charge may be taken over an obligation that is supported by a letter of credit. The chargee has an implied right to the sums due under the letter of credit and the scheme provides that the charge over these need not be registered separately from the charge over the principal obligation. Under regulation 24 above, the charge over the supporting obligation will have the same priority as that over the principal obligation. However it is possible that the principal obligation may be subject to competing charges (probably by accident, for example if the company assigns a particular receivable forgetting that it is already the subject of a general charge over receivables, or vice versa). In this rather particular context, regulation 26 provides that the chargee who notifies the issuing bank or the confirming bank (a 'nominated person') will have priority over one who has relied merely on registering the charge. The bank will normally have to pay the sum due to the party that first notified it; regulation 26 ensures that this will be the party who has priority.

Transfers

Regulation 27 Priority of charges in transferred collateral

If a company acquires property that is subject to a charge, that charge will still be effective though it is not registered against the name of the acquiring company (provided that, if the charge was originally created by another company, the charge was registered against that company). Regulation 27 ensures that the charge will have priority over any charge that already exists, or that is created later, over the property of the acquiring company. (There is in effect an exception in those cases related to financial collateral in which the chargee's interests may be overriden in order to preserve the ready transferability of financial collateral, see regulation 38.)

Regulation 28 Transfer of collateral free of unregistered charge

A purchaser of property that is subject to a charge (other than a purchaser by way of security and a buyer of receivables: see regulation 28(5)(b) and regulation 24 above) will take free of an unregistered charge unless the purchaser knows of the charge. If the charge is a floating charge, the purchaser will take free unless it also knows that disposition is in breach of the charge (regulation 28(3)), and the same rule is applied to transferees of negotiable instruments and negotiable documents of title in order to maintain their ready transferability (regulation 28(2)).

Regulation 29 Circumstances in which transferee takes collateral free of registered charge

A buyer of the property subject to a registered charge will take subject to the charge unless the disposition is specifically authorised or the charge is a floating charge. The buyer of property subject only to a floating charge will take free unless it knows that the sale is in breach of the charge. In practice this will rarely happen unless a receiver has been appointed or the company has ceased trading or is in administration or liquidation.

Regulation 29 applies to a charge that was created as a floating charge. There is some uncertainty over what happens if a chargee takes a fixed charge and then permits the chargor to dispose of the property without obtaining consent on each occasion. This may make the fixed charge wholly ineffective or it may transform it into a floating charge. Regulation 29(2)(b) covers the latter possibility.

Regulation 30 Protection of transferees of money, negotiable instruments etc

This saving provision preserves the protection the law currently provides to recipients of money and funds transfers, holders in due course of negotiable instruments and holders of negotiable documents of title.

Miscellaneous

Regulation 31 Priority: liens

This preserves the current rule that a lien or charge that arises by operation of law has priority over a charge over the same property.

Regulation 32 Distress for rent or rates

Regulation 32(1) preserves the priority of a landlord's right to distrain on goods over a charge on the same goods. Regulation 32(2) provides that a local authority's rights to distrain on goods for unpaid rates will be subject to a registered charge. Under current law the local authority is in principle entitled to distrain if the charge is a floating charge that has not crystallised. In practice the floating charge will normally include an 'automatic crystallisation clause', causing the charge to crystallise as soon as any attempt is made to distrain. Such clauses defeat the local authority's right. Thus this Regulation reflects the practical position.

Regulation 33 Effect on priority of mistaken discharge of filing

It is possible that a registered financing statement may be discharged by accident, either by the secured party or by an agent acting for it. That will have the result that the charge will not be effective in insolvency or affect a buyer. It will also lose priority to any subsequently registered charge. However, if the mistake is picked up and corrected within a short period, it seems harsh that the chargee should lose its priority even against charges that, before the discharge, were subordinate to it. Those chargees are very unlikely to have acted in reliance on the discharge. Therefore regulation 33 provides a 30-day grace period in which the discharged filing can be re-activated (by means of a further additional statement) without loss of priority as against the previously subordinate charges. This is without prejudice to further advances made before the re-activation (regulation 33(2)).

Regulation 34 Voluntary subordination

The purpose of regulation 34 is to make it clear that it is always possible for a chargee to subordinate its rights to what would otherwise be a junior charge (or sale of receivables). This may be done, for example, by an agreement between the senior and junior creditors; or the charge agreement may permit the creation of charges that will rank above it in priority.

Consequential amendments will be made to Insolvency Act 1986 to clarify the effect of a subordination agreement on preferential creditors and the fund for unsecured creditors. See the notes to regulation 45.

Regulation 35 Rights of assignees

Regulation 35(1)-(4) ensure that the new rules of priority do not affect the existing law

(1) on when an account debtor may, as against an assignee, rely on defences and set-offs that it has against the assignor; and

(2) that a debtor who pays the assignor before it has received notice of the assignment will discharge its obligation by doing so, but after receiving notice of assignment must pay the assignee.

Regulation 35(5) applies to contracts that create receivables, defined narrowly to cover only those debts commonly subject to factoring or discounting agreements. The regulation provides that a term in the contract purporting to prohibit or restrict assignment of the receivable (other than an assignment in part) will not be effective against the assignee. This removes a common (but often unintentional) obstacle to receivables financing.

PART 5 FINANCIAL COLLATERAL

This Part applies only to financial collateral, which needs separate treatment in order:

(1) to comply with the requirements of the European Directive on Financial Collateral Arrangements^[2] ('the Financial Collateral Directive' or 'FCD') and the Financial Collateral Arrangements (No 2) Regulations 2003^[3] ('FCAR') which implement the FCD, and

(2) to ensure that investment property is freely transferable without the need for the purchaser (whether intending buyer or secured party) to make investigations as to whether the property is subject to a charge.

In outline, the FCD provides that when financial collateral subject to a 'security financial collateral arrangement' (that is, a mortgage, charge or pledge) has been 'provided' in such a way as to be in the 'possession or control' of the 'collateral-taker', formalities such as registration cannot be required in order to render the arrangement enforceable (art 3).

(The FCD also requires that certain remedies must be available (unless otherwise agreed) and remain so notwithstanding winding-up or re-organisation of either party (art 4); that agreed rights of use must be available (art 5); and the arrangements must be exempted from certain effects of insolvency law (art 8). These aspects of the FCD are not affected by the Company Security Regulations. Nor are 'title-transfer collateral arrangements', such as 'repos', to which the FCD also applies.)

The FCD does not define what is meant by 'possession or control', and it does not deal with the priority of security interests over financial collateral or the rights of buyers. The Company Security Regulations provide guidance as to when charges over financial collateral need not be registered. They also set out rules of priority as between competing charges and other forms of security, and as between a security interest and the interest of a person who purchases the financial collateral not knowing of a charge over it.

Regulation 36 Effectiveness of charges over investment property or cash in insolvency proceedings

Like charges over other forms of collateral, a charge over financial collateral will be effective in the debtor company's insolvency if it is registered. However, as an alternative to registration the chargee may take control of the financial collateral. Not only will taking control render the charge effective in the company's insolvency; it will confer advantages in terms of priority.

The FCAR do not provide a definition of 'possession or control'. The recitals to the Directive indicate that the chargee will not have 'possession or control' if the debtor company remains free to dispose of the collateral free of the charge. It is widely agreed that if the debtor company is no longer free to dispose of the collateral free of the charge (often described as the chargee having 'negative control'), that amounts to 'possession or control' within the FCD. The Law Commission is as confident as it can be that this is the correct test to apply. However it is advised that it cannot rule out the possibility of the European Court of Justice adopting a more liberal interpretation. For example, the ECJ might hold that a party has 'possession or control' if it is in a position to realise the company's investment property at short notice, even though the debtor meanwhile remains free to deal with the collateral. (In English law this would amount to a form of floating charge.) It has therefore proved impossible to provide a definition for the purposes of the Directive without the risk that parties to arrangements that relied on the definition might be deprived of the rights (for example, in insolvency proceedings) that they must be given under the FCD. Conversely, they might receive preferential treatment that is not justifiable under the Directive.

Nonetheless, the Regulations give guidance on when a charge need not be registered. They provide that it need not be registered when either it is a 'security financial collateral arrangement' (that is, the chargee has 'possession or control' and the arrangement is evidenced in writing) within the meaning of the FCD (whatever that means) or it has control within the meaning set out in detail in regulation 40. A chargee who obtains control within the terms of regulation 40 can be confident that the charge will not be ineffective in insolvency for want of registration. It is also widely agreed that the chargee who complies with regulation 40 or 41 will have done sufficient to have 'possession or control' within the meaning of the FCAR and thus to gain the various advantages offered by the FCD. It is possible that a party who has merely taken steps that do not meet the tests set out in regulation 40 may also be held to have satisfied the requirements of the FCD. It would then be entitled to the same advantages, including its charge being effective in the debtor's insolvency though not registered. Whether a chargee wishes to take the chance that a more liberal interpretation of the FCD is correct is a matter for its legal and commercial judgement.

The test of 'control' laid down in regulation 40 is also used to determine issues of priority under regulation 39.

Regulation 37 Automatic charge in favour of intermediary etc

It may happen that an investor buys indirectly-held financial assets through an intermediary, which credits them to the investor's account before the investor has paid the intermediary. The intermediary will have an automatic fixed charge over the assets. The charge does not require registration to be effective but it will lose priority to a subsequent charge under which the chargee takes control of the collateral (regulation 39). A charge will also arise in favour of a party who delivers certificated financial instruments under an agreement under which payment was due on delivery before the payment has been made, but in this case, since the relevant certificate has been handed over to the debtor, the charge will be only a floating charge.

Regulation 38 Purchaser takes free: investment property

Regulation 38 sets out rules on when purchasers of investment property will take free of a charge over the property. The provisions are designed to ensure that investment property is readily transferable without the need for purchasers to make enquiries. Essentially, purchasers who do not know of the security interest, or know of it but do not know that the disposition to them is in breach of the security agreement, will take free if (before they acquire any relevant knowledge) they take the investment property into their own name. A person does not have knowledge of something for the purposes of the scheme merely because it has been included in a registered financing statement (regulation 19). Thus 'innocent' purchasers who have taken the steps described can be confident that no other charge over the investment property will be effective against them.

Under the regulations, 'purchaser' includes a mortgagee or chargee. This means that a secured creditor may rely on regulation 38 even when it would not obtain priority under regulation 39. Thus if a secured creditor is permitted to have investment property transferred into its name, not knowing that the disposition to it is in breach of a previous charge agreement, it will take free of the charge. This will apply if the previous charge was a floating charge, or if it was a fixed charge which was merely registered instead of the chargee having control of the collateral. It will also apply if the chargee under the previous charge had obtained control but by some accident the collateral was nonetheless transferred into the name of the second secured creditor. This might happen if, for example, an intermediary overlooked a notice of assignment or an agreement with the earlier chargee. The earlier chargee would have a remedy against the intermediary but the second secured party would take free.

Regulation 39 Special priority rules for investment property and cash

Regulation 39 sets out the rules governing the priority of competing charges and, for the rare cases where it will be relevant, pledges of financial collateral. The basic principles are two. First, a charge perfected by control will take priority over one that it not perfected by control, for example, one that is perfected by registration (and see regulation 37). This means that a chargee who has control may safely advance funds without needing to search to see if a charge over the collateral has been registered. Secondly, as between competing charges each of which is perfected by control, priority depends on the order in which control was obtained. For directly-held securities, it is not possible for more than one secured party to obtain control. Where investment property is held through an intermediary and with cash, it is possible. In each case a potential chargee can make enquiries of the intermediary or 'cash debtor' to find whether any other party already has control.

Any issues not settled by regulation 39 fall to be decided according to the residual rules on priority in regulation 24.

It should be noted that a secured party may also be a protected purchaser within regulation 38. This may result in a mortgagee of investment property taking priority even over an earlier charge that has been perfected by control of another form, such as by notification of the charge to the intermediary.

Regulation 40 Meaning of control

Regulation 40 sets out steps that a chargee (or, in the case of a bearer security, a pledgee) of particular forms of investment property may take to obtain control over various forms of investment property and over 'cash'.

In each case there must be evidence in writing of the agreement and the arrangement under which the collateral was provided, as required by the FCAR. However the requirement is attenuated. It need not be signed and it need only be available by the time the relevant dispute arises. Moreover, in accordance with the accepted interpretation of the FCD (based on the travaux préparatoires) a recording of a telephone or other conversation will suffice (as will an email or other electronic communication using writing, which is generally sufficient in English law to satisfy a requirement of writing).

Paragraph (2) deals with bearer securities, (3) with directly held-certificated registered shares and paragraph (4) with uncertificated securities held in the CREST system.

Paragraphs (5) and (6) deal with financial assets held through an intermediary, and paragraphs (7) and (8) with 'cash'. In the majority of cases the chargee can obtain control by giving notice of its interest to the intermediary or 'cash debtor' ('cash debtor' is defined in regulation 41(1)). If the intermediary or cash debtor is entitled to disregard a notice of assignment, the chargee will need to obtain that person's agreement in order to achieve control.

Regulation 40(9) provides a 'residual test' for cases that do not fall within (2)-(8), for example new situations that might emerge. It is, in broad terms, that the chargee will have control (within the meaning of these Regulations) if it has the 'negative control' described earlier. It too is subject to the requirement of evidence in writing, see above.

Regulation 41 Meaning of other expressions used in Part 5

So far as appropriate, the definitions and terms used in relation to financial collateral are the same, or are derived from, those in the FCD, the FCAR and the Hague Convention on the Law Applicable to Certain Rights in Respect of Securities held with an Intermediary.

The provisions on financial collateral apply to 'investment property' and to 'cash'. Regulation 41 defines 'investment property' as:

(1) 'financial instruments', whether these are securities for which there is a certificate ('certificated financial instruments') in bearer form or registered form, or are uncertificated. The definition of 'financial instruments' is closely modelled on that used in the FCAR, but is limited to directly-held interests; and

(2) any other form of 'financial asset' that is held through an intermediary. This includes rights under commodity futures contracts and options. The account to which to which financial assets may be credited or debited is termed a 'securities account', the person who maintains the account as an 'intermediary' and the person in whose name the intermediary maintains the account as the 'account holder.'

'Cash' has a particular meaning that is found in the FCD and the FCAR. It means not cash in the everyday sense ('money') but sums of money credited to an account (including a bank account), money market deposits and sums due under a close-out netting arrangement.

PART 6 MISCELLANEOUS AND SUPPLEMENTARY

Regulation 42 Interpretation: General

Regulation 42 provides definitions of a number of terms that are used in the Regulations and which are not defined in the particular regulation in which they appear.

Regulation 43 Index of defined terms

This index enables a user to find the definition of any of the terms defined in the Regulations.

Regulation 44 Account debtors and cash debtors

This regulation is to confirm that a 'charge-back', or similar agreement under which a debtor takes a charge over the sum that it owes to the chargor, may be effective.

Regulation 45 Consequential amendments

This regulation will make a number of amendments to Insolvency Act 1986. [Items (2), (3) and (4) are yet to be drafted.]

(1) Because it will be possible to register a financing statement at any time, section 245 of the Act will be amended to apply not only to floating charges created in the run-up to insolvency but also to those created before the run-up yet only registered during that period.

(2) Under the scheme, a floating charge that is registered before a subsequent fixed charge will have priority over the fixed charge, unless the parties agree otherwise. However, in insolvency preferential creditors and the unsecured creditors' fund have priority over the floating charge but not the fixed charge. (The same issue arises under current law if the fixed chargee takes with notice of a negative pledge clause in the floating charge.) An amendment to the Act will provide that as, against the preferential creditors and the unsecured fund, the floating charge should have priority to the extent of any fixed charges over which it has priority.

(3) In practice, where a person contemplating taking a fixed charge over a company's assets discovers that the company has already granted a floating charge over the same assets, it will normally not go ahead without reaching an agreement with the floating-charge-holder. It will seek to obtain the floating charge-holder's agreement to allow the fixed charge to take priority. (This is frequently done under current law if the person suspects the floating charge may contain a negative pledge clause.) A further amendment to the Act will make it clear that such a subordination agreement, or any other arrangement that a fixed charge should have priority to a floating charge, will result in the fixed charge also having priority over the preferential creditors and the unsecured creditors' fund.

(4) Payments may be made to a secured creditor and the relevant financing statement then discharged, but later the payments may be 'clawed back' by the liquidator under the provisions of the Act. Provision will be made, if necessary, to ensure that the creditor's right to revert to the security is not impaired.

Regulation 46 Transitional provisions and savings

It will not be necessary to re-register charges that were registered before the date of commencement of the new scheme. They will remain effective and retain their priority as against other pre-commencement charges. As against post-commencement interests, they will be treated as having been registered at the moment of commencement, thus normally giving them priority against later interests (other than charges perfected by control).

Equally it will not be necessary to register charges that were created before the commencement but under current law do not require registration. (This is because it would be very difficult and expensive for many chargees to identify all the unregistrable charges they hold.) These will therefore not appear on the register; it is envisaged that the system will carry a warning of this to searchers. They too will remain effective and retain their priority as against other pre-commencement charges; and they will be treated as having been registered at the moment of commencement.

In contrast, by the end of a transitional period of 2 years sales of receivables and arrangements under which receivables may be sold must be covered by a financing statement. (Such agreements will be much easier to identify, since the agreement will normally be 'active', with receivables being transferred and payments made by the receivables financier to the company on a regular basis.)

Note 1    Regulation on Insolvency Proceedings, Council Regulation (EC) No 1346/2000 of 29 May 2000, OJ L160/1, June 30, 2000.    [Back]

Note 2    Directive 2002/47/EC of the European Parliament and Council of 6 June 2002, OJ L 168/43.    [Back]

Note 3    SI 2003 No 3226.    [Back]