#17306 - Security Rights - Personal Property Law

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)

   • 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.

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?

  • 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)

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

Weaknesses:

• 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.

  • 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 (unfair surprise)

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:

1. On true security, the creditor holds the surplus on trust for the debtor, whereas he doesn’t with quasi

2. With a quasi security interest the creditor obtains a property right in something that the debtor owns.

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.

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.