Secured Transactions

Author:Hugh Beale
Position:Professor, University of Warwick

Hugh Beale

Professor, University of Warwick

Secured Transactions

In this paper I describe the work that is currently under way, within the Network of Excellence charged with creating a draft Common Frame of Reference, to draft rules on security over moveable assets. After a brief introduction, I deal with two broad questions: (1) the general aims and scope of the scheme for security interests in the traditional sense (such as possessory and non-possessory pledges or mortgages) and (2) registration and other forms of 'perfection' (i.e., ensuring that the security interest will be as fully effective as is possible under the applicable law of insolvency). Professor Veneziano's paper1 deals with the enforcement of security interests and the very controversial question of whether transactions that are not traditionally classified as security transactions but that serve the same economic function (such as retention-of-title clauses and finance leases) should be brought within the scheme.

1. Introduction

The field of security over moveable property is one in which the laws of the various Member States are so different that the pan-European picture is one of complete disarray. There are wide variations in the extent to which it is possible to create security interests over moveable property: whereas some legal systems allow security to be taken over almost any form of business asset, others are much more restrictive, particularly with respect to non-possessory security over goods. Moreover, there are major differences among both the practical requirements (for example, whether security interests must be registered if they are to be fully effective) and the concepts involved (for example, whether registration is necessary in order for any proprietary right over the moveable to come into existence or whether a failure to register merely means that the security right may not be effective in certain cases, such as that of the debtor's insolvency). This creates two problems, one a practical one and the other a legal one.

The practical problem is that it may be difficult for a business that is accustomed to employing secured credit to operate in its accustomed way in another jurisdiction, if that jurisdiction does not recognise the relevant type of security right or does not recognise it over the kind of asset available. Indeed, it is strongly arguable that there is a problem here for many Member States themselves. The lack of a comprehensive and efficient system of security over moveable property may mean that credit is less readily available in that jurisdiction, or at least that it will cost more, and this is likely to hinder economic development.

The legal problem arises if assets are moved from one Member State to another. A security interest created over moveable assets in the first Member State may not be recognised by the law of the second Member State. In commonly accepted conflicts of laws practice, the creation of the security right is governed by the law of the situs at the relevant time. If the second Member State's domestic law recognises a similar kind of security right, it will probably treat the asset as if it were subject to that type of right created in the first state. But if the second state's law simply doesn't recognise that kind of right (for example, it does not recognise non-possessory security rights over goods), it may not be able to translate the right into its own terms and it may simply ignore it. It is strongly arguable that this is incompatible with the freedom of movement of goods guaranteed by the European Treaty2.

Even if the relevant kind of security right over the assets is recognised in the second Member State, it may be treated as less than fully effective (for example, not effective in the security provider's insolvency) unless it is registered in the second state. This may not be incompatible with the freedoms under treaty, in that requiring registration in the second Member State may be justifiable in order to protect third parties who might buy the asset or take further security over it without having a way of finding out about previous encumbrances. However again practical problems are created for the secured creditor.

There is therefore a strong case for European legislation. This might take the form of harmonisation measures, requiring Member States to recognise security rights created in other Member States (and thus probably to harmonise the kinds of security right that can be created in the different Member States). Alternatively, it may be possible to circumvent the differences in the national laws by creating a form of security right that would have to be recognised and enforced by the laws of all Member States - the so-called European security interest. This would be, in effect, a form of optional instrument but one that allows the parties to create proprietary interests that are not necessarily recognised by their domestic laws3.

There has been a limited amount of harmonisation already. The Financial Collateral Directive4 requires Member States to recognise security rights (and also functionally equivalent title-transfer arrangements) taken over investment securities, bank accounts, and similar "financial collateral" where both parties are public authorities, central banks, or financial institutions5 and the secured party has "possession or control" over the collateral6. Formalities such as registration may not be required7; certain types of enforcement procedures such as the right to appropriate the collateral in the event of default, if provided for in the security agreement, must be permitted8; and a wide range of rules that might affect the security right in the event of the debtor's insolvency must be dis-applied9.

However, with other types of moveable collateral, such as goods, receivables, or intellectual property rights, the laws of the Member States remain widely disparate. When the European Commission enquired about barriers to trade within the internal market that are caused by divergences between the laws of the Member States, respondents frequently mentioned differences in the law of security10. This seems a likely target for future European legislation.

So it is very good news that within the Study Group on a European Civil Code there is a team working on security over moveable property. The team is led by Professor Ulrich Drobnig, former director of the Max Planck Institute for Comparative and International Private Law. It is hoped that the results of their work will form part of the revised DCFR to be submitted to the European Commission by the end of 2008. With Professor Veneziano, I am a member of the group of advisers to the team, and it is largely my ideas for the DCFR book on security over moveable property which I will be discussing. Naturally, what I say is only my personal view, not that of the team or of the Co-ordinating Committee of the Study Group.

At the same time, a working group within UNCITRAL has been busy with the Legislative Guide on Secured Transactions. This is now in almost finished form11. It contains a great deal of valuable information and discussion, even if in producing model rules for Europe we may not want to follow it to the letter.

The team and the advisers have many other models to look at also. There are the various laws of the Member States, some of which are highly developed. There is the European Bank for Reconstruction and Development Model Law on Secured Transactions. There is article 9 of the US Uniform Commercial Code, now in its 'Revised' form. There are the many Canadian Personal Property Security Acts12 (PPSAs) and the variant of those acts adopted in New Zealand13. Lastly, there are consultation papers and a report issued by the Law Commission for England and Wales14. The Law Commission recommended extensive reforms, though these have not been implemented by the national government.

2. General aims and scope

The general aims of the scheme can be set forth quite concisely:

  1. The scheme for security rights should be flexible and simple, and taking of effective security rights should be quick and inexpensive.

  2. There should be effective means of enforcing the security rights. This obviously benefits secured creditors but also, in the same way as other aims of the system, will benefit debtors also: the more effective the security rights are, the lower will be the costs of enforcement and therefore the cost of credit.

  3. There should be adequate warning to other potential secured parties, to unsecured creditors, and to persons who may wish to buy or lease the debtor's property when it is or may be subject to a security right.

  4. The scheme may need to provide some protection for the debtor, particularly when security is taken over property that is not used by the debtor for business purposes (i.e., the debtor is acting as a consumer). It may also need to protect some classes of creditor, such as employees who have not been paid their wages.

  5. There may need to be safeguards against fraud, for example, to prevent fraudulent claims that a security right was created in favour of a particular creditor at some time in the past.

This objectives are stated here in my own words, but they seem to be fully compatible with the 'Key Objectives' listed in the UNCITRAL guide15.

Let me explore some of these points in a little more detail.

2.1. Flexibility as to the secured obligations

The scheme should be flexible in three ways. First, there should be flexibility as to the obligations secured. It should be possible...

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