Asset Security Flashcards
What are securities for?
To give you protection agains the risk of non-payment and insolvency by providing that if the debtor goes bust you are more likely to get paid. As well, they give you protection from the risk that the debtor will not pay.
What categories do rights in security fall into?
Rights in security fall into (1) personal securities (where the creditor ends up with two personal rights (against the debtor, and agains the gaurantor) (2) asset and property based securities where creditor gets a right in a particular piece of property.
-(2) fall into one of two broad categories — either (1) asset based security where creditor gets ownership of the asset or (2) where creditor gets a right in security in the strict sense in an asset owned by someone else. This is what will be concentrated on below. This is where there is an owner in the asset and the creditor has right in their property.
What is a right of retention?
Where the creditor gets ownership in the asset this is called a right of retention (see right of retention cases).
What is a right of security in the strict sense?
A right in security in the strict sense is a “real right in property of another person which secures the performance of an obligation”.
Mere obligation to grant security is not security. Must be constituted as a real right. This usually means possession or registration. See eg Bank of Scotland v Hutchison Main & Co 1914 SC (HL) 1.
How can you distinguish (1) proper from (2) improper assets?
Distinguish (1) proper from (2) improper asset security (sometimes referred to as quasi-securities). In (1) there are two real rights in the thing: the real right of ownership, which the debtor has, and the (subordinate) real right of security, which the creditor has (jus in re aliena). In (2) there is only one real right, ownership, which is vested in the creditor. The debtor has no real right, but has personal right to be made owner when debt is paid. Debtor may be regarded is owner in functional sense, but in law creditor is owner. Ownership is being used as security.
What are the key characteristics of a right in security?
So the key characteristics are:
⁃ It is a right in the property of another
- A right in security (in strict sense) is over property belonging to someone other than the creditor Must it be owned by the debtor?
⁃ There is a real liability in the asset which is distinct from the personal liability owed by the debtor to the creditor
⁃ The security is accessory (parasitic)
⁃ The security secures “obligations”
⁃ It is a real right
Must the asset be owned by the debtor?
The owner of the asset that is secured need not be the debtor; it is possible to grant a security over an asset for a debt owed by somebody else.
It must be property belonging to someone other than the creditor. The person who grants the right in security must be the owner of the property, but the owner need not be the debtor (that the creditor has the personal right against). e.g. Third party pledge cases (Smith v Bos).
The owner of the property need not be the debtor common exam mistake.
Why must personal liability be distinct from the (real) liability of the asset?
The debtor’s liability is quite separate from the liability of the asset. So the debtor is personally liable. The owner of the asset is not personally liable for the payment of the debt. This means if the debtor dies, it is the debtor’s estate that assumes this liability. This is because the real liability lies with the property, not a particular person. So if somebody transfers the property with a security over it they transferee acquires with a security over the property. The owner of the asset will always be subject to the real right until the debt is discharged or until the security is extinguished. And transferring the asset which is secured has no impact on either the personal or real liability.
NB Real right is enforceable against the world.
What happens to personal liability if debtor dies?
??
What happens if the asset is transferred?
Example: S owes money to bank and is personally liable for this. They have a right in security over S’s house, if he sells house to X, and X buys house. Nothing happens to the personal liability, it stays as it is and S still owes money to bank. They can only sue S and his executor even where he absconds.
The right in security is also not affected by the transfer. This means that if the personal liability is not fulfilled, the property is at risk against whoever is owner of the property at that time.
The liability of the asset to which the real right attaches remains constant.
***Transferring asset has no impact on real liability or personal liability.
What does it mean when we say that rights in security are parasitic?
Rights in security are parastitic. Securities existence is dependent on the personal right secured. Securities have no existence if there is no debt. So on the extinction of the personal right the real right in security is also extinguished.
One difficulty is where you have a security over a fluctuating account (e.g. a security over an overdraft) it is thought that the security will not need to be reconstituted every time the debt is reincurred (so the debt is not immediately extinguished when this account goes into credit - the security does not need to be regretted every time).
⁃ (NB only one academic (Andrew Steven) has ever written about this)
See Albatown case and the two year missives.
What obligations can be secured?
It is very difficult to find a statement on this in the common law. It is clear under common law that debts can be secured.
Under the Conveyancing and Feudal Reform 1970 Act provides that in addition to debts being capable of being secured, you can also grant a security over an obligation ad factum praestandum - this is an obligation to do something. But there cannot be a security over a negative obligation.
Why does granting securities over an obligation create conceptual problems?
Granting securities over an obligation to do something[ An obligation ad factum praestandum.] causes some conceptual problems
⁃ This is because a security empowers the creditor in the event of the underlying debt not being complied with to sell the asset. What does the creditor get in the event of sale? NOBODY KNOWS. It is thought that the debt which is due is perhaps the damages for non performance.
What kind of real right is a security?
The real right is not just a right to sell or to extract cash - it encompasses both. It empowers the creditor to sell. The right is effective against anyone.
⁃ E.g. If you have a standard security over land and the debtor grants a least in favour of a third party after a standard security has been granted, the secured creditor can kick the tenant out - their right is reducible at the instance of the secured creditor.
How do you determine whether a security is effective?
The acid test is to determine whether the security is effective in insolvency. If the right is not effective in insolvency you do not have a real right.
How do you validly create a security?
So this concerns how you make sure you validly create an effective real right.
What do you need to do?
⁃ Since it concerns a real right the publicity principle applies. There are two principle ways of publicising real rights:
⁃ 1) Registration
⁃ For securities over land and floating charges.
⁃ 2) Possession
⁃ If the creditor takes possession of the asset, their having physical control of the asset is a way of notifying that they have an interest in the asset. To have possession the general requirement of the law of possession are required (animus + corpus).
⁃ Possession is the standard mode under Scots law of creating a security over corporeal moveable property.
Must be granted by the owner of the asset (otherwise nemo dat applies (see eg Bankruptcy and Diligence etc (Scotland) Act 2007, s 208 (7)) – any exceptions?)
Different types of property have different securities
In addition to the publicity principle, what other principles from property law are applicable to securities?
In addition to the publicity principle, two other fundamental principles from property law are applicable to securities:
⁃ 1) Nemo dat quod non habet
⁃ If a non owner tries to grant a security then this principle applies and the transaction is absolutely void - it is of no effect.
⁃ 2) Prior tempore potior iure
⁃ This means where there are competing securities it is the one that is created first which wins.
What are the various ways to divide securities?
There are various ways to divide securities and different types of property have different securities which are applicable to them.
What are the ways you can divide moveable securities?
Corporeal moveables are either secured by
1) Pledge
⁃ Where the debtor hand’s over the possession of the asset to the creditor voluntarily. The creditor can retain possession until such time as the debt is paid.
2) Lien
⁃ This is a security which arises by implication - it arises as a result of certain facts happening. The typical situation is e.g you go to get your watch fixed, the repairer does so and it costs £100 - the repairer is entitled to retain possession of the watch until such time as the debt is paid.
3) Landlord’s hypothec
⁃ This is a specific type of hypothec[ The generic term for non-possessory securities: see below.]. It is unusual because it arises by implication but without publicity (all other rights in security fit with the publicity principle but the landlord’s hypothec does not.) It arises by implication as a result of rent not being paid (if the tenant doesn’t pay rent then the landlord is entitled to a security over the assets that are within those premises.
What are the ways you can divide heritable securities?
1) Standard securities
⁃ This is the only competent form of security over heritable property. (s 9 Conveyancing and Feudal Reform Act 1970)
⁃ This is a written document signed by the owner of the property and registered against the title of that property (so publicised by registration).
2) Incorporeal property [no right in security as assignation required (transfers right).]
⁃ There is no valid subordinate real right in security over corporeal property under common law in Scotland. The only way in which you can create a security over incorporeal property is to transfer ownership of it to the creditor. This covers not just rights to payment but also various forms of intellectual property. This means the creditor receives a right of retention rather than a right in security in the strict sense. The debtor receives a person right to get the asset back when the debt is paid. So the debtor is potentially at risk if the creditor becomes insolvent.
What are possessory and non-possessory securities?
⁃ Possessory securities are those where the creditor has possession of the asset.
⁃ The two examples of possessory securities are pledge and lien.
⁃ Non-possessory securities are those where the creditor does not have possession of the asset.
⁃ The generic term is the ‘hypothec’. These include standard securities etc.
What are express, voluntary and judicial securities?
⁃ An express (voluntary, consensual, conventional ex voluntate) security is created by the volition of the owner
⁃ There are two express securities in Scots law:
⁃ 1) standard security
⁃ 2) pledge
⁃ An implied security arises by operation of law - as a result of certain circumstances occurring.
⁃ The two implied securities are the:
⁃ 1) Lien[ Implied, possessory, moveable security.]
⁃ 2) Landlord’s hypothec[ Implied, non-possessory, moveable security.].
Tacit (legal, arising by operation of law, ex lege) or Judicial = diligence.
What are judicial securities?
⁃ These securities are created by the courts where the court gives a creditor a right over certain assets of the debtor. The judicial securities in Scots law are generally referred to as diligences.
⁃ The diligences that apply to land are referred to as adjudications[ This gives the creditor a right in a particular asset which gives them a real right in security from the point of registration.
This is a judicial, heritable, non-possessory security.] or inhibitions[ NB this is not a security - it simply stops the debtor from transacting with the property .].
⁃ The diligences over moveable property vary depending on whether the property is corporeal or incorporeal.
⁃ If the property is corporeal the diligence is referred to as attachment[ Look up if this isn’t covered in the later lectures…].
⁃ If the property is incorporeal the diligence is referred to as arrestment[ Two types of arrestment. Look up if not covered in the later lectures.].
What is a floating charge security?
⁃ This is a security which can be granted by a company or by an LLP. It is created voluntarily. It does not give possession to the creditor - it is created by registration. It covers the totality of the assets of the debtor (the whole of the ‘property and undertaking’ of the debtor). This means that it covers the corporeal and incorporeal property, the heritable and the moveable property. But unlike the other rights in security which become a real right at an early stage, the floating charge floats and is not a real right at that time. This means the company can buy and sell assets. If the company sells and asset then this is removed from the scope of the floating charge. If the company buys an asset then it is brought within the scope of the floating charge. The floating charge becomes a real right on a process called attachment - at this point the floating charge becomes a real right. The floating charge can attach on liquidation of the company, receivership of the company or the company going into administration and the administrator telling the court / register of companies that there isn’t enough money to pay the debts.
Sharp v Thomson
⁃ Albion Construction sell property to Steven and Carol Thomson. Albion had a floating charge over their assets. They sold the property to the Thomson’s. The Thomson’s move in (but hadn’t registered) and the company goes into receivership so the floating charge attaches to Albion’s assets. Was the house caught by the floating charge or not?
⁃ Explained later
Can a creditor use the asset secured?
⁃ No - the creditor is not entitled to use your asset.
⁃ But they are obliged to make sure it is not damaged if they have possession.
⁃ The debtor is still entitled to use the asset (but obviously in possessory securities the debtor cannot use it because the creditor has possession.)
⁃ But the debtor must ensure that they don’t do anything which prejudices the value of the security.
Can there be multiple securities over an asset?
There can be more than one security over same asset (nb this is probably only possible in relation to non-possessory securities)
⁃ e.g. 2 standard securities
Ranking concerns who gets paid first and how much do they get paid.
What are the two types of ranking a multiple security asset?
There are two types of ranking:
⁃ 1. Postponed ranking
⁃ This means that one person gets paid first and the other(s) have to wait and obtain what is left.
⁃ 2. Pari passu ranking
⁃ The securities rank equally (where the securities are registered on the same day). NB if the value of the securities is different then the amount that each creditor can claim is proportionate amount based on the value that their debt bears to the total debt over the asset (see example 2 below).
⁃ Examples:
⁃ 1) A owns house. Security in favour of B for £100,000 and in favour of C for £100,000. House sold for £150,000.
⁃ If B and C rank pari passu because they registered on the same day then B and C will both receive £75k
⁃ If B ranks first (prior tempore potior jure) because B registered first, then B receives £100k and C receives £50k.
⁃ 2) A owns house. Security in favour of B for £200,000 and in favour of C for £100,000. House sold for £150,000.
⁃ If B and C rank pari passu because they registered on the same day then B and C will both receive a proportionate amount based on the value that their debt bears to the total debt over the asset. Thus B will receive £100k and C will receive £50k.
⁃ If B ranks first (prior tempore potior jure) because B registered first, then B receives £150k.
⁃ In both cases there is a shortfall. Does this mean the debt is extinguished? No - selling the asset does not extinguish the personal right unless it is fully discharged. This means that A’s other assets become potentially at risk because the creditor could apply to court to do diligence against them to seize the assets.
What are catholic and secondary securities?
There is not a huge amount written on this. The following text is from a piece by Scott Wortley on rights in security.
The special rules for catholic and secondary creditors serve to mitigate the effect of the general rules of ranking. With no special rules the following would apply. If X has a security over plots A and B and Y has a postponed security over plot B, in the event of default X would have the power to realise either plot A or plot B. If X realised plot A and X's debt was paid in full Y would be free to realise plot B and could be paid. However, if X instead decided that the outstanding debt would be satisfied by the sale of plot B then the proceeds of sale of plot B would go to X initially, and Y would only receive a payment in the event that X's debt was not fully paid. If X was not fully paid from the proceeds of sale Y could end up with only a personal right against the debtor. This is not in the interests of the debtor. The interest of the debtor is to ensure that debts should be paid as fully as possible. An equitable adjustment is made to the default position. In the example given X is known as a catholic creditor, and Y is known as a secondary creditor and a series of rules apply to protect the secondary creditor's interests. The underlying principle is summarised by Professor Wilson, ⁃ "Where there is one secondary creditor, the catholic creditor is not entitled to proceed so as to injure the secondary creditor while not obtaining any benefit himself." In effect this means that the catholic creditor should act in such a way as to leave the largest possible sum for the secondary creditor. ⁃ If the catholic creditor has securities over plots A and B, both owned by the same party, and the secondary creditor has a postponed security over plot B the catholic creditor should act in such a way as to maximise his or her payment from plot A. However, this does not prevent the catholic creditor from realising plot B. Plot B may be more marketable. If the catholic creditor realises plot A and the debt due is satisfied the catholic creditor's security over plot B will be discharged and the secondary creditor will be able to realise plot B and obtain payment. However, if the catholic creditor realises plot B the catholic creditor must assign his security over plot A to the secondary creditor. The protection for the secondary creditor also applies where the debtor becomes insolvent through liquidation or sequestration. If in such insolvencies plots A and B are realised, the secondary creditor will be secured and paid from the proceeds of sale of plots A and B once the catholic creditor has been paid in full. The position may be complicated where both plots have a secondary creditor with a postponed security. The catholic creditor cannot unilaterally prefer one of the secondary creditors. In such a case either secondary creditor can insist that the burden of the catholic security should be apportioned rateably between the two plots – based on their respective values, and irrespective of the dates of ranking of the secondary creditors. Alternatively, if the catholic creditor realises the full amount of indebtedness due from one plot only the secondary creditor is entitled to an assignation of the catholic creditor's first ranking security over the other plot to the value the catholic creditor would have been entitled to claim from that plot. An example makes this clearer. Assume that X is the catholic creditor with first ranking securities over plots A and B. Plot A is worth £100,000 and plot B is worth £200,000. Each plot is also encumbered by a postponed security. If X's security is for £150,000 as a catholic creditor X should draw payment proportionately from the two plots. X will be entitled to £50,000 from plot A, and £100,000 from plot B. However, if X chooses to recover the full payment from plot B this would (without application of the special rules) prejudice the secondary creditor in plot B, while benefiting the secondary creditor in plot A. The secondary creditor in plot B – to maintain an equitable position – is entitled to an assignation of X's first ranking security over plot A to the extent of £50,000. This will have a neutral effect on the secondary creditor in plot A. The rules of catholic and secondary creditors are equitable and do not prevent catholic creditors acting in a way that is in their legitimate interests. For example where the catholic creditor has a security over plots A and B, and also has a second security for a different debt over only plot A, the catholic creditor is entitled to realise the catholic security wholly from plot B in order to avoid detrimentally affecting his or her own interests by diminishing the value of the security over plot B. The principles applicable to catholic and secondary creditors apply whether the securities are voluntary or involuntary. However, it appears that the rules do not apply where the catholic creditor has a floating charge.
What are general securities?
Some securities are general/unrestricted (“all sums due and to become due”) ie creditor can charge asset with any debt due to him by that debtor.
What are special securities?
Others special[ For a specific sum of money]/restricted ie creditor can charge only certain debts to that asset.
⁃ So if you have a pledge and the pawnbroker gives you money in return, the pawnbroker can only keep your watch if you fail to pay back that particular debt - they cannot keep your watch for subsequent borrowings unless you specifically agree to the retention of the watch.
The general position is that securities are thought to be special unless there is an exception. ⁃ NB for standard securities there is a statutory exception that you can expressly provide that the security is for all sums due and to become due - this means that any subsequent borrowing that you make is already covered by the security.
What is the general principle in relation to the transfer of rights in security?
The general principle in relation to transfer of rights in security is accessorium sequitur principale (the accessory follows the principal — it is dependent on the existence of a principal debt).
⁃ Thus in theory if the personal right is assigned then the security will follow with it. [NB there is no case law on it. But there are two conflicting academic views. Ross Anderson argues that transfer of the personal right will automatically transfer the right in security. Andrew Steven argues that the right in security must also be transferred (so the creditor in the security must transfer the right in security to the third party). Scott Wortley thinks that Andrew Steven is right.]
⁃ One area it is clearer is if there is assignation in relation to the assignation of a standard security.
⁃ If there is a creditor who has a personal right to a loan and has a right in security over an asset, an assignation of the right in security has to be registered in order to transfer the right to the third party. (The standard security will not pass until registration takes place).
LOOK THIS SECTION UP - PERHAPS NEED A BIT OF CLARIFICATION
What rights does the creditor holding a right in security have?
The creditor holding a right in security has two rights:
(a) the personal right against the debtor for fulfilment of the personal obligation (typically the loan); and
(b) the real right in the encumbered subjects. Entitlement to the personal right and entitlement to the real right lie vested in one person, and the rights cannot be separated, but what happens where (i) there is an attempt to assign the claim to payment? (ii) there is an attempt to assign the right in security? Does it matter if the right in security is created by registration?
What happens to the doctrine of transfer if you have a non-possessory security?
If you have a non-possessory security the doctrine of transfer will typically embody both an assignation of the right and the right to security in the same document. This makes it more straight forward. If you are assigning a personal right however, you have to intimate this to the debtor (so two means of transferring = intimation + registration in land register or in companies register.).
UK Acorn Finance Ltd v Smith 2014
issues are not focused here but may be relevant so look up*. This case in essence confirms…
How do you enforce a right in security?
In most other countries the enforcement of a security is a very formal process. If the debtor defaults and the creditor wants to enforce the security, in most other countris you have to go to court to enforce the security. The general position in Scots law is that the creditor has to apply to the court to sell the asset. But express provision in the grant of the security can provide otherwise (e.g. so you could expressly provide in a pledge that the creditor can simply realise the asset).
Security can generally be enforced by sale. (Exception to the principle of nemo plus juris ad alium transferre potest quam ipse habet?) Obligation to get best price. Balance returned to debtor, or to other secured creditors.
For standard securities the default position was (until 2010) that the creditor could sell without going anywhere near the court. The creditor could simply serve a calling up notice or a notice of default which triggers breach of a particular condition which entitles the creditor to enforce the asset. ⁃ For residential properties this rule has changed from 2010 - the creditor must apply to court to get the authorisation to sell the asset. ⁃ For commercial and agricultural properties this rule remains that the security can be enforced without a court order (includes farm land and factories). The creditor has a general duty to obtain the best price for the property. ⁃ This means they must market the property (but they can recover the costs of marketing from the proceeds of sale of the property) Once the asset is sold the proceeds go to pay: ⁃ the secured creditor for the outstanding amount of the loan (including interest on the debt due). ⁃ expenses incurred within the sale process Anything left over will either go to a second ranking creditor, or if there is none, back to the debtor (owner of property). ⁃ If the debtor is bankrupt / company in liquidation then the proceeds left over will go to the trustee in sequestration or the liquidator to distribute to the general body of unsecured creditors.
