This brief note examines, in outline, some of the major advantages in having security ‘caught’ by the provisions of the FCAR and then examines recent judicial commentary and case-law as to what type of security can benefit from the advantageous exemptions detailed in the FCAR.
The FCAR came into force on 26 December 2003. The purpose of the FCA Directive was to simplify the process of taking financial collateral across the EU by introducing a minimum uniform legal framework.
If your security complies with the criteria as stipulated in the FCARs (detailed below) then the following, amongst a number of other advantages, apply:
- There is no requirement to register a charge under section 860 of the Companies Act 2006 (charges created by a company) and section 874 (consequence of failure to register charges created by a company) does not apply.
- Paragraph 42(3) of Schedule B1 to the Insolvency Act 1986 (“IA”) (restriction on enforcement of security) does not apply. This means that neither the consent of the administrator nor the permission of the court is required to enforce such a security interest.
- Paragraph 65(2) of Schedule B1 to the IA 1986 (distribution) is disapplied. This paragraph means that, in an administration, a company’s preferential creditors will not be paid in priority to the claims of a floating charge holder, if that floating charge is created or otherwise arises under a financial collateral arrangement.
In brief, the FCARs apply to:
- Financial collateral which is defined as cash, financial instruments or credit claims;
- Financial collateral arrangements which is defined as a security financial collateral arrangement or a title transfer financial collateral arrangement (this note only examines security financial arrangements);
- Under the definitions (for both type of arrangements):
- The arrangement must be evidenced in writing.
- The collateral-provider and the collateral-taker must both be non-natural persons.
- security financial collateral arrangements which are arrangements that have both of the following features:
- The collateral-provider creates, or there arises, a security interest over financial collateral to secure amounts owed to the collateral-taker
- The financial collateral is delivered, transferred, held, registered or otherwise designated so as to be in the possession or under the control of the collateral-taker or a person acting on its behalf. Any right of the collateral-provider to substitute financial collateral of the same or greater value or withdraw excess financial collateral or to collect the proceeds of credit claims until further notice will not prevent the financial collateral being in the possession or under the control of the collateral-taker.
The FCAR defines ‘security interest’ as any legal or equitable interest or right created by way of security and includes a floating charge, a pledge, a mortgage, a fixed charge, and a lien.
Therefore, in circumstances where your security is:
- evidenced in writing;
- over, for example, shares in a company;
- made between two companies;
- those shares are in the possession or the control of the collateral-taker; and
- the rights of the collateral provider are limited to substitute financial collateral of the same or greater value or withdraw excess financial collateral or to collect the proceeds of credit claims until further notice
then, as a collateral-taker, you will benefit from the provisions of the FCAR.
However, what would be the position if, for example, a collateral-provider has greater rights than those detailed above? If this was the case, then that would mean, under a strict interpretation of the FCAR, that the financial collateral is not ‘in the possession or under the control’ of the collateral-taker and that therefore the security does not benefit from the exemptions of the FCAR. These issues have recently been considered in Re Lehman Brothers International (Europe)  EWHC 2997 (Ch) and the Financial Markets Law Committee (“FMLC”).
In that case, it was held that possession requires much more than the mere holding by, or delivery or transfer to, the collateral taker i.e. that the collateral-provider must in fact be dispossessed and that the limited rights referred to above are not a comprehensive description of the rights which may reside with the collateral provider. Indeed, as was considered and referred to by the FLMC, it is commonplace to see security arrangements in place where collateral is held in an account in the name of the collateral-provider rather than the collateral-taker. In these circumstances, it is clear that the collateral is not in the possession of the collateral-taker. However, can it be said to be under the control of the collateral taker, especially when the security arrangements severely limit the collateral-providers ability to deal with collateral? Again, on a strict interpretation of the FCAR, and using our example of shares, if the collateral-provider is entitled to exercise any voting rights attached to those shares forming part of the collateral (if the security has not become enforceable), then this would not amount to “control” under English Law.
In light of the importance of security in the financial markets, the FLCM have considered the confusion surrounding the phrase “possession or control” and have suggested that the FCARs be amended so as to clarify this issue. This is beyond the scope of this paper but a link is attached below. Therefore, until such time as amendments are made to the FCAR or further clarity is provided judicially, unfortunately, the uncertainty as to the exact application of the FCAR to security arrangements will remain.
For more information, visit http://www.fmlc.org/Pages/home.aspx.