The Secured Transactions Law Reform Project was established to consider the effectiveness of the law and how it can be improved. The Project has published discussion papers on certain aspects of security. The papers include discussions on fixed and floating charges, registration and priorities.
Potential changes to the law considered by the papers include:
- replacing the distinction between fixed and floating charges
- filing notice of security at Companies House before it is created
- determining priority by the date notice of security is filed at Companies House
These changes would transform the concept of security, the process for creating it and the determination of priority. Below we consider the potential reforms as they relate to security provided by companies.
ONE TYPE OF CONSENSUAL SECURITY INTEREST
The Project considered replacing the different types of consensual security interest with one concept. This would replace the distinction between fixed and floating charges.
Currently the distinction between fixed and floating charges can have a large financial impact. A floating charge is, unlike a fixed charge, subordinated on insolvency to a certain extent. Preferential creditors rank ahead of floating charge holders, but behind fixed charge holders. The expenses of an insolvency rank ahead of floating charge holders, but behind fixed charge holders. Some of the proceeds from selling assets subject to a floating charge are allocated to unsecured creditors, but none of the proceeds from selling assets subject to a fixed charge are allocated to unsecured creditors.
Whether a charge is fixed or floating depends upon the amount of operational control the security holder has over the assets subject to the charge. The question of whether a security holder has sufficient control for a charge to be a fixed charge can require complex analysis. The answer can be debateable and result in litigation.
Abolishing the distinction between fixed and floating charges would provide certainty. It would also remove the need for some transactions to use complex structures designed to provide the security holder with what is considered at the time to be sufficient control for a charge to be a fixed charge. The Project thought the distinction between fixed and floating charges, based on operational control, should be abolished.
The Project thought the distinction between fixed and floating charges would need to be replaced with a different distinction between two types of security interest.
The Project thought the distinction between fixed and floating charges could be replaced by a distinction based on the type of assets subject to the security. The Project thought security over inventory, receivables and money could be subordinated. The Project thought the subordinated security could include other types of what are sometimes called “circulating assets”, such as raw materials and crops.
Replacing a distinction between types of charge based on operational control with a distinction based on the type of assets subject to the charge would simplify the law. Advantages of simplifying the law include making it easier for overseas lenders to quickly understand it. This may increase the likelihood of overseas lenders funding businesses in England & Wales, thereby stimulating the economy. Simplifying the law may also reduce the scope for litigation.
ADVANCE FILINGS AND PRIORITY
Currently the law provides for security registerable at Companies House to be registered after the security is created. If security required to be registered at Companies House is not registered within 21 days, beginning on the day after the security is created, it will be void against creditors of a company as well as a liquidator and an administrator.
Provided security is registered within the 21 day period priority is determined by the date security is created, not the date it is registered. A lender funding and taking security on the same day, as often happens, risks its security ranking behind security created earlier which is subsequently registered at Companies House within the 21 day period. Such a lender bears the risk of a 21 day invisibility period.
The Project suggested a scheme under which security could be registered before it is created. The Project thought the default priority rule should be the first to register has priority. This would enable a lender to advance funds without the risk of a prior created security interest being subsequently registered and having priority. A creditor could, if it chose, register a security interest after it is created. The 21 day period would be abolished.
The Project considered it hard to think of any arguments against a system of priority by date of registration when coupled with being able to register in advance of creation.
The Project suggested a scheme under which, if registration relates to an interest not yet created, the registration would show the interest has not yet been created. The parties would elect how long the registration would last. If an interest is created during this time the creditor would be obliged within a specified number of days to amend the registration to show the interest had been created. If amended within the specified period the date for determining priority would be the date of the initial registration. If amended after the specified period the date for determining priority would be the date of the amendment.