Security over moveable property

The Scottish law Commission in its eighth programme of law reform has committed itself to a review of the Scottish law of security over corporeal moveable property, and a look at securities over, and assignation of incorporeal moveable property. This is a development from the earlier proposal in the seventh programme of law reform where the assignation of incorporeal moveable property was identified as a subject for reform, work to commence following the completion of the substantial project on land registration.

Proposed reform of the law of moveable securities is not new. The rigidity of common law rules (which generally prohibited voluntary hypothecs – non-possessory securities – over moveable property) was in marked contrast to the approach in roman law, from which Scots law drew where hypothecs were common (although Scots law was not out of keeping with other jus commune systems on this). There are a number of explanations offered in the Institutional writers as to why Scots law did not follow the liberal regime of later Roman law.  Erskine suggests (III.1.34) that

“the impignoration [or pledge] of moveable goods without their delivery to the creditor cannot but prove a heavy weight on the free currency of trade, it being impracticable to keep a record of moveables, by which purchasers may be ascertained of their danger.”

Such a concern seems based on the general policy of a publicity principle – whereby rights affecting property are publicised in order to notify third parties (including prospective purchasers and creditors).

But, the lack of a readily available hypothec led to calls for reform, at least since the days of Gloag and Irvine who argued that the law should be liberalised, and for a model looked to the introduction of bills of sale legislation in England and Wales. 

Gloag writes,

“The law on the subject of security-rights over corporeal moveables is beset with difficulties; and is not, perhaps, in a very satisfactory state, as the result of its rules is often to deprive the owner of such property of the power to make use of it as a security for his debts.  It is open to question whether the rigidity of the law of Scotland on this subject should not now be relaxed by the adoption of a system analogous to the English bill of sale." (pp 187 – 8)

The difficulties inherent in the system can be seen from the discuission of the interviews with solicitors in the Central Research UNit report on Business Finance and Security over moveable property carried out in 2000 – 2001 by professor Jenny Hamilton, Andrea Coulson and myself. For example,

"If the prospective borrower owned the asset and was looking to raise finance on it they could not readily grant a security over the asset.  Such a problem could arise in the hotel industry, or in factories.  In both, assets (in the former tables and chairs, in the latter large items of plant) were already owned and possessed by the prospective borrower.  To give up possession of the asset would mean that the asset was no longer available as a means of producing profit for the borrower.  Accordingly, an alternative device was necessary.  Typically the borrower would look to sell the asset to the financier, and reacquire the asset on a lease or hire purchase agreement.  However, the solicitors noted that there was difficulty with this in Scots law.  Under section 62 (4) of the Sale of Goods Act 1979 “sham” sales that are truly securities are not covered by the 1979 Act.   If the 1979 Act does not apply then in order for the transaction to be legally effective it must be valid at common law.  In order to effect a sale at common law the seller had to deliver the asset to the purchaser.  This meant that to ensure the effectiveness of a sale and leaseback arrangement the business had to deliver the asset to the financier before the asset was leased back to the borrower.  The disapplication of the Sale of Goods Act 1979 means that to protect the financier by ensuring the efficacy of the sale and leaseback such delivery has to be made today.  One interviewee explained that in one transaction involving a bus company that wished to raise finance through a sale and leaseback of the buses owned, the financier had to let (or hire) a warehouse for one night so that the buses could be driven in and out of the warehouse in order to effect delivery to the financier."

Such difficulties are apparent even though the strict Scottish prohibitions were tempered somewhat following the introduction of the floating charge in 1961 (a non-possessory security available to company debtors – extended in recent years to limited liability partnerships too).

And Gloag and Irvine were not alone in calling for reform. In the past forty years there have been four substantial reports arguing in favour of the reform of Scots law. In 1971 the Crowther Committee  recommended United Kingdom wide proposals for securities.  They proposed that the system for regulation of security interests be based on the registration of information with a scheme largely based on Article 9 of the Uniform Commercial Code of the United States of America. To assist in determining whether or not to implement this a working party under the chairmanship of Professor J M Halliday was established.  This working party reported to the Scottish Law Commission in March 1986, recommending a new form of non-possessory security, designed primarily to address the existing inadequacies of Scots law.   The Committee recommended that

“There should be a new system of security over moveable property based upon the establishment of a register of security interests with notice filing.  There would be no requirement of possession of the security subjects by the creditor.  Certain categories of transactions would be excluded from the scheme and would continue to be regulated by existing law.  Apart from pledge in the case of corporeal moveable property, the new security would be the only competent form of security by agreement within its area of application.”

The Working Party recommended a number of exceptions to this general rule and made explicit their view that the new scheme should have restricted application.  The Working Party specifying that.

“The new scheme should … be restricted to the area where the existing law is unsatisfactory.”

The third report was a United Kingdom wide review of securities over moveable property.  This review was carried out by Professor A L Diamond and was published in 1989.   This review, like the Crowther Committee, proposed a new scheme of security creation across the United Kingdom.  He specifically noted that in Scotland the weight of consultation received suggested that

“Scots law makes it too difficult – in practical terms impossible – to utilise security to facilitate the obtaining of credit and has concentrated attention on the floating charge which tends to cover all assets rather than utilising specific categories of assets such as stock or specialist items of plant.”  

Professor Diamond proposed that there should be a new system for the creation of moveable securities.  He was of the view that this system should be simple and unified and, like Crowther, believed that it should “be based closely on Article 9 of the American Uniform Commercial Code with a similar approach to be taken in both Scotland and England and Wales.

He wrote

“[G]iven the economic, financial and business links there would in my view be substantial advantages to both legal systems, and to business, if the relevant branches of law could resemble each other more closely, so that, for example, a business with interests both sides of the border could enter into similar transactions in England and in Scotland.  It would be to Scotland’s disadvantage if Scottish companies have to form English subsidiaries as the vehicles for their credit activities, thus shifting their financial centres of gravity from Scotland to England.  But fundamental differences of principle between the two legal systems would make it impossible to unify the law so as to have a single piece of legislation applicable to both jurisdictions.”

While there was little enthusiasm in England and Wales for the Diamond proposals, following consultation there was broad support in Scotland.  The consultees argued that Scots law was relatively undeveloped, and Scottish enterprises were disadvantaged when seeking finance as compared to English enterprises.  Similar concerns had led to the introduction of floating charges in 1961.

Taking account of the consultation process the Department of Trade and Industry established an advisory group to prepare a consultation document on the introduction of a new form of security into Scots law.  The Department of Trade and Industry produced a paper, with draft bill annexed, on Security over Moveable Property in Scotland  in November 1994.   This paper rejected the Article 9 approach.  It was argued that a system of notice filing “would have borne no relationship to any part of our law on the creation of real rights in security, or, in particular, to the current law on the registration of company charges.”

The paper  proposed firstly, that the power to grant floating charges should be extended to other enterprises, specifically partnerships and individual businessmen.   It was perceived that this power would be a less radical solution to the perceived problems with current Scots law than the introduction of a system based on Article 9.   For firms and sole traders the floating charge could only be competently granted over moveable property, compared with the floating charge granted by companies that may be granted over heritable and moveable property. The second principal proposal of the Department of Trade and Industry’s advisory group was the introduction of a new moveable security.  This security would be a non-possessory real right in security over moveable property, whether corporeal or incorporeal, excepting consumer goods (that is, corporeal moveable property exempt from what is now attachment) .  This moveable security would be capable of being granted by any person.  To be constituted as a real right in security, the moveable security would require to be registered, meeting the necessity of publicity to give notice to third parties identified earlier. A number of special rules were proposed in relation to the moveable security including provisions to protect third parties acquiring property subject to the moveable security.  

This most recent paper explicitly identified the perceived problems that their proposals were intended to address.

“In evaluating the extent of the need for reform of the law on security over moveable property in Scotland, the perceived problems were identified as being that: 

(a) it is not possible to create a non-possessory, fixed security over corporeal moveable property (apart from certain categories of property where special statutory provision has been made, as in the case of ships and aircraft); and

(b) there are practical difficulties associated with the granting of securities over incorporeal moveable property.  For example, the creation of a fixed security over book debts requires not only assignation of the rights to the book debts to the creditor in the security agreement, but also the intimation of that assignation to the common debtors under those debts.  That not only is practically inconvenient, but also means that it is impossible to create a fixed security over future book debts, as intimation cannot be made to as yet unascertained common debtors.”

The perceived legal problems identified remain those identified by Gloag a century before, and have been echoed throughout the century. While these policy concerns remain they are not explicitly referred to in the Scottish law Commission's statement in the eighth programme of law reform. There justification is given for expanding the proposal in the seventh programme to the much wider remit today, while noting the importance of various comparative law developments – which indicate the extent to which Scotland is out of step with other systems.

"2.5 …[S]ince the publication of the Seventh Programme we have come to think that the subject of security over corporeal moveable property should also be included. It too is regarded by many as being outmoded. We do, however, recognise that the addition of corporeal moveables would bring with it a degree of asymmetry to the project, for whilst outright assignations would be covered, outright transfers of corporeal moveables would not be. (In most cases the outright transfer of corporeal moveables is covered by the Sale of Goods Act 1979.) This asymmetry may cause certain difficulties for the project. But the link, from a practical point of view, between security over corporeal moveable property and security over incorporeal moveable property is strong, and the link between security over incorporeal moveable property and outright assignation of incorporeal moveable property is likewise strong. Hence there exists some degree of unity in the expanded project.

"2.6 Article 9 of the Uniform Commercial Code has been adopted by all states in the USA and has been copied (with variations) in a number of other jurisdictions, for example New Zealand with its Personal Property Securities Act 1999. It is likely that something broadly on these lines would at least be an option worth considering for Scotland, though of course bearing in mind the differences between our background law and that of the common law tradition. We would also take account of such recent initiatives as (i) the Draft Common Frame of Reference (Book III Ch 5 and Book IX), (ii) the United Nations Convention on the Assignment of Receivables in International Trade, and (iii) the European Bank for Reconstruction and Development Model Law on Secured Transactions."

So this is a fifth project, but no reform has taken place in the last forty years. Is this down to legislation previously having been in the hands of the UK government and particularly the Department of trade and INdustry (its predecessors and successors)? Or is it simply that the policy questions are well-balanced and complex?

The various proposals over the past forty years would have served to make life easier for creditors to obtain security (and potentially for debtors to raise finance – although evidence is equivocal on that) but they must be set against the interests of other creditors. Those that can obtain security tend to be powerful creditors with loan finance. Those that end up as unsecured creditors are people who have carried out work, or other suppliers of services as well as some suppliers of goods. Each of these creditors will have a contractual relationship of some sort with the debtor. However, some creditors end up as creditors without any voluntary relationship with the debtor. Creditors in delict or unjustified enrichment, or those with unpaid local or national taxes do not have a choice about being a creditor. And any enhancement of the law of securities will potentially prejudice their position. The balance between the interests of these competing secured and unsecured creditors, and the balance between the interests of creditors and debtors makes this a challenging project. To assist the Commission has established an advisory group comprising experienced practitioners, and academics. That group met for the first time last week.

One wishes the Commission well.