Seminar 1 The What’s & Why’s of Security?

Aim

The aim of this first seminar is to gain an overview of what is meant by security and to introduce students to the major foundational

basis and classification of security. It is also intended to consider the rationale for taking security and to assess the economic

arguments surrounding secured lending.

Objectives

At the end of this seminar you will be able to

 Explain the distinction between:

o Personal and real security;

o Security and quasi security;

o Fixed sum and revolving credit.

 To identify the characteristics of real security; and

 Explain the legal foundations of lending and security.

 List and explain the functions of security;

 Evaluate the advantages and disadvantages to the economy of secured lending.

Reading

The Meaning of Security:

Goode & Gullifer Legal Problems of Credit and Security (LPCS) Chpt 1

The Purpose of Security -just take a look at a couple of this selection:

Clarke A & Kohler P, Property Law Commentary and Materials CUP 2005 at p659

Clarke A, Security Interest in Property in Property Problems From Genes to Pension Funds Harris JW (ed) London

Kluwer,1997

Finch V, (2000) Insolvency Lawyer 194

Mokal RJ, (2002) 22 OJLS 686, (2001) 60 CLJ 581 & (2008) 71 MLR 699

Bridge S, (1992) 12 OJLS 333-345 – do not concern yourself at this stage with the rest of the article on Quistclose Trust.

Finch V, Corporate Insolvency Law (2 ed) Cambridge 2009 Chpt 3.

There is considerable American literature from law and economic scholars on the efficiency of security an example is Jackson TH and

Kronman AT (1979) 88 Yale LJ 1143-1161 and the further reading below.

Seminar Notes

Classification of Security
Many devices have been developed to assist a creditor or trader to recover the debt owed to them or to ensure the fulfilment of other

obligations. We will be exploring the most important of these devices and the associated legal issues that attend their creation and

enforcement. Before we do so we need to gain an understanding of what is meant by security, some of the basic terminology that is

associated with security transactions and the areas of law that underpin security transactions.

It is possible to look at security in terms of form or function. In other words does a transaction comply with the required legal form of

security or does it serve the function of trying to ensure that a creditor or trader can recover the debt or other obligation owed to them.

We distinguish between form and function using the terms security and quasi-security.

A creditor may acquire a security either by looking to the property of the debtor or by looking to another person for repayment. Where

security creates an interest in the property of the debtor it is termed real security since it creates a right in rem which prima facie can

be exercised against that asset even though the debtor is bankrupt/in liquidation or no longer is the owner of the asset. A personal

security by contrast is a right in personam which is enforceable only by action against the person who has shouldered the obligation

and is placed in jeopardy by the insolvency of that person.

Have a look at the definition of real security that Sir Nicholas Browne Wilkinson VC accepted in Bristol Airport Plc v Powdrill [1980]

Ch 744 at 760 and the characteristics identified by Goode at para 1-16.

Real security in English law commonly takes one of four forms – what are they?

See Millet LJ in Re Crosslet Contractors [1998] Ch 495 at 508.

What further distinction does Millet LJ explain between these four forms of security?

To recap when classifying security we can distinguish between:

 Security which may be:

o Personal; or

o Real which in turn may be classified as:

 Possessory;

 Non-possessory.

 Security and quasi-security depending on whether:

o We look only to form –security; or

o Also to function – quasi-security.

See if you can identify into what category the following belong and why:

1. An agreement by A given to B (the creditor) that they will pay the sum of £X that C (the debtor) owes to B. What do we

commonly call this type of transaction?

2. A contractual set-off ie an agreement that A Bank who has lent money to B that A bank may use money deposited with them

by B to repay the debt owed by B.

 3. A term in a sale of goods between A (as seller) with B (as buyer) that the ownership in the goods will remain with A unit B

pays A the full price.

See Amour v Thyssen Edelstahlwerke AG [1991] 2 AC 339 at 352 per Lord Keith and 354 per Lord Jauncey

4. An agreement that A may have possession/retain the possession of goods belonging to B until B repays the £X that A has

made available to B.

Have a look at the other types of transaction explained by Goode which fall at the security and quasi security divide see LPCS above.

Accommodation given by a creditor to a debtor may arise in two main contexts. First, where a creditor makes a loan available to a

debtor and secondly where a seller provides credit to buyer in the purchase of goods or services by deferring payment of the price. We

will be concentrating on the first of these contexts. Here we must distinguish between fixed sum loans and revolving or current

account credit.

Can you think of examples of these two types of loan finance?

All types of property may be used as security. What do you think is the most attractive form of property belonging to a commercial

borrower over which a lender would like to take security?

Legal Foundations of Security

In our study of security we will need to appreciate the legal foundations which underpin the creation and enforcement of security

transactions. The enforcement of a security transaction will generally be concerned with establishing:

1) the validity of the loan as an enforceable contract which satisfies established contractual principles; and

2) the validity of the security which creates a recognised proprietary interest in an asset of the borrower for the benefit of the

lender to support the performance of the loan agreement;

3) a breach of the loan agreement or the security. The most common form of breach by the borrower is of course non-payment of

the loan but there may be other breaches, for instance a breach of one of the other terms contained in the loan agreement or security. In

addition either the lender or borrower may have committed a wrong as a result of breach of a duty owed in tort or equity.

Thus the significant areas of law that form the foundation of security transactions and which we will encounter are:

 Contract – contract lies at the heart of lending thus we will be concerned with such issues as to how contracts are formed, the

capacity of the parties to enter into a contract, common contract terms and controls over those terms, the factors which may

vitiate a contract. You can find these issues discussed in Hudson’s Law of Finance Part V.

 Property – real security creates a proprietary interest and thus we will need to understand the types of proprietary interest

recognised in English law. Here we need to understand not just legal ownership of tangible and intangible property but also

the concept of the trust and equitable ownership and the lease granting possession of property for a defined period. Also of

concern is title to property and its proof as well as the ability to trace (or follow) that title into the hands of third parties.

Hudson explains these concepts in Part VI of his book The Law of Finance.
  Wrongs – the need to rely upon security only becomes an issue when things go wrong! A borrower may have failed to repay

the debt or committed some other breach of the loan agreement. One or other of the parties may have committed some fraud,

misrepresentation, undue influence which affects the validity of the transaction so as to release the other party from

performance or one or other of the parties may have committed some breach of their contractual, tortuous or equitable duties

in the performance of their obligations. Different remedies will flow from these wrongs which may require performance or

release the parties from their obligations or result in a claim to damages or restitution for unjust enrichment. The impact of

wrongs upon security transactions is discussed by Hudson in Part VII of The Law of Finance.

There are of course other areas of law that we will touch upon including company law (most borrowers and lenders are corporate

entities), insolvency, conflicts of law and domestic and European regulation affecting security transactions.

The Function of Security

Have a look online to see if you can find information and statistics about the level of secured lending for instance the Bank of England

Statistics.

List the functions of security which do you think is the most significant reason for taking security?

When a company becomes insolvent, what is the order in which its creditors are paid? You should find the answer in any company

law or insolvency text although note that the law was changed by the Enterprise Act 2002.

Consider the following question for discussion at the seminar:

Security makes nonsense of the pari passu rule for the repayment of creditors on insolvency and cannot be justified? Discuss.

Further Reading

Allen (1989) 15 Mon LR337

Goode (1989) 15 Mon LR 361 and (1987) 103 LQR 433

White JJ (1984) 37 Vanderbilt LR 473,

Scott RE (1986) 86 Columbia LR 901,

(1997) 82 Cornell Law Review 1279-1567 – a whole issue is devoted to the subject