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Optimizing English and American security interests.


Security is a relationship between collateral and monetary obligations. The essence of the relationship is that if the obligations are not paid, the collateral may be sold and the sale proceeds applied to pay the obligations. The security concept is embodied in mortgages, security interests, and liens.

Security enjoys a highly privileged position in American law. A simple-sentence grant of a security interest, (1) combined with the filing of notice in an obscure set of public records, will give the secured creditor's claim priority over employees' wage claims, (2) child support obligations, (3) tax claims, (4) civil damage judgments, (5) criminal fines and forfeitures, (6) claims for unjust enrichment, (7) and just about any other kind of debt imaginable. (8)

Scholars have attempted to justify security on both contract and property theories. On the American side, Dean David Leebron best articulated the contract argument:
   The priority claim of a secured creditor rests almost entirely on
   principles of contract and notice. A persuasive theory of secured
   credit financing has been elusive, but the priority of a secured
   creditor over other financial creditors can be justified on the
   grounds that non-secured creditors grant a loan knowing that some
   assets are subject to security interests or could be subjected to
   security interests without their permission. If particular
   creditors will not tolerate other creditors having security
   interests in the borrower's assets, they can refuse to make a loan
   or make it only if the borrower agrees not to subject its assets to
   any security interests. (9)

Contract cannot, however, justify security because security agreements "[are] effective according to [their] terms ... against purchasers of the collateral, and against creditors." (10) That includes purchasers and creditors who did not consent to the security agreement, had no way of knowing of its existence, or never chose to become creditors at all. (11) Agreement is the essence of contract, but the affected purchasers and creditors have not agreed. As Professors Lynn LoPucki and Elizabeth Warren put it, "[s]ecurity is an agreement between A and B that C take nothing." (12)

Other scholars attempt to justify security on property theories. For example, Professors Stephen Harris and Charles Mooney argued:
   It seems clear enough that security interests, under Article 9 and
   real estate law alike, are interests in property. The legal regime
   for security interests reflects property law functionally as well
   as doctrinally. We believe it follows that the law should honor the
   transfer or retention of security interests on the same normative
   grounds on which it respects the alienation of property generally.

The property theory begins from the generally accepted premise that a building owner can, by conveying the building in an otherwise unobjectionable transaction, cut off the rights of the debtor's creditors to the building. By analogy, the property theory holds that by conveying the first $100,000 of the value of the building in return for a $100,000 loan, the owner should be able to cut off the rights of the debtor's other creditors to the first $100,000 of the value of the building. Frequent American literature references to security interests as "property" (14) and English literature references to charges as "proprietary" (15) are invocations of this theory.

A necessary implication of the property conveyance theory is that encumbered property has multiple owners. The secured creditor owns the value of the collateral up to the full amount of the debt. The debtor owns the value of the collateral in excess of the amount of the debt, the right to redeem the property by paying the debt, (16) and the right to use the property in the interim.

The principal policy objections to security are that it is deceptive (17) (the "Deception Problem") and that it distorts incentives for the management of property (the "Incentives Problem"). The essence of the Deception Problem is that debtors who have granted security interests appear to have wealth, but do not. The effect is to deceive third parties who extend credit without knowledge of the pre-existing security. The problem is generally referred to as "ostensible ownership" in the United States (18) and as "false wealth" in England. (19)

The Incentives Problem is most egregious and easiest to see when the amount of the secured debt equals or exceeds the value of the collateral. Consider, for example, a business that operates with one billion dollars in assets encumbered by one billion dollars in secured debt. As the property's owner, the debtor has the right to control its use. The debtor can engage in business activities that risk inflicting billions of dollars in damages on third parties. (20) Those third parties have no remedy against the debtor, because the debtor owns no part of the value of its own assets. (21) They have no remedy against the secured party because the secured party--switching its metaphorical role from "owner" to "creditor"--has priority over them. (22) By shielding the debtor's property from the valid claims of third parties, security renders both "owners" judgment-proof (23) and encourages the irresponsible management of wealthy. (24)

Through a functional comparison of English and American security interests, this Article identifies potential practical solutions to the Deception and Incentives Problems. The proof that these solutions can potentially work in one country is that they appear already to be working, in similar circumstances, in the other.

The challenge was to distinguish these potential solutions from the hundreds of differences that exist in legal doctrines and concepts between English and American security interests. We accomplished that by conducting our comparison at the functional rather than the doctrinal level. Put simply, we focused on the resolutions of particular problems in the two systems. We treated the systems as the same if they reach the same resolutions--what LoPucki and Weyrauch have referred to as "delivered law"--regardless of the paths by which they arrived at them. (25) To the extent that terminology differed between the two systems, we posed the problems and resolutions in a neutral language, which we constructed as needed. This method is well-recognized in the field of comparative law. (26)

Functional comparison dramatically reduces the apparent level of difference between two legal systems. (27) The explanation for this previously recognized phenomenon is beyond the scope of this Article. In our comparison of English and American security interests, the effect was to demonstrate that the systems are operating almost identically.

The few functional differences that remain are each true policy alternatives. We know that each is likely capable of transplant to the other system, because each is already operating in an otherwise almost-identical system.

Of the seven functional differences we identify, the most important addresses the Incentives Problem. In the American system, security interests have priority over virtually all competitors. In the English system, a "carve-out" gives administrative expenses, preferential creditors, and an unsecured creditor "prescribed share" priority over security interests.

Three other differences address the Deception Problem. Both the English and American systems generate secret liens, but they do so in different ways and with respect to different collateral. The English system is company-based while the American system is name-based. The English system supplies more information, and to a wider audience. The three remaining differences are of only minor importance.

We do not claim to have shown that the devices identified solve the underlying problems, even in the countries in which they are currently in use. Our claim is that they are potential solutions because they are purported to have mitigated those problems.

We also make two other claims. First, our comparison is the most extensive point-by-point comparison of the English and American law governing secured transactions to date. (28) Second, the extraordinary level of similarity we observed at the functional level suggests that law-making is in most instances better described as a search for the only solution that will work, than as a process of choosing among alternative policy solutions.

Both the English and American security systems recognize a wide variety of security devices. (29) To render our subject manageable, we confine consideration in this Article to the principal forms of security granted by companies. In the American system, that is the Uniform Commercial Code Article 9 security interest with respect to personal property and the mortgage with respect to real property. In the English system, that is the fixed and floating charge, either of which can--in theory at least--extend to both real and personal property.

This Article proceeds in four parts. Part I compares the English and American systems with respect to attachment, perfection, and enforcement of security interests. Part II explains the distinction between fixed and floating charges under English law. Part III compares American security interests with English fixed charges by comparing the outcomes in prototypical cases. Part IV compares American floating liens with English floating charges in the same manner. The final Part concludes that the Americans should consider adopting the English Carve-out, the English should consider adopting the American cramdown, and both should consider improvements to their security interest registration systems.


English fixed and floating charges are created, perfected, prioritized, and enforced in essentially the same manner as American security interests.

A. Attachment

In both the English and American systems, debtors and creditors create security interests by contract. In both, the creation is referred to as "attachment." The conditions necessary for security interests to attach in the two systems are almost identical. To illustrate:
   Goode describes four conditions which are necessary in order for an
   interest to attach: (1) there must be an agreement between debtor
   and creditor that the interest shall attach; (2) the asset must be
   identifiable as falling within the scope of the agreement; (3) the
   debtor must have a present interest in the asset, or power to give
   the asset as security; and (4) there must be some current
   obligation of debtor to creditor which the asset is designed to
   secure. (30)

Each of these four conditions for attachment is clearly visible in the provisions of the Uniform Commercial Code that define attachment:

[section] 9-203(a). A security interest attaches to collateral when it becomes enforceable against the debtor with respect to the collateral....

(b) ... [A] security interest is enforceable against the debtor and third parties with respect to the collateral only if:

(1) value has been given;

(2) the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party; and

(3) one of the following conditions is met:

(A) the debtor has authenticated a security agreement that provides a description of the collateral.... (31)

The English requirement of an agreement is matched in the UCC [section] 9-203(b)(3) requirement of an authenticated security agreement. If the collateral is land, both systems require that the agreement be the equivalent of a writing. (32) For other collateral, the American system requires a writing or tangible equivalent, (33) while the English system does not. (34) But in both countries, security agreements are nearly always in writing to meet registration requirements or for evidentiary reasons, making the difference of little commercial importance.

The English requirement that "the asset must be identifiable as falling within the scope of the agreement" (35) is matched by the American requirement that the security agreement "provides a description of the collateral" (36) that "reasonably identifies what is described." (37) The English requirement that the debtor "have a present interest in the asset, or power to give the asset as security" (38) is matched by the American requirement that "the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party." (39) Lastly, the English requirement that there be "some current obligation of debtor to creditor which the asset is designed to secure" (40) is matched by the American requirement that "value has been given." (41) Although the American statute does not say who must give value "the assumption seems to be that it is the creditor." (42) Typically, that value will be the loan.

One apparent difference between the English and American systems is that the English system permits the taking of floating charges against "the undertaking," that is, the business of the debtor. (43) The American system permits only the taking of security interests in specific property, or specific categories of property. (44) A description of the collateral as "all of the debtor's assets" or words of similar import, is insufficient. (45) The difference may, however, merely be cosmetic. American lawyers combine all possible categories of property to create descriptions that cover all property of the debtor that can serve as collateral. Such descriptions are upheld. (46)

B. Perfection

The legitimacy of secured creditor priority ultimately rests on the assumption that "all creditors have [had the] opportunity to discover the existence of the secured creditor." (47) In recognition of this dependence, both the English and American systems impose "perfection" requirements designed to provide notice. Perfection requirements include taking possession or control of collateral and public lien registration.

The English and American registration systems differ in four relevant respects. First, American registrations are generally effective when made, while English registrations relate back to charge creation. Second, the English system is company-based, while the American system is name-based. Third, although both systems grant exceptions from registration that result in secret liens, the exceptions are different. Lastly, the English system seeks to provide public notice, while the American system seeks to provide notice only for the benefit of prospective secured lenders.

1. Security Interest Priority Dates

In the United States, the approach taken by the Uniform Commercial Code is that the first creditor to file or perfect has priority over creditors who file or perfect subsequently, (48) regardless of when the security agreements were made or the loan proceeds disbursed. This has been referred to in the American literature as a "pure race" approach, because "a filing secured creditor prevails even over those unrecorded security interests of which he was aware." (49)

The English rule is that competing company charges "rank in order of their creation." (50) (That is also the basic rule for competing real estate mortgages in the United States.) (51) A charge is created upon the execution of "a contract for valuable consideration to ... charge [an item of collateral, which] passes a beneficial interest by way of property in that [collateral]." (52) The order in which the competing creditors register their interests does not matter. However, the Companies Act requires a charge created by a company to be perfected by registration within twenty-one days after the date of its creation. (53) Failure to comply with this provision renders the charge void against other creditors and against the liquidator or administrator of the company. (54)

The deceptive nature of the English rule is well recognized. The rule creates an "invisibility period" of up to twenty-one days:
   The principal rule is that priority of competing charges is
   determined by the order of their creation. The combination of this
   and the 21-day period allowed for registration has given rise to
   what has been called the '21-day invisibility' problem. A person
   who searches the Companies Register, finds no record of an earlier
   charge and takes and registers her own charge immediately, may
   nevertheless be postponed to an earlier chargee who registers after
   the taking, or even the registration, of the second charge but
   within the 21 days allowed. (55)

The Law Commission has already recommended that priority be determined solely by comparing dates of registration. (56)

2. Entity-based Versus Name-based Filing

The system for filing and searching is entity-based in England, but name-based in the United States. That the English system is entity-based means that a security interest registration is associated with a particular company at the time it is made. That is, the secured creditor selects the company against which to file or search by reference to the company records. The secured creditor can make the match by name, company number, or other information in the company records, (57) and the filing officer places the filing in the company records. The secured creditor can err only by choosing the wrong company.

In the American name-based system, the secured creditor must file in the exact, correct name of the debtor. Because the filing officer does not associate the security interest registration with the company registration, the filing officer does not know whether the security interest registration identifies an existing company. With difficulty, the filer can search the company records to discover the debtor's name, and computer search logic may or may not save filers or searchers from minor errors in punctuation and abbreviation. But the American system will not overcome the use of a trade name, or a misspelling. As a result, as many as fifteen to seventeen percent of registrations against corporate entities in the United States are ineffective. (58)

In 2001, the Article 9 drafters laid the groundwork for a change to entity-based filing, by changing the place for filing and searching to the debtor's incorporation state and requiring inclusion of the company number on each filing. Those changes made it possible for the filing officers to associate filings with companies. But in the ensuing nine years, only one or two commercially unimportant states actually made the association. (59) In 2010, the American Uniform Law Commission apparently abandoned this reform effort by dropping the requirement that company numbers be included on filings, (60) and declaring the exact, correct name of an entity not necessarily to be the name on the computerized records of the filing office. (61) For the filing office to match filings to company records is no longer practical.

3. Secret Liens

Second, in both the English and American systems, some security interests are effective without registration or any substitute method of publicity. The effect is to validate secret liens, and deceive those who deal with the debtor on the basis of the public record.

In the English system, all floating charges must be registered, (62) but fixed charges must be registered only if they are of particular types listed in the Companies Act. (63) The list does not, for example, include charges on insurance policies (64) and on shares. (65) The shortcomings caused the Law Commission to conclude:
   [B]ecause the list of registrable charges is incomplete (in part
   because the list has been little changed since its introduction
   over a century ago), and because the priority aspect has developed
   only as an indirect effect of attempts to secure compliance, the
   current scheme does not seem to fulfil either its 'public notice'
   function or its 'priority' function efficiently. (66)

The American system has the same shortcoming with respect to security interests in insurance policies or shares. (67) In addition, the American system authorizes secret liens in bank accounts, investment property, and some other kinds of collateral. (68) The American system does so by requiting that the secured creditor take "control" over the collateral, but defining control in a manner that taking it is unlikely to alert third parties to the existence of the security interest.

The American requirement for perfecting a security interest in a bank account is illustrative. No public filing is required. (69) The secured creditor can perfect by taking control. (70) The secured creditor takes control by entering into an agreement with the debtor and the bank, in which the bank agrees to "comply with instructions originated by the secured party directing disposition of the funds in the deposit account without further consent by the debtor." (71) The secured creditor has control "even if the debtor retains the right to direct the disposition of funds from the deposit account." (72) Thus, the debtor can continue to use the secured-creditor-controlled account in the exact same manner as if it were unencumbered. The bank "is not required to confirm the existence of the [potential control] agreement to another person unless requested to do so by its customer." (73) The result is a lien that is invisible to the public, including all but the most diligent who deal with the debtor. Similar potential for secret liens exists with respect to "control" of securities and commodity accounts. (74)

English law does not permit secret charges in bank accounts. (75) Ordinarily, a charge against a bank account would be a floating charge. (76) As was discussed above, with one minor exception floating charges must be registered. (77)

English and American law differ with respect to the sale of accounts receivable. American law regards such sales as the equivalent of security interests and requires registration. (78) English law does not require registration of a sale of accounts:
   In the case of a factoring agreement, the purchase rights of the
   factor, which are not charges, do not require registration.
   Consequently, there is no means in the nature of public notice by
   which a competing factor or secured creditor can discover the
   existence of a previous sale of the book debts. (79)

4. Public Notice Versus Prospective-Lender Notice

The English registration system makes information about registrations more widely available than does the American system. The English broadly conceive the system's purposes to include the provision of information to the public, (80) credit rating agencies, insolvency administrators, and creditors who no longer have leverage over their debtor because they have already committed their funds:

Commentators now recognise that registration fulfills several purposes:

(1) it provides information on the state of the encumbrances on a company's property to those who may be interested (for example, creditors and those considering or advising on dealing with the company, including credit reference agencies, financial analysts and potential investors);

(2) it assists companies in enabling them to give some form of assurance to potential lenders that their property is unencumbered;

(3) it provides a degree of protection to a chargee, in relation to the validity and priority of its registered charge; and

(4) it assists receivers and liquidators in deciding whether or not to acknowledge the validity of a mortgage or charge. (81)

The English system also provides relatively generous access to the terms of the security agreement. Each company is required to keep "available for inspection a copy of every instrument creating a charge requiring registration" (82) and "a register of charges ..., [into which the company is required to enter] (a) all charges specifically affecting property of the company, and (b) all floating charges on the whole or part of the company's property or undertaking," (83) which "in each case [shall] give a short description of the property charged, the amount of the charge and, except in the cases of securities to bearer, the names of the persons entitled to it." (84) The documents and the register are required to be open to the inspection of any creditor or member of the company without payment of a fee. (85) Any person can inspect the documents and the company's register of charges (but not copies of the instruments) on payment of a nominal fee. (86)

By contrast, the American system operates on the principle that existing liens are the business of no one but the debtor, and those to whom the debtor wishes to disclose them:
   Because creditors of and prospective purchasers from a debtor may
   have legitimate needs for more detailed information, it is
   necessary to provide a procedure under which the secured party will
   be required to provide information. On the other hand, the secured
   party should not be under a duty to disclose any details of the
   debtor's financial affairs to any casual inquirer or competitor who
   may inquire. For this reason, this section gives the right to
   request information to the debtor only. The debtor may submit a
   request in connection with negotiations with subsequent creditors
   and purchasers, as well as for the purpose of determining the
   status of its credit relationship or demonstrating which of its
   assets are free of a security interest. (87)

Despite the acknowledgement that creditors and prospective purchasers from the debtor may need additional information from the secured creditor, Article 9 gives only the debtor a legal right to obtain it. "Section 9-210 provides a statutory procedure under which the secured party, at the debtor's request, may be required to make disclosure. However, in many cases, information may be forthcoming without the need to resort to the formalities of that section." (88) The information obtainable through U.C.C. [section] 9-210 does not include a copy of the security agreement. In most cases, however, the debtor will have a copy. No provision of Article 9 requires that either the debtor or the secured party furnish a copy of the security agreement to anyone.

The difference between the English and American systems in access to information is most visible in the example of an unsecured creditor who is considering whether to take legal action against its debtor. In the English system, this creditor would have the right to review copies of every instrument creating a charge against the company. In the American system, this creditor would have the right to only the names of persons who might have security interests and general categories of property those interests might encumber. (89)

C. Enforcement

If an American debtor defaults on its obligations under the security agreement, the secured creditor has by law the right to repossess tangible personal property collateral by self-help if it can do so without breach of the peace. (90) An English debtor has the same right only if the security agreement so provides, but security agreements almost invariably so provide. (91) Neither system permits self-help with respect to real estate. (92) In both systems the secured creditor can sell the cop lateral under its own power of sale (93) or through a court-supervised sale, (94) and apply the proceeds of sale to payment of the secured obligation. (95) In both, the debtor has the right to "redeem" the collateral after default by paying the full amount due under the contract prior to sale of the collateral. (96)

In summary, the English and American systems are highly similar with respect to attachment and enforcement of security interests. Both function poorly with regard to perfection, although they do so in different ways.


The distinction between fixed and floating charges is important because floating charges are subject to the English Carve-out, while fixed charges are not. The distinction has been difficult to make because no statute defines "floating charge" (97) and the process of defining it by case law has proceeded slowly. As Professor Goode put it in an article advocating abolition of the floating charge:
   Corporate floating charges have now been with us for some 135
   years--plenty of time, one might think, for the courts to have
   worked out in detail their nature and priority.... It is
   astonishing that after all this time we still extol the virtues of
   a security device which continues to generate controversy and
   differences of opinion among the judiciary as to its essential
   nature. (98)

The slow process of case-based definition began in 1903. In In re Yorkshire Woolcombers Ass'n Ltd., (99) Lord Justice Romer set forth the following three-part test for the existence of a floating charge. A charge is floating:

(1.) [I]fit is a charge on a class of assets of a company present and future;

(2.) [I]f that class is one which, in the ordinary course of the business of the company, would be changing from time to time; and

(3.) [I]f you find that by the charge it is contemplated that, until some future step is taken by or on behalf of those interested in the charge, the company may carry on its business in the ordinary way as far as concerns the particular class of assets [subject to the charge]. (100)

The first criterion makes clear that a floating charge can extend to assets the debtor does not yet own, or that do not yet even exist. The second indicates that a floating charge is typically taken over "revolving assets" (101) such as inventory or accounts receivable. The third is interpreted to mean that the floating charge debtor remains "free to manage and deal with" the collateral in the ordinary course of business until some future event occurs which terminates that right. (102)

Lord Justice Romer acknowledged that he was not giving a precise definition of the floating charge.
   I certainly do not intend to attempt to give an exact definition of
   the term "floating charge," nor am I prepared to say that there
   will not be a floating charge within the meaning of the [Companies]
   Act [1900], which does not contain all the three characteristics
   that I am about to mention, but I certainly think that if a charge
   has the three characteristics that I am about to mention it is a
   floating charge. (103)

As he predicted, later cases chipped away at the relevance of the first two criteria. (104)

The essence of the distinction remained unclear for the next one-hundred years. In 2001, through Lord Millett, the Privy Council in Agnew v. Commissioner of Inland Revenue (105) held that "the first two [criteria] are typical of a floating charge but they are not distinctive of it, since they are not necessarily inconsistent with a fixed charge." (106) Lord Millett went on to say that Lord Justice Romer's third criterion "is the hallmark of a floating charge and serves to distinguish it from a fixed charge." (107) This reduction of Lord Justice Romer's criteria from three to one was corroborated in 2005 by Lord Scott. In In re Spectrum Plus Ltd., Lord Scott stated that "if a security has Romer LJ's third characteristic ... it qualifies as a floating charge, and cannot be a fixed charge, whatever may be its other characteristics." (108) In other words, Lord Justice Romer's third criterion for characterizing a charge as floating--lack of secured creditor control over the collateral--is both necessary and sufficient; while Lord Justice Romer's first and second criteria are merely indicative.

A. Control as the Distinction

Although his comment was not ultimately as influential as Lord Justice Romer's, Lord Justice Williams also weighed in on the distinguishing factor in Yorkshire Woolcombers. He said:
   [W]hat you do require to make a [fixed charge] is that the security
   whenever it has once come into existence, and been identified or
   appropriated as a security, shall never thereafter at the will of
   the [chargor] cease to be a security. If at the will of the
   [chargor] he can dispose of it and prevent its being any longer a
   security, although something else may be substituted more or less
   for it, that is not a '[fixed] security.' (109)

In Agnew, Lord Millett quoted Lord Justice Williams's comment as part of his rationale for declaring that the first two of Lord Justice Romer's three criteria were not necessary components of a floating charge. (110) In so doing, he stated that "[s]ince the existence of a fixed charge would make it impossible for the company to carry on business in the ordinary way without the consent of the charge holder, it follows that its ability to do so without such consent is inconsistent with the fixed nature of the charge." (111) This viewpoint was clarified and expanded upon by the House of Lords (112) in the Spectrum case:
   T]he essential characteristic of a floating charge, the
   characteristic that distinguishes it from a fixed charge, is that
   the asset subject to the charge is not finally appropriated as a
   security for the payment of the debt until the occurrence of some
   future event. In the meantime the chargor is left free to use the
   charged asset and to remove it from the security.. (113)

   After Spectrum, Professor Goode states that:

   The acid test for distinguishing between a fixed and a floating
   charge is not whether the assets comprising the security are fixed
   or circulating but whether the creditor has or has not taken
   sufficient steps to exclude the debtor's right to continue to
   manage the assets and dispose of them in the ordinary course of
   business free from the charge. (114)

In essence, the debtor has "control" if the debtor can dispose of the collateral free of the charge. The disposition intended is in the English ordinary course of business, not the American ordinary course of business. (115)

B. Collateral's Nature as the Distinction

Agnew and Spectrum held the existence of creditor control to be legally determinative of whether a charge is fixed or floating. But it is the collateral's nature that is actually determinative.

In theory a floating charge "is not confined to circulating assets but can be made to cover any description of property" (116) and "a fixed charge may be taken over revolving assets." (117) But, as we previously noted, secured creditors gain greater advantage from fixed charges than from floating charges, principally because floating charges are subject to the English Carve-out. "Hence, in England banking lawyers have had a powerful incentive to develop new types of security which will be classifiable as 'fixed' from the outset." (118) Secured lenders also have sufficient leverage in their dealings with borrowers to frame their charges against revolving assets as fixed. (119)

In doing so, however, secured creditors encounter a practical difficulty. To make their charges fixed, they must actually control their borrowers' disposition of the revolving assets. Such control does not merely impede the borrowers' businesses, (120) it is expensive for secured creditors to exercise.

In Spectrum, Lord Walker gave this succinct description of the operation of a typical business: "Trading stock is sold and becomes represented by book debts; these are collected and paid into the bank; the trader's overdraft facility enables it to draw cheques in favour of its suppliers to pay for new stock; and so the trading cycle continues." (121) Translated from the English to American, Lord Walker is pointing out that businesses sell their inventory on credit. Their customers' obligations to pay are accounts receivable. The businesses collect the accounts receivable and deposit the proceeds to their accounts at their secured creditor banks. The businesses then write checks on the bank accounts to purchase new inventory to replace what was sold. The "overdraft facility" to which Lord Walker refers is the business' loan account with the bank, which is often combined with the bank account (a debt owing from the bank to the business) in a single, negative balance. These assets, inventory, accounts, and bank deposits are the typical revolving assets of a business. The remaining assets of a typical business, real estate, equipment, and intangibles such as intellectual property and licenses are "fixed" assets.

Under Spectrum, a charge against accounts receivable can be a fixed charge only if "the assets can be released from the charge only with the active concurrence of the chargee." (122) Lord Walker gave this illustration of what arrangement might suffice:
   [I]f the terms of the debenture were such as to require the trader
   to pay all its collected debts into the bank and to prohibit the
   trader from drawing on the account (so that the account is
   blocked), a charge on debts, described as a fixed or specific
   charge, would indeed take effect as such.... In those circumstances
   the chargee would be in control, prior to crystallisation, and the
   trader would be unable to trade in the ordinary way without the
   chargee's positive concurrence. In Agnew's case ... Lord Millett
   pointed out that it was not enough to provide in the debenture for
   an account to be blocked, if it was not in fact operated as a
   blocked account. (123)

What that illustration required of the bank was its "positive concurrence" in each disbursement of funds from the blocked account. The credit agreement in Spectrum provided for the bank's positive concurrence in decisions dealing with the accounts while they remained outstanding, (124) but not in withdrawing funds from the bank account. The provision at issue was as follows:
   With reference to the book debts and other debts hereby
   specifically charged [Spectrum] shall pay into [Spectrum's] account
   with the bank all moneys which it may receive in respect of such
   debts and shall not without the prior consent in writing of the
   bank sell factor discount or otherwise charge or assign the same in
   favour of any other person or purport to do so and [Spectrum] shall
   if called upon to do so by the bank from time to time execute legal
   assignments of such book debts and other debts to the bank. (125)

Thus, the Bank had an agreement entitling it to whatever control it chose to take--what we refer to in this Article as "potential control"--but it hadn't actually taken that control. The insufficiency of potential control to create a fixed charge suggests that, for the English banks to succeed in their quest for fixed charges over the revolving assets, the banks will have to insist on approving each disbursement from the bank account. Neither we nor the English commentators can imagine bankers seeking to understand and meaningfully approve each disbursement from their debtors' bank accounts. (126) We can imagine them setting up a system in which software evaluates each disbursement by some lax standard and claiming that the system meets the Spectrum test.

Such purported control seems unlikely to prove sufficient, however, because its obvious intent would be to defeat the policy favoring preferential creditors. As Lord Walker stated in Spectrum, "there is a public interest which overrides unrestrained freedom of contract.... On the fixed/floating issue, it is ensuring that preferential creditors obtain the measure of protection which Parliament intended them to have." (127)

Thus, we agree with the English commentators that the banks' quest for fixed charges over revolving assets has almost certainly come to an end (128):
   It is true that the banks still hanker after the ability to take a
   priority-preserving fixed charge over receivables by stipulating
   for control over accounts as dictated by Spectrum, but in practice
   this will not happen, as few companies will be willing to subject
   themselves to a regime requiring them to open a blocked account and
   obtain approval for every withdrawal from their account. For most
   practical purposes the fixed charge over book debts is dead. (129)

The de facto dominance of the collateral's nature test over the control test is explained legally by way of a presumption. As Goode put it, "[a] charge over circulating assets is [ ]thus presumptively intended as a floating charge, so that restrictions on the debtor['s] ... ordinary dealing powers need to be specifically agreed, whereas a charge over fixed assets is assumed to be intended as a fixed charge." (130) Case law corroborates that view:
   [If] the charged property is stock, or book debts--i.e. where the
   assets are naturally fluctuating--the court will readily conclude
   that a liberty for the [debtor] to deal with the charged assets is
   inconsistent with a fixed charge; where ... the assets are specific
   and do not necessarily fluctuate, some liberty to release the
   charged assets may not be inconsistent with a fixed charge. (131)

The effect is to bring the analysis of Yorkshire Woolcombers full circle. Although the third part of Lord Justice Romer's test--secured creditor control--has prevailed legally, the practical effect is much the same as if the second part--the revolving nature of the collateral--had. In the remainder of our analysis, we will assume that secured creditors typically "take a fixed charge over fixed assets and a floating charge merely over circulating assets." (132)

C. Crystallization

Crystallization is an event by which a floating charge becomes a fixed charge. (133) Once crystallized, the charge will have priority as a fixed charge against later competitors for the collateral. The effect is not, however, retroactive:
   A crystallized floating charge ranks as a fixed charge for the
   purposes of determining its priority against other interests in the
   company's property which are created or acquired after
   crystallization. Although there is one case that suggests
   otherwise, the better view is that crystallization does not affect
   the priority of a floating charge against other interests in the
   same property which pre[-]date crystallization. (134)

Although crystallization and default are independent concepts, crystallization often occurs at the time of default and many of the issues that arise, and the contract provisions addressing those issues, are similar. (135) Both crystallization and default are events that mark the beginning of the floating charge holder's right to enforce the charge against specific collateral. Crystallization implies a revocation of the debtor's right to deal freely with the collateral, but the revocation may not affect the rights of third parties until they learn of it. (136)

Crystallization can occur by operation of law, automatically in accord with a provision of the security agreement, or pursuant to contractual notice from the secured creditor to the debtor. Crystallization occurs by operation of law upon the occurrence of any of four events (137): (1) cessation of the debtor company's business; (138) (2) the commencement of liquidation/winding-up; (139) (3) the creditor law-fully taking possession of the charged assets; (140) or (4) the appointment of a receiver (141) or of an administrator by a qualifying charge holder. (142) The commencement of administration proceedings does not, in and of itself, result in crystallization. (143)

The debtor and the secured creditor can also, by agreement between them, provide "that any specified event" will cause the charge to crystallize. (144) The agreement can provide that crystallization occurs automatically or upon notice from the secured creditor to the debtor. The purpose of an automatic crystallization provision is usually to crystallize the charge before a lien creditor establishes rights in the collateral or the debtor grants a fixed charge to a competing creditor. (145)

If so provided in the security agreement, automatic crystallization can be reversed, a process referred to as de-crystallization. (146) De-crystallization would allow the debtor to continue to deal freely with the collateral despite the covenant breach. (147)

Automatic crystallization can occur in situations where the creditor does not desire it. (148) Professor Ferran notes that if "the crystallization clause is so widely drafted that the [creditor] has frequently to agree to de-crystallization, this pattern of events may lead a court to conclude that the original agreement was later varied by the parties so as to exclude the automatic crystallization provision." (149) De-crystallization may also force consideration of whether the "re-floated" charge constitutes the same floating charge as before or a new floating charge, (150) which would trigger a fresh registration requirement, establish a new and later priority date, and restart the statutory period for the avoidance of floating charges in insolvency proceedings. (151)

A notice-crystallization clause (152) gives the creditor more flexibility over the timing of crystallization and largely removes the need for a de-crystallization clause. The security agreement identifies events that give the secured creditor the right to crystallize the floating lien by giving notice. The secured creditor then decides whether and when to do so. (153) The giving of notice is the crystallization event.

Notice crystallization clauses need not be conditioned upon the debtor's breach of a covenant. "Pure" notice crystallization is a procedure by which the creditor may "at any time by notice to the [debtor] convert the floating charge into a [fixed] charge as regards any asset specified in the notice." (154) Under English law, if the creditor and a debtor have agreed upon terms that allow the creditor to crystallize at will, the court will give effect to their agreement.

To give notice before competitors establish prior rights in the collateral, the secured creditor must know the competitors are about to do so. Even if the secured creditor engaged in extensive and expensive monitoring, some competitors would succeed in gaining priority.

As is discussed further in Part III, the ease with which secured creditors can crystallize their floating charges makes it difficult for third parties to rely on the floating nature of the charge. Because third parties are reluctant to rely, the debtor's right to deal freely with the collateral becomes largely theoretical. Floating charges have the effect of fixed charges because, as far as third parties know, they may already have become fixed charges.


In this Part, we compare the function of English fixed charges with those of American security interests in the contexts of collateral sales, competitions among security interests, competitions of security interests with execution creditors, and in insolvency proceedings. We conclude that English fixed charges and American security interests function in highly similar manners.

A. Sale of Collateral

1. Original Collateral If an English debtor "sells property that is subject to a [fixed] charge, and the sale is not authorised by the chargee, the buyer will take subject to the charge." (155) The secured party can then "follow his asset into the hands of any third party [with certain exceptions]." (156)

The American rule is the same. U.C.C. [section] 9-315(a)(1) provides that "a security interest continues in collateral notwithstanding sale, lease, license, exchange, or other disposition thereof unless the secured party authorized the disposition free of the security interest." (157)

In both countries, buyers in the ordinary course of business who buy from the sellers' inventories take free of security interests in that inventory. In the English system this result is explained by saying that, because the charge is against revolving assets, the charge is a floating charge. By the nature of the charge, the debtor can deal freely with the collateral. In the American system, this result follows from a statutory rule that a buyer in ordinary course of business takes free of a security interest created by his seller. (158)

The English concept of "sale in the ordinary course" is broader than the corresponding American concept. Under the American concept, only inventory can be sold in the ordinary course of business. Official Comment 3 to U.C.C. [section] 9-320 states that "subsection (a) applies primarily to inventory collateral" and the courts generally have interpreted the section as limited to sales of inventory. (159) Narrowing the protected categories of buyers even further, the American definition of buyer in ordinary course specifically excludes buyers of bulk sales of inventory. (160)

Under the English concept, "capital" or "fixed" assets such as business equipment or licenses can be sold in the ordinary course of business. (161) English law is generally highly protective of buyers in the ordinary course. (162) That buyers can buy fixed assets in the ordinary course of business has led to concern that they might be able to take free of fixed charges. (163) Thus, after noting that "a purchaser (as opposed to a subsequent chargee) of the company's assets will not be put on notice of the charge merely because it has been registered ... because a buyer of goods in the ordinary course of business cannot be expected to search against her seller," (164) the Law Commission continued:
   It may be that in this context a distinction should be drawn
   between the purchaser of an item of the company's normal stock
   (which is in any event unlikely to be the subject of a fixed
   charge) and the purchaser of a capital asset which is sold by the
   business. It might seem reasonable to expect the purchaser to check
   for charges against capital assets. However, it seems to be assumed
   that, in the context of floating charges, sales of capital assets
   are in the ordinary course of business as much as sales of
   inventory; and in the context of the Sale of Goods Act 1979,
   section 14, the sale of a capital asset has been held to be in the
   course of business. Thus it is not clear that this distinction
   between purchasers of capital assets and purchasers of inventory
   can be maintained. (165)

If the distinction could not be maintained, buyers of capital assets in the ordinary course of business would be able to take free of fixed charges and a sharp functional difference would exist between the English and American systems.

We can find no direct authority, however, that buyers of capital assets in the ordinary course can take free of fixed charges. In Ashborder BV v. Green Gas Power Ltd, (166)--the only case we can find holding that capital assets can be sold free of a charge in the ordinary course--the court held the charge over the capital assets to be floating.
   There was a danger in the present case in laying too great an
   emphasis on the nature of the assets in question, namely the
   licences and the OGL shares. The fact that assets were not part of
   a company's circulating capital or stock in trade, which it needed
   to sell as part of its ordinary business, could understandably have
   an important influence in the categorisation of a charge as a fixed
   charge, rather than a floating charge, in an appropriate case. In
   the present case, however, the parties had agreed an express
   provision permitting each of the Octagon group companies to dispose
   of assets in the ordinary course of its business. The clause in the
   debenture assigning rights to the trustee effected an equitable
   assignment rather than a legal assignment and an equitable
   assignment was not inconsistent with a floating charge over the
   assets specified. The debentures did not create a fixed charge over
   the licences or the OGL shares. (167)

In describing the current state of English law in its final report, the Law Commission sided more strongly with the fixed charge holder:
   In the [Consultation Paper] we explained that a buyer will take
   subject to a registered fixed charge, unless the doctrine of a bona
   fide purchaser of a legal estate without notice applies. There is
   some doubt as to when a purchaser who does not have actual
   knowledge of the charge will be put on notice of it because it has
   been registered. It is possible that a buyer of a capital asset
   would be expected to search the register but not one who buys
   stock-in-trade. We think that it is desirable to clarify the law by
   providing that a buyer should be bound by a registered fixed
   charge. (168)

Although expressed with considerable uncertainty, this passage states, in essence, that current English law is probably the same as current American law. In both systems "a buyer of a capital asset would be expected to search the register but not one who buys stock-in-trade" and a debtor would be able to sell a capital asset free of the security interest if the creditor authorized the sale, but not otherwise. (169) This interpretation effectively imposes a burden on English buyers of capital assets in the ordinary course to search for fixed charges just as American buyers must. (170)

2. Proceeds

After an authorized disposition, the security interest of both an American secured creditor and an English fixed charge holder will continue in any proceeds. On the American side, U.C.C. [section] 9315(a) (2) states, "a security interest attaches to any identifiable proceeds of collateral." (171) On the English side, the Law Commission has stated that "if a sale was authorized ... the [creditor's] only claim will be to the proceeds." (172) American law and English law take slightly different approaches if the creditor did not authorize the disposition of the collateral. Under U.C.C. [section] 9-315(a), the security interest continues in the collateral and in any identifiable proceeds of the collateral. The secured creditor can pursue both and "collect its money where it can" up to the amount owing. (173)

Like an American secured creditor, an English law fixed charge holder initially has an interest in both the original collateral and its proceeds after an unauthorized disposition. (174) However, as soon as the English secured creditor performs "an unequivocal act showing that [it] has chosen one [it] cannot afterwards pursue the other." (175) The creditor loses its interest in whichever of the original collateral or the proceeds was not pursued. (176) Therefore, unlike an American secured creditor, an English law fixed charge holder is not entitled to collect the money owed to it "where it can." Once it has elected to pursue its interest in either the collateral or the proceeds it loses its interest in the other.

This distinction between English and American law may seem significant on its face. It is, however, merely a default rule. As the Law Commission has noted, a creditor need elect between pursuing a right either in the original collateral or in the proceeds only when the "charge does not cover the proceeds as a distinct category of asset." (177) According to Professor Ferran, "well-drafted security documentation will include express provision for the security to cover receivables and their proceeds." (178) For example, if a debtor sold fixed charge collateral to a buyer on credit, the debt owing from the buyer would be proceeds. The security agreement would likely provide that the debtor has charged all debts owing to the debtor to the secured creditor, by way of fixed charge. (179) Thus in the example under discussion, the fixed charge holder would be able to pursue its interest in both the collateral sold and the debt owing for its purchase price. The holder's claim to each would be as original collateral. As a result, we doubt that the difference in default rules makes a significant difference in the functioning of secured credit in the two jurisdictions.

B. Encumbrance of Collateral

With respect to both American security interests and English fixed charges, the basic principle governing priority is that first in time is first in right, (180) That is, if the holder of the security interest or fixed charge takes whatever steps are necessary to perfect its interest, the holder will have priority over competitors who establish interests later.

Both the English and American systems determine the order of priority by assigning priority dates to each competing interest. That "priority date" is the date and time when the creditor took some particular step, or one of alternative steps necessary to perfect its interest.

1. Competing Secured Creditors

In competitions between American security interests, the first to file or perfect has priority. In competitions among English fixed charges, the first charge created has priority, provided that it is registered within twenty-one days. As was previously discussed, the English rule creates a period of invisibility. Except with respect to accounts receivable, the English rule does not cause any other difference in the functioning of English fixed charges and American security interests. Both have priority over all later interests, with the exception, in both systems, of property tax liens.

With respect to priority in accounts receivable as collateral, the American. rule is that the first to file or perfect has priority. Priority does not depend on notifying the account debtors, and secured creditors rarely notify them unless or until the secured creditors seek direct payment from them. The English priority rule is that, as between two charges registered within twenty-one days of their respective dates of creation, priority goes to the creditor who is first to notify the account debtor of its charge, regardless of the order in which the charges were created or registered. (181) The effect of the English rule is "that a receivables financier must make enquiries of the 'account debtor,' and notify the debtor of the arrangement, or risk losing out to a second financier." (182) The ultimate effect is that English account financiers will give individual notice to each account debtor, while American account financiers will merely file a financing statement.

Individual notice may be of some benefit to English account debtors who would not have taken the time to run searches. But the costs of providing individual notice may be greater than the benefits, and the Law Commission had no difficulty in reaching a recommendation that England adopt the American rule. (183) Aside from the additional costs of the English rule, we see no significant difference in system operation and no policy issue for resolution.

2. Lien Creditors

In both England and the United States, the basic principle is that fixed charges, American security interests, and execution liens rank in order of time. A security interest or fixed charge with an earlier priority date has priority over an execution lien with a later priority date. For example, with respect to English fixed charges, Gough states:
   An execution creditor takes subject to previous legal and equitable
   interests in the property of the debtor, arising through
   disposition by the debtor or otherwise. This is true in respect of
   execution by a writ fieri facias over goods.... The rule applies
   regardless of whether the execution creditor has had notice of the
   prior interest.... [T]he priority issue is simply whether or not
   that proprietary interest exists at the relevant priority point in
   execution. (184)

As one court put it, the "sheriff cannot by seizing [the collateral] get rid of the rights of third persons to which the property is subject when in the hands of the debtor." (185) Thus, once perfected, security interests and fixed charges have priority over later executions.

Executions that predated the security interest or charge would, in theory, have priority over the security interest or charge. However, that rarely occurs. Judgments and executions are public records in both countries. Lenders conduct due diligence to discover and clear any judgments against their borrowers and executions against proposed collateral.
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Title Annotation:Introduction through III. Fixed Charges Compared with Security Interests B. Encumbrance of Collateral, p. 1785-1823
Author:LoPucki, Lynn M.; Abraham, Arvin I.; Delahaye, Bernd P.
Publication:Notre Dame Law Review
Date:Apr 1, 2013
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