In law, perfection relates to the additional steps required to be taken in relation to a security interest in order to make it effective against third parties and/or to retain its effectiveness in the event that the party granting the security interest goes into bankruptcy. Generally speaking, once a security interest is effectively created, it gives the relevant rights to the holder of the security as against the person who grants the security.Mace Builders v Lunn [1987] Ch 191 However, in many legal systems, additional steps (”perfection”) are required to enforce the security against other third parties, such as a liquidator.For example, section 395 of the Companies Act 1986 of the United Kingdom requires certain security interests to be filed at Companies House within 21 days of being created. A failure to make such a filing does not affect the validity of the security interest between the debtor and the secured party, but if the debtor goes into insolvent liquidation, the security interest is void against the liquidator.
Concept
As a legal concept, perfection needs to be distinguished from:
- the grant or creation of the security interest, which creates its primary validity;
- attachment, which refers to the steps necessary to ensure that the security interest attaches to the relevant asset; and
- priority, which refers to the order in which competing security interests over the same assets rank.
However, in some legal systems there is a degree of overlap between perfection as against certain third parties (such as subsequent security holders) and priority as between holders of competing security interests. For example, the common law rule in Dearle v Hall is both a rule relating to perfection and to priority.
In most legal systems, the need to perfect only arises in relation to security interests which are proprietary in nature (such as a mortgage or equitable charge). Other arrangements which constitute “security” in the loose sense of the word, such a title retention arrangements, hire purchase or leasing transactions do not normally need to be perfected in the legal sense.
Types of perfection
There are three principle modes by which a security interest may be perfected (which method of perfection is applicable depends upon the nature of the security interest and the laws of the relevant country).
- possession of the collateral;
- statutory registration or filing;Such as the filing under section 395 of the United Kingdom Companies Act 1986 referred to above and
- notice to the debtor or a fundholder.
Possession
some types of security interest can only be perfected by taking actual possession of the asset. For example under a common law pledge (or pawn), the right to enforce the power of sale in relation the asset is dependent upon the possession of the asset. An agreement to grant a pledge which leaves the debtor in possession of the pledged collateral does not give rise to an enforceable security interest.Dublin City Distilery Co Ltd v Doherty [1914] AC 823
In certain cases, the possession does not need to be actual possession, but may be constructive possession. For example, possession of a document of title will often suffice where it is not possible to possess the goods.Although see Official Assignee of Madras v Mercantile Bank of India [1935] AC 53 where Lord Wright inferred that this may not be the case, discussed and explained in other terms in Commercial Law by Roy Goode. In many legal systems, there may also be constuctive possession by attornment.
The law relating to perfection of security interests by taking of possession can sometimes be confused with the law relating to the granting of security interests, which provides that the deposit of certain assets (usually documents of title) can amount to an equitable mortgage of the goods.For a recent example an equitable mortgage created this way in Australia, see Theodore v Mistford Pty Ltd [2005] HCA 45
Registration or filing
Certain security interests may be perfected by some kind of registration or filing. Although the terms are used interchangeably, it is more accurate to speak of registration as the lodgment of particulars, and filing as the lodgment of the security instrument itself.Report of the Committee on Consumer Credit (Cmnd. 4596, 1971), para 5.7.13; the distinction does have some meaning, as registration of particulars only makes third parties aware that there is a security interest, whereas filing they can see the terms of the security interest.
Generally systems of registration divide into two types:
- registration against a particular debtor; and
- registration against a particular asset.
Each has their own advantages and disadvantages.
Registration against a particular asset only tends to practical where the assets are of a nature and substance that makes it feasible to have a register for recording security interests against them. Most countries have systems for the registration of security relating to land, aircraft, ships and intellectual property rights. The advantage of a register relating to the asset is that if the debtor wishes to provide an asset as collateral, the proposed lender can swiftly check definitively whether the asset is encumbered or not.
Registration against a debtor tends to operate by way of requiring the registration of certain security interests by the debtor. The advantage is that a lender can quickly see which assets of the debtor are encumbered and which are not. However, because many registration systems do not require all types of security interest to be registered gaps can remain. Also, systems which register security against the debtor do not act as a check that the debtor actually has title to any of the relevant assets, merely that he has not created any security interest over them.A lender can still be in difficulty if it transpires that the goods are subject to a lease, or retention of title arrangement, or other form of non-registrable arrangement.
However, the position is complicated by the fact that many legal systems employ both, interchangeably. A security interest granted by a debtor over a particular asset in any given country may need to be registered against the debtor, against the asset, both or neither.For example, in the United Kingdom if a company was to grant a mortgage over land and its rental income, this would be registrable both against the company (under section 395 of the Companies Act) and the asset (under the Land Registration Act and/or the Land Charges Act), but the same company granting a fixed equitable charge over a car would not be required to register it anywhere.
Notice
In some legal systems, perfection of a security interest requires notice to be given to a relevant third party. This most commonly arises in relation to security over a debt or other chose in action, notice being required to be given to the party owing the debt or holding the fund. Under English law, an often cited example is the well-known rule in Dearle v Hall. Under the rule if A is owed money by X, and then A grants an equitable charge over that debt to B, and then grants a second equitable charge over the same debt to C, then the ability to enforce the charge by either B or C against the money in X’s hands is dependent upon the giving of notice to X. The controversy in the rule relates to the fact that it is also a rule of priority, meaning that (if their rights are otherwise equal) the first one to give notice to X has the prior claim, irrespective of the order in which the equitable charges were granted.
Similarly, in many common law legal systems, where there is an assignment (law) of a debt, the assignee cannot enforce the rights of the assigning creditor against the debtor unless notice of the assignment has been give, and until notice of the assignment has been given, the debtor can still discharge the debt by paying the money to the creditor, notwithstanding the assignment.
See also
- Security interest: perfection
- Tacking (law)
Footnotes
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