chapter  5
38 Pages

Effectiveness of security interests against third parties

Third-party effectiveness of security interests (which has similar functions to the UCC Article 9 concept of ‘perfection’)1 is the process whereby, following the creation of a security interest (where the security interest becomes effective against the debtor/grantor), the secured creditor takes an additional step (notifi cation, registration, taking possession or control) to make the security interest binding on or effective against third parties (liquidator, administrator and creditors).2 The additional step, particularly the public notice, prevents potential creditors being adversely affected by the principle of nemo dat quod non habet.3 Methods of achieving third-party effectiveness vary among legal cultures. Broadly, there are two methods: registration and possession. A lesser known method (except in North American jurisdictions or in jurisdictions refl ecting UCC Article 9 type secured transactions regime) is control,4 whereby the collateral, in the form of funds credited to a bank account, investment security or letter of credit rights, is controlled by the secured party through an agreement concluded between the bank and the secured party and particularly effective in the case of debtor default. In comparison with English law,5 methods for third-party effectiveness under UCC Article 9 provide a broader array of options, where control, automatic perfection, and temporary perfection may be indicated depending on the nature of collateral. Problems in creating practical and inexpensive publicity methods in order to establish priority among creditors have negative impact on lending decisions. In

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tence of registry the creditor can achieve third-party effectiveness and provide notice. Unreformed secured transactions regimes either have no method to publicise the existence of a security interest, requiring traditional methods of possession by creditor, or their existing methods are impractical, fragmented or too expensive for third parties to be able to do searches (as in the case of paper based registries or excessive fee requirements for registry searches), which in turn increases the cost of credit. In some systems the law requires registration of the security agreement, which is not feasible, and in others there are restrictions as to who can access those registry systems. Arguably the most feasible method to lower the cost of credit is establishing an electronic registration system, which can be accessed with nominal fees and by anyone interested and this registration system should give notice to third parties on the possible existence of the security right over the collateral. This system should be supplemented with alternatives (possession and control) for certain collateral. This chapter examines third-party effectiveness of security interests. The recurrent theme is that for facilitation of credit, reducing the risk associated with credit and establishing certainty, it is necessary to have clear rules for third-party effectiveness. The additional step has the advantage of informing third parties of proprietary rights over the debtor’s assets by avoiding claims of apparent/ostensible ownership and having a positive impact on the lending decisions to the extent that it creates predictability. It is arguable that third-party effectiveness should preferably be registration of security interests but, naturally, there will be alternatives to registration. The particular issue of debate is about the requirement of a general security interests registration system necessary to notify potential creditors. The system is well known in secured transactions regimes that adopt a comprehensive and functional approach to security interests but not so much in others. The signifi cance of this point is that a functional approach, as envisaged in the Guide or the Receivables Convention, will require all security interests to be registered (save for exceptions under the Guide and options provided under the optional annex of the Receivables Convention) for third-party effectiveness. The Cape Town Convention’s registration concept contains original features and requires international interest to be registered for public notice and priority purposes. The Model Law underlies the importance of public knowledge and ensures that publicity is achieved by relying on registration for registered charges.6