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The Private Initiative and Security for Payment under English Law - article ; n°1 ; vol.54, pg 41-53

14 pages
Revue internationale de droit comparé - Année 2002 - Volume 54 - Numéro 1 - Pages 41-53
13 pages
Source : Persée ; Ministère de la jeunesse, de l’éducation nationale et de la recherche, Direction de l’enseignement supérieur, Sous-direction des bibliothèques et de la documentation.
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Sir Roy Goode
The Private Initiative and Security for Payment under English
In: Revue internationale de droit comparé. Vol. 54 N°1, Janvier-mars 2002. pp. 41-53.
Citer ce document / Cite this document :
Goode Roy. The Private Initiative and Security for Payment under English Law. In: Revue internationale de droit comparé. Vol.
54 N°1, Janvier-mars 2002. pp. 41-53.
doi : 10.3406/ridc.2002.17844
http://www.persee.fr/web/revues/home/prescript/article/ridc_0035-3337_2002_num_54_1_17844R.I.D.C. 1-2002
The private finance initiative (PFI) is in concept a form of partnership
between the public and private sectors in which a government department
or other public sector body requiring buildings, bridges, roads, management
services, and other public services and facilities, does not itself provide
them but grants a concession to a private sector project company or
consortium to procure or provide what is required, payment being made
by the public body or other user to the project company according to the
use, volume and quality of such provision. In other words, the private
sector is the provider, and is responsible for raising the necessary funds,
while the public body is the user. Underlying the PFI are three fundamental
concepts : value for money (the PFI being measured against a public
sector comparator) ; the transfer of risk from the public body to the private
party, wholly or in part ; and a high degree of flexibility in the structuring
of contractual relationships, which vary greatly from one project to another.
"Deals, not rules" is the PFI slogan. The project company/consortium
procures the necessary funds from the private sector. Commonly such
funds are a mixture of internal funding in the form of equity or subordinated
debt by the project sponsors and external funding from banks or from
the market through the issue of bonds.
Security in PFI projects
Security techniques used in PFI project funding are not in principle
different from those used in ordinary commercial transactions. Funding
* Professeur Emeritus à l'Université d'Oxford. 42 REVUE INTERNATIONALE DE DROIT COMPARE 1-2002
for PFI projects, as for other types of project finance, is typically on a non-
recourse basis. That is to say, the borrower incurs no personal obligation to
the funders, who simply take security over the prospective income stream
and other assets. But the public sector factor does introduce some distinc
tive considerations, in particular, the question of vires, that is, the legal
power of the public body to enter into the transaction ; the distribution
of risk ; and the imposition of certain constraints on the realisation of
assets that would ordinarily be available to the secured creditor as a default
remedy. The use of security in PFI projects is considered in Part VIII of
this paper. Funders will usually seek to buttress their security by a direct
tripartite agreement with the public body awarding the concession and
the project company by which the awarding authority undertakes to give
prior notice to the funders of its intention to terminate the project agreement
and to allow the to give notice that they intend to step into the
project and take it over or arrange for it to be taken over by some entity
which the funders control. Such step-in clauses enable the funders to keep
the project on foot and under their control during the step-in period, with
a view to getting the project back on track, after which the funders step
out and the project company resumes control, or alternatively the funders
exercise a right to step out anyway because they regard the project as
no longer viable.
The importance of security
Security for payment or other performance is crucially important in
modern financing. Even the soundest and most well-run company is not
immune from the impact of competition, loss of markets or a recession
or from the domino effect of the collapse of its major customers. The
significance of security rights has increased with privatisation and
government- sponsored private finance initiatives to support public projects,
with the consequent shift of risk from government to the private sector.
The development of the multinational enterprise and of global trading has
also made it more difficult to ensure the effectiveness of security, since
rights which are recognised by the law of the state where the security is
created will not necessarily be accepted in another state where the
interest comes to be enforced. Indeed, it is often far from clear what law
governs the security interest.
Real and personal security
Security may be either real or personal. Real security is security in
or over an asset ("collateral") so as to entitle the creditor to have recourse
to the asset for payment in priority to the claims of general creditors.
Personal security is security given by way of a payment undertaking by
the debtor or a third party to reinforce the debtor's primary payment
undertaking. For example, a debtor may give a bill of exchange as collateral R. GOODE : PFI UNDER ENGLISH LAW 43
security for a payment obligation under a contract of sale of goods ; the
bill renders the debt more liquid but otherwise adds little to the strength
of the primary obligation. Much more effective is personal secu
rity given by a third party, for example, by way of a bond, guarantee or
letter of credit. Personal security of this kind is given not only for ordinary
commercial transactions but also by way of credit enhancement of a public
offering of securities for the purpose of improving the credit rating of
the offered debt or equity. The rest of this paper is confined to real
Legal and equitable interests
The English law of security interests cannot properly be understood
without some reference to the role of equity, which is distinctive in systems
based on the common law. The mediaeval common law strictly confined
legal rights and remedies. Nowhere was this more true than in relation
to the transfer of property. In order for ownership to pass the transfer
had to relate to existing property of the transferor and to comply with
strict legal formalities. Further, the common law did not recognize the
trust, by which property was transferred to A to hold for the benefit of
B. The common law treated this as a transfer of full ownership to A and
ignored the trust in favour of B.
To mitigate the rigours of the common law recourse might be had
to the King by petition to his Chancellor, who would intervene on equitable
grounds to give remedies denied by the common law and to restrain the
exercise of common law remedies where their exercise was considered
to be against conscience. Over time these equitable remedies developed
into a distinct set of rules administered by separate courts of equity. The
rules of equity in many respects remain distinct from those of the common
law to this very day, though all courts now administer both law and
equity, the rules of the latter prevailing in case of conflict.
Courts of equity were willing to enforce the trust, initially by acting
in personam to compel performance by the trustee but later extending
the ambit of control to compel observance of the trust by donees and by
those acquiring the trust property with notice of the trust. Eventually the
position was reached where the rights of the beneficiary under a trust
became converted from a purely personal right into a full-blooded property
right (equitable interest) which had priority over all subsequent interests
in the property other than the interest of a bona fide purchaser of the
legal title for value and without notice of the trust. Equity also acted on
the conscience of a party who had contracted to transfer property by
treating as done that which ought to be done, and thus regarded an
agreement for a transfer as if it were a transfer. Finally, whereas the
common law insisted that an agreement to transfer future property was
a mere contract and did not operate to transfer a property interest, even
upon the grantor's acquisition of the new property, without a new post-
acquisition act of transfer, equity — again treating as done that which
ought to be done — was prepared to recognize the grantee as obtaining
an interest in the new asset automatically upon the grantor acquiring the 44 REVUE INTERNATIONALE DE DROIT COMPARE 1-2002
asset so long as it was identifiable as falling within the scope of the
These three developments — the trust, the treatment of an agreement
for transfer as if the transfer had been carried out and the recognition of
interests in future property — enormously expanded the range of real
rights in English law and correspondingly reduced the assets available to
unsecured creditors in the grantor's bankruptcy. Almost the sole exception
is the contract of sale of goods, where the Sale of Goods Act 1979 is
considered to lay down a complete code for the transfer of title, so that
unless otherwise agreed between the parties the buyer acquires no property
interest until the full legal title has passed to him.
Tracing from an asset into its products and proceeds
English law also recognizes that ownership of, or a security interest
in, an asset may carry through to its products and proceeds. For example,
a seller of materials may stipulate that if they are incorporated into a
new product he, and not the buyer, will be the owner of the product ;
and if a person in possession of an asset belonging to another wrongfully
disposes of the asset to a third party then the owner, instead of following
the asset into the hands of the third party, may elect to claim a proprietary
right to the proceeds received by the wrongdoer — in effect, a form of
real subrogation.
The creditor-oriented approach of English law
English law has long had a liberal approach towards the creation of
security rights, particularly where the debtor is a company. This approach
is based largely on the concept of party autonomy. Parties are free to
agree on the grant of security over any kind of asset, tangible or intangible,
present or future, to secure any kind of existing or future obligation.
Moreover, a company can give security over classes of asset — for
example, equipment, receivables — without the need for individual specifi
cation, and may, indeed, give security over all its assets, present and
future, by a single security instrument perfected by a single registration
in a public register. Security in movables may be effected by the delivery
of possession to the creditor but this is neither necessary nor usual ; most
security is non-possessory in character and is fully effective. Possession
need be taken only where the security takes the form of a pledge.
This laissez-faire approach to the grant of security applies equally
to remedies for default. In their security agreement the parties are almost
entirely free to agree between themselves on remedies for default and on
what constitutes a default event. Even minor breaches of a loan agreement
may be specified as default events. Also standard in a loan
are cross-default clauses by which the debtor's default under any other
agreement with the agreement is made to constitute a default under the
loan agreement, triggering the specified default remedies, including enfor
cement of any security. In contrast to the position under French law,
English law has a benevolent approach to self-help remedies, such as R. GOODE : PFI UNDER ENGLISH LAW 45
possession, sale, or the appointment of a receiver. The creditor is free to
exercise any of these remedies without recourse to the court.
It will therefore be apparent that in relation to the provision of
corporate finance English law is relatively creditor-oriented. The status
of London as a world financial centre depends in large degree on the
receptiveness of English law to new financing techniques and the freedom
of parties to fashion their own bargains with only a limited degree of
legal control and without the need for judicial intervention. These features
as seen as reducing risk, cost and delay, all important factors to a financier.
The elements of security
Recognition of security interests in English personal property security
law is founded on four principal elements : agreement, interest, value and
notice. Except for security created by the law, the creation of security
depends on express or implied agreement, and the agreement must describe
the collateral sufficiently to enable it to be identified as falling within
the scope of the security agreement. This requirement applies both to
existing and to future collateral. It is also necessary that the debtor have
an interest in the collateral (though this need not be full ownership) or
alternatively a power to dispose of it, for example, as an agent acting
within the scope of his actual or ostensible authority. Security is at its
strongest if taken for new value, for example, for a contemporaneous or
future loan. Where an advance is made on the security of the debtor's
future property, each addition to the collateral is considered to be given
for new value. For example, Creditor lends Debtor £100 on the security
of its future assets. After the loan has been made Debtor acquires a new
asset worth £500. Creditor's security interest in the asset is considered
to be have been granted for value. This would apply to any further assets
acquired by Debtor. Of course, the security interest can never exceed in
quantum the amount owing to Creditor. It is permissible to take security
for past indebtedness but if the debtor company is insolvent at the time
the security interest it will be vulnerable to attack if the company goes
into liquidation or receivership within a prescribed statutory period. The
fourth requirement is public notice. Most forms of non-possessory security
given by a company require to be registered in the public register maintai
ned by the Companies Registry. Registration is not a prerequisite of the
validity of the security against the debtor, who, after all, knows it has
given the security interest. But failure to register will result in the security
being subordinated to a subsequent security interest in favour of another
creditor and in the invalidity of the against the debtor's
general creditors in the event of its going into winding up.
The four forms of security
There are four forms of consensual known to English law,
namely pledge, contractual lien, mortgage and equitable charge. 46 REVUE INTERNATIONALE DE DROIT COMPARE 1-2002
(1) Pledge
The pledge consists of a transfer of possession by way of security
and is therefore confined to tangible movables, such as goods, documents
of title and bearer securities. Possession may be actual or constructive,
for example, where goods are in the possession of a third party who
agrees to hold possession for the creditor.
(2) Contractual lien
The contractual lien is the right given by contract to detain by way
of security for payment goods delivered to the detainer for some other
purpose, e.g. storage or repair.
(3) Mortgage
The mortgage is the transfer of ownership by way of security upon
the express or implied agreement that will be retransf erred to
the debtor when the mortgage has been paid off. As indicated earlier, an
uncompleted agreement for an mortgage is treated in equity as a mortgage
and for most purposes is as effective as a legal (completed) mortgage.
(4) Equitable charge
The equitable is an agreement by which an asset of the debtor
is appropriated to the satisfaction of the debt in priority to the claims of
ordinary creditor. In effect it creates a preferential claim to the proceeds
of the asset. It does not involve the transfer of ownership, nor does it
depend on possession ; it is an incumbrance, a clog on the asset which
travels with it into the hands of a third party and can in principle be
asserted against that party except where he acquires the legal title for
value and without notice of the charge.
In the context of PFI financing, only the last two forms of security
are likely to be used. To a considerable degree the mortgage and the
charge are interchangeable. The former is more likely to be used where
the creditor feels the need to obtain legal ownership, for example,
the collateral consists of receivables which the creditor intends to collect
itself instead of leaving it to the debtor to collect as its agents. Since the
charge does not involve the transfer of ownership it does not as such
confer on the chargée a right to collect debts, take possession of tangible
property or appoint a receiver. But these weaknesses can readily be su
rmounted by contractual provisions in the charge instrument.
Fixed and floating charges
Mention should here be made of that mysterious instrument, the
floating charge. A charge may either be fixed (or specific) or floating.
A fixed charge is one which confers in rem rights on the chargée either
at the time of creation of the charge or, in the case of future property,
when the debtor company acquires an asset falling within the scope of
the after-acquired property clause. This principle of equity by which an
agreement for an interest in future property attaches to it in favour of
the transferee immediately on acquisition by the debtor, without the need R. GOODE : PFI UNDER ENGLISH LAW 47
of post-acquisition act of transfer, has proved crucial to the development
of modern financing in England, for it enables security to be taken over
future assets which by their nature are incapable of individual specification.
It is, however, inherent in a fixed charge that the debtor cannot
dispose of the charged asset free from the except with the consent
of the creditor. A general consent in advance does not suffice, for it is
inconsistent with the concept of a fixed security that the debtor should
be able to continue to deal with the collateral as its own property. In the
case of a charge of debts this requires not merely that the chargor cannot
dispose of the debts without consent but also that any proceeds of collec
tions must be contractually controlled by the creditor, for example, by a
requirement that they be paid into a bank account under the creditor's
A fixed charge is appropriate for most types of collateral. However,
it is not suitable for stock in trade (inventory), for by its nature this is
held for the purpose of resale rather than use, and it is usually impracticable
for the debtor to seek the consent of the creditor every time it wishes to
sell an item of stock. Similar considerations often apply to receivables,
in that the chargor relies on the collections to run its business. How, then,
can the debtor company be given freedom to trade and turn over its stock
in trade and receivables in the ordinary course of business while still
giving the creditor some form of security ? This problem was surmounted
in the 19th century by the willingness of the courts to recognize a new
form of security, the floating charge, which would float over the collection
of assets from time to time owned by the company and falling within
the scope of the charge description but would not attach to any specific
assets until such time as the charge "crystallised" into a fixed charge by
some event which brought the debtor company's management powers to
an end, e.g. liquidation. Upon crystallisation the charge would fasten as
a fixed charge on all assets then owned or subsequently acquired by the
company so far as falling within the classes of asset described in the
charge instrument. Until then, the company was free to deal with its assets
by sale or grant of a fixed charge, and the purchaser or fixed chargée
would acquire the asset free from the floating charge. In effect, the floating
charge is a security over a shifting fund of assets, the fund having an
identity distinct from that of the individual assets that might from time
to time be comprised in it. The floating charge, though covering future
property, is nevertheless a present security which, on crystallisation, has
priority over the debtor's general creditors other than those designated
as preference creditors in the insolvency legislation.
The trust
Trust clauses are also commonly found in financing agreements. The
debtor declares himself a trustee for the creditor of an asset coming into
the debtor's hands. For example, a person lending money on the security
of debts payable to the borrower may find it convenient to leave the
borrower to collect in the debts on the lender's behalf, and will usually
include a provision in the mortgage or charge that the collected proceeds REVUE INTERNATIONALE DE DROIT COMPARE 1-2002 48
received by the borrower are to be held on trust for the lender. The trust
confers on the lender an equitable proprietary right which, if the security
is registered, will give the lender priority over subsequent secured creditors
and over the borrower's general creditors in a winding up. The trust is
not an independent security device, merely a particular form of equitable
mortgage or charge.
Security may also be given in the context of securitisation of receivab
les, whether or not the receivables themselves are secured. The receivables
are sold by the original creditor (the originator) to a company formed as
a special-purpose vehicle which raises the funds to pay the price by
borrowing from a bank or by issuing a bond or note secured by the
There are various kinds of right which fulfil a security function but
do not constitute a security in the legal sense because they are not rights
given over an asset in which the grantor has an interest. These include
(a) reservation of title under a contract of sale of goods ; (b) finance
leases ; (c) sale and repurchase/lease-back ; (d) contractual set-off, by
which a debtor sets off against the debt a cross-claim owed to him by
his creditor ; (e) a term of a deposit that the deposit is withdrawable
only where the depositor and/or an associated company discharges its
indebtedness to the bank holding the deposit ; (f) a negative pledge, by
which the debtor agrees not to give any other creditor a security over its
assets, or not to give any security ranking equally with or in priority to
that of the first creditor ; (g) a pari passu clause providing in relation
to an unsecured loan that if the debtor gives security to another creditor
it will give equal and pro rata to the first creditor ; and (h) a subordination
agreement. It is very common to find one or other of these quasi-security
devices used to reinforce security in a financing transaction. Direct agree
ments between the funder and counterparties, of the kind referred to earlier,
can also be regarded as a quasi-security device.
As stated earlier, English law does not usually insist on any particular
form for security interests other than those relating to land. Usually,
however, is given in the form of a written agreement signed by
or on behalf of the debtor.
In order to protect the security interest against subsequent claimants
it is usually necessary to register the security in the Companies Registry GOODE : PFI UNDER ENGLISH LAW 49 R.
under section 395 of the Companies Act 1985. Registration is not, however,
necessary to enable the creditor to enforce the security against the company
and unsecured creditors where the company is not in liquidation.
It is necessary to distinguish perfection from priority. Registration
is a perfection requirement, not a priority point. Successive security inte
rests in favour of different creditors normally rank in order of creation,
subject to registration of the earlier interest within the 21 days allowed
by statute. Accordingly registration does not guarantee priority. In the
case of successive assignments of a debt there is a special priority rule
by which the second assignee who takes its assignment without notice
of the earlier assignment obtains priority if it is the first to give
of assignment to the debtor. But in contrast to French law notice to the
debtor is not a condition of the validity of the assignment or of its efficacy
against unsecured creditors in the liquidation of the assignor.
Special priority rules apply to the floating charge. This is because
by definition the charge is one which leaves the debtor company free to
deal with its assets in the ordinary course of business. Accordingly a sale
in the ordinary course of business will take effect free from the charge,
and a fixed charge will have priority over an earlier floating charge except
where the floating charge prohibits the grant of a subsequent fixed charge
ranking in priority to or pari passu with the floating charge and the holder
of the fixed charge had notice of the prohibition. Further, while in general
a security interest, as a real right, has priority over unsecured creditors
in a liquidation, a charge which as created was a floating charge, is
subordinate to preferential claims, such as certain claims for taxes and
unpaid wages.
Remedies given by law
Inherent in every form of security are the right of preference and
the right of pursuit. The secured creditor has priority over unsecured
creditors and later secured creditors and can follow the collateral into the
hands of any third party other than one having priority. A mortgagee (but
not a chargée) of a tangible asset can also take possession of it and/or
sell it without having to go to the court, and where the asset is a debt
the mortgagee can collect it from the account debtor.
Contractual remedies
Invariably the security agreement expands the default powers of the
secured creditor and sets out the default remedies in extenso. A typical
agreement will allow the secured creditor, upon default, to call up the
outstanding balance of the debt under the agreement or under any other

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