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Security Interests in Derived Assets” Magdalena Eliza Raczyńska “Security interests in derived assets” Thesis submitted for a PhD degree at University of East Anglia UEA Law School October 2012 "This copy of the thesis has been supplied on condition that anyone who consults it is understood to recognise that its copyright rests with the author and that use of any information derived there from must be in accordance with current UK Copyright Law. In addition, any quotation or extract must include full attribution.” 1 2 To Jonathan for whose understanding, support and patience I am so grateful 3 4 Abstract This thesis focuses on the extent of security interests in property. A security interest is a right of a creditor to resort to an asset with priority to at least some other creditors of the grantor of security when debtor defaults on the secured obligation. This works examines to what extent the secured creditor’s right is, or ought to be, affected when the encumbered asset undergoes changes that result in a new derived asset. Three scenarios are looked at: where new assets (“fruits”) are derived from the original collateral; where the original collateral is substituted for another asset or where it is incorporated or mixed with other assets into a new product. The question has attracted little judicial or academic attention. In the key case Buhr v Barclays Bank Plc [2001] EWCA 1223 it was held that that the secured creditor had a right to sale proceeds of collateral by virtue of its property right. This was termed as a “principle of substitutions” encompassing accretions, fruits and proceeds of the original collateral. It is suggested that this “principle” does not exist in current English law. This is so whether the security is fixed or floating. If a security interest is to extend to derived assets, parties ought to bargain for it. If new assets are a result of dispositions unauthorised by the secured creditor the creditor may claim the proceeds by asserting a new right based on unjust enrichment, not by virtue of the original property right. English law contrasts with Article 9 of the Uniform Commercial Code in the US, where the secured creditor automatically acquires right to proceeds. Law and economics analysis suggests that extending security to proceeds promotes efficiency of secured credit but only if proceeds are understood narrowly and do not include fruits. 5 6 Outline Table of Contents INTRODUCTION CHAPTER I – The concept of security interests CHAPTER II – Defining derived assets CHAPTER III – Security agreements without a derived assets clause CHAPTER IV – Security agreements covering derived assets CHAPTER V – Secured creditor’s right to proceeds of unauthorised dispositions CONCLUSION 7 8 Table of Contents INTRODUCTION ................................................................................... 33 CHAPTER I - THE CONCEPT OF SECURITY INTERESTS ... 41 1 INTRODUCTION...............................................................................................41 2 RATIONALE FOR SECURITY INTERESTS...................................................42 2.1 Conventional explanation of security interests ...........................43 A. The benefit for the debtor: facilitating finance...................................................44 B. The benefits for the secured creditor .....................................................................45 2.2 Property-based theory of security interests..................................46 2.3 Efficiency of security interests ...........................................................47 A. Impact of security interests on creditor’s risk preferences.............................50 B. Overcoming problems of asymmetry of information and adverse selection .......................................................................................................................................52 C. Overcoming the moral hazard problem ................................................................54 (a) Reduction of costs of monitoring.................................................................55 (b) A mutually-interested relation reducing moral hazard....................56 D. Fair distribution and efficiency in a wider context – third party issues.....56 (a) The net impact on society ...............................................................................57 (b) The impact of security interests on unsecured creditors..................57 2.4 Efficiency of security interests in derived assets.........................59 A. Promoting efficient credit market equilibrium: security in substitutes......60 B. Security in fruits as an impediment to an efficient equilibrium....................62 (a) Oversecuritisation..............................................................................................62 (b) The deadweight loss of the fruits rule.......................................................63 3 TYPES OF SECURITY IN ENGLAND ............................................................65 3.1 Pledge..........................................................................................................65 3.2 Lien...............................................................................................................67 3.4 Charge.........................................................................................................72 A. Distinction between fixed and floating charges.................................................73 (a) Hallmark of a floating charge: right to dispose free of security without consent ..........................................................................................................74 (b) Restriction on the dealing power as a necessary element of the fixed charge..................................................................................................................77 B. Practical consequences of characterisation as fixed and floating security 79 4 THE CONCEPT OF SECURITY INTEREST UNDER ARTICLE 9 UCC....82 4.1 Attachment.................................................................................................83 4.2 Perfection...................................................................................................84 4.3 Security interests in proceeds and products under Article 9 UCC .....................................................................................................................85 5 SUMMARY ........................................................................................................86 CHAPTER II – DEFINING DERIVED ASSETS ............................ 88 1 INTRODUCTION...............................................................................................88 2 ROMAN LAW OF DERIVED ASSETS............................................................91 2.1 Mixed or joined assets...........................................................................92 A. Accessio ..........................................................................................................................92 B. Commixtio and confusio............................................................................................95 C. Specificatio.....................................................................................................................97 D. An alternative approach to mixed assets under Article 9 UCC....................98 2.2 Fruits.........................................................................................................100 A. Rights to natural fruits.............................................................................................100 (a) Accession by natural increase as an unhelpful rule in relation to fruits.............................................................................................................................101 9 (b) Specifically conferred right to fruits ......................................................102 (c) Relevance of possession.................................................................................102 B. Rights to “civil fruits” (intangible “fruits”)......................................................106 3 CLASSIFICATION OF CHANGES TO SUBJECT MATTER OF SECURITY INTERESTS......................................................................................................... 108 3.1 Changes of subject matter not leading to a new asset...........109 A. Following into the original collateral (accretions, confusion) ...................109 B. Destruction of subject matter of security...........................................................110 3.2 Changes of subject matter leading to a new asset...................110 A. Proceeds and products (substitutes)....................................................................110 B. Fruits..............................................................................................................................111 C. Distinction between fruits and substitutes ........................................................113 (a) Functional similarity based on economic efficiency.........................114 (b) Conceptual distinctions ................................................................................116 3.3 “False friends” of derived assets: rights to payment ............119 4 CONCLUSION ................................................................................................ 120 CHAPTER III – SECURITY AGREEMENTS WITHOUT A DERIVED ASSETS CLAUSE ............................................................121 1 INTRODUCTION...........................................................................................
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