Move for a modern law on secured transactions:

The move, on a global scale, for a modern and consolidated law on enforcement of security interests has been on for quite some time. Legal systems to enable secured transactions have been considered as an obvious must with the increasing need for private capital. "Every commercial investor is interested in making a profit from his investment but in many cases the first fundamental concern is to obtain protection against loss of the investment. A legal framework for secured transactions is a key requirement in creating an investor-friendly climate. An investor who knows that he has legally recognised rights to turn to his debtor's assets in case of non-payment may assess the investment risk quite differently. It may influence his decision whether to invest or not; it may also change the terms on which he is prepared to invest (typically by lowering the interest rate on a loan)." In an often-cited article titled Power of the Collateral, Heywood Fleisig says: "The issue of collateral is one of great economic importance. When borrowers cannot use their assets as collateral for loans and cannot purchase goods on credit using the goods themselves as collateral, interest rates on loans tend to be higher to reflect the risk to lenders. In many developing countries, where legal and regulatory constraints make it difficult to use movable property as loan collateral, the cost of loans makes capital equipment more expensive for entrepreneurs relative to their counterparts in industrial countries; businesses either postpone buying new equipment or finance it more slowly out of their own limited savings. Small businesses, in particular, are hit hard by the scarcity of low-cost financing, but the whole economy suffers because the lack of new investment dampens productivity and keeps incomes down. Estimates put welfare losses caused by barriers to secured transactions at 510 percent of GNP in Argentina and Bolivia."

Thus, it is also agreed that a strong secured transactions law directly contributes to lower cost of providing credit, whereas the cost of credit tends to unreasonably high in countries which do not have strong secured credit laws.

With globalisation of commerce, international harmony in laws dealing with secured transactions is also essential. Therefore, multi-lateral institutions such as IMF, EBRD, ADB also took it upon themselves to have a model law for secured transactions internatioally.

The European Bank for Reconstruction and Development (EBRD) took an early lead and initiated a project for a harmonised law on secured transactions soon after it was established in 1991. The advisory panel for the project consisted of some of the World's best-known scholars on property and security law. The EBRD model law was formulated in 1994. The EBRD model law is not a model law as such but a statement of broad principles.

EBRD's Core principles of law on secured transactions:

EBRD has stated 10 core principles of a security law, developed in course of consistent international dialogue after publication of its model law:

1. Security should reduce the risk of giving credit leading to an increased availability of credit on improved terms.

This goes to the basic assumption made by EBRD on all its work on secured transactions law reform.

2. The law should enable the quick, cheap and simple creation of a proprietary security right without depriving the person giving the security of the use of his assets.

In most market economy scenarios depriving the debtor of the use of his assets is self-defeating; non-possessory security which gives a remedy attached to the charged asset is an essential element of a modern secured transactions law. Any delay, cost or complexity in the creation process reduces the economic efficiency of security.

3. If the secured debt is not paid the holder of security should be able to have the charged assets realised and to have the proceeds applied towards satisfaction of his claim prior to other creditors.

The exact nature of the proprietary right that arises when security is granted has to be defined in the context of the relevant laws. If it is to be effective it must link to the creditor's claim the remedy of recovering from the assets given as security.

4. Enforcement procedures should enable prompt realisation at market value of the assets given as security.

A remedy is only as good as the procedures and practice for exercising it allow it to be. If the value received on realisation is expected to be only half the market value, then the provider of credit will require more assets to be given as security. If it is expected that enforcement will take two years then the creditor will give less favourable credit terms to the debtor.

5. The security right should continue to be effective and enforceable after the bankruptcy or insolvency of the person who has given it.

The position against which the creditor most wants protection is the insolvency of the debtor. Any reduction of rights or dilution of priority upon insolvency will reduce the value of security. A limited exception to this principle may be necessary to make it compatible with rules which permit a moratorium at the commencement of insolvency.

6. The costs of taking, maintaining and enforcing security should be low

A person granting credit will usually ensure that all costs connected with the credit are passed on to the debtor. High costs of security will be reflected in the price for credit and will diminish the efficiency of the credit market.

7. Security should be available (a) over all types of assets (b) to secure all types of debts and (c) between all types of person.

This principle covers a multitude of issues that may arise between the way law is applied and the needs of commercial reality. They may appear technical but can be of critical importance when seeking to implement a commercial agreement. With very limited exceptions (e.g. personal clothing) a person should be able to give security over any of his assets, including assets he may acquire in the future. Similarly a charge should be capable of securing any type of present or future debt or claim that can be expressed in money terms. The charged assets and the secured debt should be capable of general description (e.g., all machines in a factory, all debts arising under sales contract). It should also be possible to charge constantly changing 'pools' of assets such as inventory, debts receivable and stocks of equipment and to secure fluctuating debts such as the amount due under a bank overdraft facility. Any physical or legal person (whether in the public or private sector) who is permitted by law to transfer property should be able to grant security.

8. There should be an effective means of publicising the existence of security rights.

Where security is possessory the mere fact that the assets are held by the creditor is enough to alert third parties that the debtor has charged them. Where security is non-possessory some other means (normally a public registry or notification system) is needed to ensure that third parties do not acquire charged assets without being made aware of the existence of the charge.

9. The law should establish rules governing competing rights of persons holding security and other persons claiming rights in the assets given as security.

Even when an effective means of publicity is in place there remain some cases for which the law has to provide, for example sales of charged assets in the ordinary course of the owner's business (where the purchaser cannot be expected to inspect a register before purchasing).

10. As far as possible the parties should be able to adapt security to the needs of their particular transaction.

The law is there to facilitate the operation of the secured credit market and to ensure that necessary protections are in place to prevent debtor, creditor or third parties being unfairly prejudiced by secured transactions. It should not be the purpose of the law to create rules and structures for the operation of secured credit which are aimed principally at directing the manner in which parties to secured credit should structure their transaction.

ADB's project for Asian countries:

In 2001, the Asian Development Bank (ADB) also did a comparison of security interests law in some key Asian countries (China, India, Indonesia, Pakistan and Thailand) and deliberated extensively on the options for reform, and gave suggestions on a model security enforcement law.

The key features as suggested by ADB are the following:

The law must set out a system for security interests that meets certain minimum economic requirements. The economic requirements for a regime whose single goal is to promote secured credit are:

oCreation that is cheap, simple, comprehensive

An economically effective law permits inexpensive creation of a security interest against all property by any person for any transaction.

oPublicity that is public, inexpensive to file, easy to search

The law enforces publicity of the priority by public filing system where the public can, both inexpensively and quickly, search for prior security interests and file anew

oPriority based on a simple and unambiguous rule

An economically effective law fixes priority by clear first-to-file rules that include the claims of third parties such as junior secured and unsecured creditors, a trustee in bankruptcy trustees, or some purchasers of the collateral.

oEnforcement that is fast and cheap

The law provides inexpensive and fast enforcement, permitting recovery and sale even at low costs relative to the value of the collateral; that means, typically, a system substantially administered by the creditor.

The key legal features of such a regime are that it is unified functionally, provides for publication by registration, gives security interests high priority with no exceptions, and provides for speedy enforcement outside the courts. This is the extreme form of the broad functional approach that Chapter IV (of the ADB report) also describes. In practice, countries do not enact a law in such an extreme form because they have other values than simply maximizing secured credit. This model is useful, however, as a baseline against which exceptions need to be justified.

Essential principles of security enforcement law as per World Bank working paper:

In Sept 1999, the World Bank also published a detailed working paper on creditor-debtor relations. The working group included Prof Roy Goode, one of the World's most celebrated experts on security laws. The working group suggested 10 essential principles of security enforcement law as under:

(1) Types of collateral available as security

The legal regime should in principle recognize security over all types of asset, movable and immovable, tangible and intangible, including inventory and receivables and proceeds. It may well be that there are particular categories of asset or debtor which call for special treatment, such as farm equipment. But subject to such special cases the availability of security should not be limited to land but should embrace all forms of movable property, tangible or intangible, including accounts receivable and intellectual property rights. New forms of collateral are emerging as the drive to reduce the risk, expense and inconvenience of issuing and transferring paper has led to the abandonment of paper-based investment securities in favour of dematerialisation through electronic records, or alternatively to the immobilisation of paper-based securities by deposit with global custodians and other depositary institutions, rights in the underlying securities being replaced by security entitlements recorded in accounts with the securities intermediary, such entitlements constituting distinct property rights which themselves are capable of being given in security.

(2) Classification of collateral

Not all types of collateral can be subject to the same rules. In particular, it is necessary to distinguish tangibles (in respect of which security can be perfected by possession as an alternative to registration) from intangibles (where this method is not available), and to distinguish equipment held for use in the debtor's business from inventory held for resale or lease.

(3) Future property and global security

Common law systems have long recognized the ability of a creditor to take security over the debtor's future property and to treat the security interest as automatically attaching to such property after acquisition by the debtor without the need for any new act of transfer - this is the well-known concept of floating charges. A number of civil law systems also allow this for particular categories of asset. For example, German law has the Sicherungsübereignung for the security transfer of tangible movables and the Sicherungsabtretung for the security assignment of claims, both of which accommodate security in after-acquired property. It is vital to modern financing that the lender should be able to take security over a shifting pool of assets, without which a global (or all-assets) security is impossible. In England the floating charge has proved a highly efficient and flexible financing tool, while in North America similar effects have been achieved more directly by the floating lien embodied in Article 9 and the Canadian Personal Property Security Acts based upon it. Civil law systems often achieve somewhat similar results through an enterprise mortgage, such as the nantissement de fonds de commerce of French law.

(4) Identification of collateral by class or description

The requirement which is still found in a number of legal systems to identify each item of collateral specifically is cumbersome even when applied to existing assets, particularly where they are not of a kind lending themselves to unique identification, and makes it difficult, if not impossible, to provide for security over future property, still less for global security. It should suffice that the description of the collateral is such that the asset over which security is asserted can be identified as falling within the scope of the security agreement. For this purpose security over "all the debtor's present and future receivables or even "all the present and future property of the debtor" should be regarded as sufficient.

(5) Obligations capable of being secured

The security agreement should be able to secure any or all obligations of the debtor to the creditor, present or future.

(6) Non-possessory security

In the case of security over chattels a requirement of delivery of possession is a serious impediment. Typically such chattels will be held by the debtor either as equipment for use in its business or for sale as inventory. Delivery of possession to the creditor would thus deprive the debtor of the ability to use or sell the chattels and thereby generate the income from which to repay its indebtedness. including security by class or description (as opposed to individual specification) and global (all-assets) security. Further, the law should permit not only possessory but non-possessory security over tangible assets, since these will typically be assets of the enterprise which the debtor company needs to hold and use in order to carry on its business and earn the income from which to repay its debts.

(7) Ease and cost-effectiveness of creation

Most legal systems (though not English law) require security to be created or evidenced by a writing signed by the debtor and identifying the collateral and the obligations secured. Formalities of this kind are relatively easy to comply with. It is desirable to avoid additional formalities which involve inconvenience and expense, such as notarisation. As regards security interests in investment securities, the move towards dematerialisation and immobilisation of securities mentioned earlier has increasingly led to the abandonment of paper-based transfers and charges and the use of electronic transfer systems to effect security transactions. Usually this requires legislation in order to remove obstacles created by legal requirements for documents, writings and signatures. In the case of security assignments of debts a number of legal systems require formal notice of the security assignment to be given to the debtor (in some cases, by an official and in a prescribed form) not merely to prevent the debtor from paying the assignor or to preserve the assignee's priority but as a condition of validity of the assignment. In other words, the notice is not simply a perfection requirement but is a constitutive element in the creation of the security. One effect of this is that if notice has not been given to the debtor prior to its bankruptcy the assignment has no effect, so that the debtor's estate is able to retain both the benefits of the advance and the debts given in security. Fulfilment of a notice requirement, which in contrast to registration does not fulfil any effective public notice function, is impracticable in the case of bulk assignments and security over ongoing streams of receivables. Moreover, the notice requirement is incompatible with the concept of security over classes of asset and security over future property, which do not lend themselves to individual specification.¹² Notice to the debtor does not feature as a constitutive element of a security assignment in the UNCITRAL Draft Convention on Assignment in Receivables Financing (see later in this Chapter) or in the draft chapter on assignment in the forthcoming Part III of the Principles of European Contract Law prepared by the Commission on European Contract Law.

(8) Ease of enforcement

It is important that intending creditors should have confidence in the ability of the legal system to provide prompt and efficient means of enforcing their security. Enforceability is at its easiest where the law allows the parties themselves to prescribe their own default remedies and thereby to bypass the need for recourse to the courts, but a number of systems view even peaceful self-help with disfavour, taking the view that it may tend to a breach of the peace, and interference with such a long-standing legal tradition may be felt to offend against public policy in the countries concerned. Moreover, it is generally accepted that even in dealings between commercial enterprises the law cannot adopt a completely laissez-faire approach and must set limits on party autonomy in the selection of default remedies, for example, by nullifying or restricting contractual provisions for the forfeiture of the collateral to the creditor.

(9) Registration machinery

Also necessary is a system by which public notice - preferably by recording in a public can be given of non-possessory security interests. Perfection by registration is the one way of bridging the gap between legal systems that adopt the common law concept nemo dat quod non habet and those which follow the civil law rule possession vaut titre. A registration or similar system is necessary to prevent the debtor from raising further credit on the strength of his apparent ownership of the assets (the so-called "false wealth" doctrine) by enabling third parties intending to acquire an interest in the asset to become aware of the existence of a prior security interest. Registration also has a central role in the ordering of priorities. For assets capable of unique identification, such as aircraft, ships and motor vehicles, it is feasible to have a system of registration against the asset itself. For other types of asset, the registration would be effected against the name of the debtor. In keeping with a policy allowing global (all-assets) security, the registration system should allow a global security over present and future property to be effected by a single registration. A modern registration system should be electronic and should allow registration and searching on-line. Experience, particularly in North America, has shown that registration and search fees can be kept down to a modest level while still allowing the registration system to operate at a profit.

(10) Priority rules

A developed regime for security interests should also lay down rules to govern the priority of competing interests in the collateral and the proceeds of inventory collateral, and these should be framed so as to produce results which in the typical case would commend themselves to the commercial community as fair and reasonable. Among other things, special priority needs to be given to the purchase-money security interest in order to avoid giving the first financier a monopoly over loans to the debtor and scooping up as a windfall the debtor's acquired property financed by subsequent lenders. The subject of priorities is complex and space does not allow further discussion in the present paper

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