Bills of sale
We have recently completed a transaction where a loan between two individuals was secured against the borrower’s collection of luxury cars. The security was taken by way of a security bill of sale. In addition, we have been asked to explore this area in the context of loans secured on high value art. We share here our views and experience.
The nature of security
Types of Security
Creating security over an asset creates an interest in the asset and provides recourse for the lender to the asset if the borrower fails to repay the debt. Taking security not only puts the lender in a higher ranking position to an unsecured lender, but also confers proprietary and/or possessory rights on the lender.
It is common to see a company providing security over real property, shares and other assets such as cash held in a bank account and interests in contracts. The method of taking security over these assets is generally by mortgage or charge. A mortgage over real property creates an interest in the land that is then registered at Companies House, in the case of UK companies, and the Land Registry. A charge over registered shares can be perfected as a legal charge by registration or effected as an equitable charge. Likewise, when contracts are secured, the procedure under section 136 of the Law of Property Act 1925 is followed to create a legal assignment of the rights that arise out of that contract.
Pledges and liens do not create a proprietary interest in the asset but are a form of possessory security as the assets are held by the lender for the security period.
When a company grants a debenture over its assets, the chattels of that company are often captured in the security net. Planes, yachts, cars and paintings fall into this category of assets along with any other moveable property. In this scenario, the company will create a charge over the asset in favour of the beneficiary. A charge is an equitable interest that creates rights in favour of the lender who has the benefit of the security which allows the borrower to continue to use the assets until the borrower defaults upon which the lender may take control of the chattel and sell it so that the lender can be repaid.
Taking security over moveable assets does have its risks including identification and tracing. To overcome these issues a notice is often required to be attached to the asset so third parties are aware of the security but this is not always appropriate especially when securing works or objects of art.
Security granted by individuals
Taking conventional security from individuals is common practice but as there is no central register for charges granted by individuals in the same way as security granted by a UK company is registered at Companies House, it is hard to check whether an asset is charged by an individual. As with all lending to individuals, the provisions of the consumer credit legislation must be complied with.
There are statutory and common law limitations on how an individual can charge their assets for example, the general rule is that individuals cannot grant floating charges because security created by an individual must always be over a specific asset and not a class of assets. In the same way, if a lender wants to register the security we have to turn to nineteenth century legislation in the form of the Bills of Sale Act 1878 (the “1878 Act”) and the Bills of Sale Act (1878) Amendment Act 1882 (the “1882 Act”) (together, the “Bills of Sale Acts”) and create security bills of sale in order to secure these assets. Bills of sale are also applicable to partnerships and unincorporated associations but this this is not covered in this note.
Features of a bill of sale – the requirements of the bills of sale acts, the limitations and the outcomes
Form and registration
When a security bill of sale is granted, the individual creates a non-possessory form of security which must be stated to be by way of security assignment in favour of the beneficiary. When creating the security there is a strict form prescribed by statute that must be followed. The bill of sale must be registered with the registrar at court within a certain time frame and any subsequent variations and amendments must also be registered. In addition, the bill of sale must be re-registered every five years. Failure to comply with the procedural elements of the legislation not only renders the instrument void against third parties but it also voids the security between the parties to the instrument.
Due to the strict procedural requirements of the legislation, the form of the instrument that documents the arrangement between the parties cannot cater for all types of modern lending structures. The statutory form set out in the schedule to the 1882 Act stipulates that only a fixed sum can be secured, and so it is not possible to secure Further advances by using this form of instrument, but instead this will require re-execution of a further bill of sale.
Interest on the loan secured by the bill of sale also has to be certain and must be expressed as a fixed rate thereby preventing any floating rate of interest (based, for example, on LIBOR on a bank base rate) from being used. In addition case law has confirmed that interest cannot be compounded and neither can interest be capitalised.
The statutory form also requires a fixed time of repayment therefore if the loan arrangement is an overdraft or a revolving loan, this type of security is not appropriate.
The Bills of Sale Acts only allow for personal chattels to be secured by way of a bill of sale. The original act defines personal chattels as “goods, furniture and other articles capable of complete transfer by delivery”. This definition arose from the fact that the bill of sale was originally a means of transferring property outright and the security bill of sale is a development of this method of transfer. The assets must therefore be tangible and moveable and the statutory form requires that the assets are listed in the instrument. Any asset that is not capable of being identified cannot be secured and therefore any future acquired assets will not be captured by the security bill of sale except where there is a replacement of machinery but this is a very narrow exception. Choses in action for example, contractual rights, because of their intangible nature, cannot be secured by a security bill of sale.
It should also be noted that where a chattel becomes a fixture the security created by the bill of sale will not attach to that asset as fixtures fall outside the scope of the definition of personal chattels set out in the 1878 Act and moreover, if there is existing security over that asset for example, a mortgage over land, then the asset may be captured by that security interest instead as it will form part of the land.
The distinction between a fixture and a chattel is not always clear but broadly the test when determining whether an asset is a fixture or a chattel is the method and extent of annexation of the asset to the land and the intention and purpose of such annexation.
In addition, the following procedural points are noteworthy:
- in order to ensure that the bill of sale has the correct priority over other bills of sale it must be registered with the registrar at the Queen’s Bench Division within seven clear days of execution
- the register is searchable but the person searching must have the name and postcode of the borrower. It is also possible to search the register against the bill of sale registration number but this is normally only known to the beneficiary and
- once the debt is repaid, the borrower or the beneficiary can apply for a memorandum of satisfaction to be affixed to the bill of sale. Satisfaction extinguishes the bill of sale.
Provided that the statutory form and procedure is followed, a valid security interest will be created which has the following benefits.
- The assets charged – Where a borrower’s home or business premises have already been charged, second ranking lending on those assets may not provide sufficient collateral for the amounts being lent. Likewise, in some cases, a single asset or a collection of assets belonging to a borrower, due to their worth, may be more valuable collateral than more conventional security assets. Taking a security bill of sale allows for the borrower to offer a larger or different collateral package to the lender and consequently borrow money on a secured basis.
- Non-possessory security – Entering into a bill of sale pursuant to the Bills of Sale Acts creates non-possessory security over chattels which means that although title is transferred to the beneficiary during the term of the debt, the beneficiary does not have to take possession of the asset in order to create effective security. The advantages are that the owner of the assets is able to continue to use the charged assets and the beneficiary does not have to take on the risk of storing the assets in the way that they would have to if they had possessory security such as a pledge or a lien.
- Absolute protection against purchasers – Provided that a security bill of sale follows the requirements of the Bills of Sale Acts and the legal title is charged, a security bill of sale creates title to the asset in favour of the beneficiary that will defeat any other person’s claim to the asset. In this way, the security created by a security bill of sale creates a better security interest in the asset than other forms of security in that its claim is valid even against a bone fide purchaser purchasing the asset in good faith and without notice. If the property is sold in breach of the security that third party would be liable to the beneficiary and therefore any loss caused to the beneficiary in dealing with the property would have to be reimbursed by the third party.
Frequently asked questions
Q: Who is responsible for insuring the asset?
A: As this form of security is non-possessory, the ownership remains with the chargor during the security period and therefore it is the responsibility of the chargor to insure the asset and this obligation can be set out in the bill of sale. It is permissible in the bill of sale to include a provision that allows the beneficiary to make payments to maintain the insurance if the chargor defaults although the amounts paid cannot be recovered through the seizure and sale of the goods. If this is the case, the beneficiary will have to sue the chargor for those amounts. Choses in action cannot be charged by a bill of sale so insurance proceeds will not be able to be charged by the security. Depending on the insurer and the asset, the beneficiary’s interest may be able to be noted on the policy but as the statutory form of security bill of sale does not specifically allow for this (and any deviation from the form could invalidate the bill of sale) it is advisable to include such provisions in the loan agreement, to which the form of the bill of sale will be attached.
Q: Can custody of the asset be passed to another person e.g. can a charged piece of artwork be lent for exhibition?
A: Provided the transfer of possession of the asset does not constitute the transfer of title to the asset and the beneficiary still has a means of seizing the asset, lending the asset to another person should be permissible.
Two of the permitted covenants in the statutory form are to not assign or underlet the assets without consent and to allow entry to inspect the assets and one of the grounds for seizure is fraudulently removing the assets from the premises where they are situated (please also see below). These provisions are designed to protect the lender and its interest in the asset. For this reason, if the chargor is to part with possession of the asset then they must obtain the lender’s consent. In addition, as the method of enforcing a bill of sale is seizure, the lender must be able to find the asset before seizing it and so the lender must be informed of the asset’s new location. The lex situs (the law of the place where the asset is situated) of an asset normally governs the method of enforcement so there may be issues with enforcement under English law if the asset is moved abroad and therefore, as a lender, care must be taken when allowing the asset to be moved out of England. It should be noted that the Bills of Sale Acts do not extend to Scotland or Northern Ireland.
Q: How can the security be enforced if it all goes wrong?
A: Pursuant to the 1882 Act the five grounds for seizure of the assets are as follows:
- if there is a payment default or the chargor breaches the covenant relating to the maintenance of security
- if the chargor becomes bankrupt
- if the chargor fraudulently removes the assets or allows the assets to be removed from the premises
- if the chargor cannot produce receipts for rent, rates and taxes
- if execution is levied against the goods of the chargor under any judgment of law.
The lender will enforce its security by seizure so it is important that the lender can access where the assets are located and that the lender is able to take control of the asset. Subject to compliance with consumer credit legislation, the assets can be seized immediately on default but there must be a five day period of waiting before the property can be sold. The period of time is built into the Bills of Sale Acts to allow the borrower to apply to the court for relief from enforcement.
Q: What is the order of priority of bills of sale?
A: In accordance with the usual rules, a prior registered bill of sale will take precedence over a subsequent bill of sale and any other subsequent created security. There are two further points to note:
- the bill of sale only applies to personal chattels and accordingly, in the event that the chattels become affixed to land and become a fixture, the bill of sale will be defeated. Any security over the land will thereafter extend to the former chattel so affixed and
- care needs to be taken in identifying the borrower’s interest in the chattel to be secured. It is possible for the borrower’s interest to be less than full legal and beneficial title in which event (i) the borrower can only charge the interest that the borrower holds; and (ii) if the borrower holds and charges an equitable interest only, the beneficiary will need to have bound the holder of the legal title in order to convey full title in the event of the enforcement against the asset and its subsequent sale.
The future and conclusion
While it is useful to have a codified means of securing personal chattels the current legislation is inflexible and outdated and does not cater for all modern lending structures. As such the Law Commission published a consultation paper on 9 September 2015 to review this type of security with a view to reform. While the Law Commission appears to be focussing on the use of bills of sale in the context of “logbook loans”, the reform could apply to all bills of sale in the future.
The responses to the Law Commission’s request for information demonstrate that the principal areas of concern in relation to the current legislation are:
- the registration procedure meaning the involvement of the High Court, the use of affidavits and the cost of registration
- the language used in the legislation meaning that the majority of parties would prefer the legislation to be updated so that it is in plain English
- protecting borrowers from a quick seizure by the lender without the involvement of the courts as is the current position
- protection for third parties as at present a bill of sale defeats the purchase by a third party for value without notice.
Therefore, whilst the Bills of Sale Acts may not be repealed in the future, it has been recognised that in order to continue to allow personal property to be charged, the legislation will most likely need to be updated.
We will keep you posted with any developments.
This article was written by Isobel Young-Herries. For more information please get in touch via email@example.com or +44 (0)20 7203 5078.
News & Insights
Brexit and Financial Services Firms
Vanessa Walters explores the regulator's position with Brexit fast approaching.
Charles Russell Speechlys promotes eight to Partner
A further four have been promoted to Legal Director and 22 to Senior Associate.