Security Rights in Movable Assets
1. Concept and function
Security rights in movable assets are proprietary rights in movables, ie in a movable thing or a right. In most cases, the security is a pledge, ie a limited property right encumbering ownership. In a few countries though, ownership may also perform the function of security; this restricted purpose of ownership is expressed in terms such as retention of ownership or security transfer of ownership.
Pledge as well as ownership for security purposes entitle the creditor of the secured claim to obtain preferential satisfaction from assets encumbered by the security right if the debtor does not perform the secured obligation upon maturity. Preferential satisfaction means that the secured creditor takes priority over all unsecured creditors and also over possible holders of later established security rights in the same encumbered asset. In practice, this priority is of overwhelming economic significance especially in an insolvency proceeding over the debtor’s property; the same also applies if other creditors of the debtor attempt to bring an execution against the encumbered asset.
Generally, a proprietary security is granted by the debtor of the secured claim. But it may also be granted by a third party, either on the basis of a desire to assist the debtor, especially among relatives, or else on the basis of a business contract against a fee. If the third party’s security right is enforced by the creditor, the third party obtains the rights of a surety both against possible proprietary or personal co-sureties and ultimately also against the debtor of the secured claim. In Sweden and Finland, this third-party pledge is even regulated in specific statutes and in Finland, consistent with its nature, in the law on suretyship (modern law).
The rules on security in movable assets reflect, to a much stronger extent than the law on personal security (suretyship (modern law) and guarantee, independent), the close connection between legal and economic development. This is primarily demonstrated by the evolution of proprietary security rights in movable assets which, starting from a very simple basic type, have evolved into instruments of broad diversity and high complexity.
2. Basic types and models of regulation
Since early times, there have been two basic types of security rights in movable assets. The first (and presumably somewhat older) is the possessory pledge, the pignus of Roman law. The possessory pledge was and is still today only valid if—as the name indicates—the pledgee (as creditor) obtains and retains possession of the asset pledged by the debtor (or a third party). As an alternative, a non-possessory security right also evolved, the hypotheca, where the encumbered asset may remain in the debtor’s possession. In the course of history, the relation between those two basic types has varied. In the 18th and 19th centuries, only the possessory pledge was permitted. The possessory pledge was and is to this day accepted and regulated in all civil codes—from the French Code civil (1804) to the German Bürgerliches Gesetzbuch (BGB) of 1900 to Book 3 of the Dutch Burgerlijk Wetboek (BW) of 1992. One exception to these two basic models, which results from the nature of the encumbered asset, had to be made only for the pledge of monetary claims because in these cases a physical transfer of possession is impossible, unless the monetary claim is represented by a document; for undocumented monetary claims, the physical transfer of possession was then replaced by a notice of the pledge to the garnishee, ie the debtor of the security provider.
With the onset of the industrial revolution in the beginning of the 19th century, the basic parameters fundamentally changed. First, the demand for credit for the development of industry, transport and trade dramatically increased. However, the needs and conditions of the new economic activities ruled out the traditional method of securing credits by transferring possession of the encumbered equipment and machinery to the secured creditors because the possession of these assets was indispensable for the debtors, ie for the manufacturing industry, for the transport business and also for the merchants’ stocks. This led to the revival of the alternative type of collateral security, ie the non-possessory security right, which is in the spotlight today: the debtor may retain the secured asset, use and work it as well as sell it as a dealer in the ordinary course of business. Only through such use and sales is the debtor able to obtain the money for repayment of the credit. The relatively insignificant trade of pawnbrokers is the only sector wherein small amounts of credit are regularly granted to consumers, and the credit is secured by the pledge of valuables and basic commodities.
The possessory pledge established in the 19th century could not satisfy the new overwhelming economic demands. Therefore, almost all European countries enacted special statutes, which—at first only for certain narrowly defined branches of business—permitted and regulated specific types of non-possessory security rights. The number of these special laws outside the civil codes increased immensely, particularly for means of transportation (ships, motor vehicles and, later, airplanes (security interests in transport vehicles) then, for several branches of industry and commerce with respect to their machinery, equipment and stock of merchandise; even individual intangible assets, such as the name of the firm, industrial property rights and copyrights were covered in part.
On the other hand, the fact that debtors were permitted to retain encumbered assets gave rise to new risks: first, the debtor appeared to be wealthier than he was; and secondly, the debtor, by being in possession, was enabled to dispose of the encumbered assets. Therefore, an external counter-balance was developed for the modern types of non-possessory security held by the debtor. Based on the model of (non-possessory) security rights in immovable property, which have to be entered in a land register, comparable registers for non-possessory security rights were instituted in many countries.
Some countries, especially France, introduced as many as a dozen of such special statutes over the course of time. Usually, their number was restricted to between three and five. Most legislatures have conditioned effectiveness against third parties upon some form of publicity, such as marking or registration.
Only Germany and, following its lead, Austria, overwhelmingly shunned this general trend of enacting special statutes and instead took a different route. In these countries, the courts sanctioned agreements of the parties under which the debtor transferred ownership of the asset to serve as security for the creditor but retained possession. The debtor was authorized to acts of disposition within the limits of the security purpose. Retention of ownership and security transfer of ownership are fruits of this development, which the courts accepted as a security device especially in Germany and also in some southeastern European countries. In Austria, as in many other countries, retention of ownership was also approved, but not the security transfer of ownership.
Retention of ownership is the security device of sellers and is widely accepted throughout Europe. It serves as a security for acquisition credits, which sellers grant their buyers to promote sales. Technically, the transfer of ownership to the buyer is conditioned on the full payment of the purchase price by either postponing the transfer of ownership until the seller is fully satisfied or by carrying it out immediately, but only under a corresponding suspensive condition.
By contrast, security transfer of ownership serves as the security device for monetary credits: the debtor transfers ownership of the encumbered assets to the creditor for security purposes, but it retains possession of the assets and may dispose of them in the ordinary course of business, ie, in particular, sell them.
All of the rules regarding the two devices of security just mentioned have been elaborated through creative standard forms as well as by the courts and legal scholarship. The legislature remained uninvolved—a unique phenomenon in a modern state. This situation allows for an enormous flexibility. Of course, registers for the registration of security rights cannot exist. Through a restrictive application of the rules concerning bona fide acquisition, however, similar results—at least between merchants—may be achieved as under a system of registration.
On the European level, one can by now observe the first indications of a partial harmonization of the Member States’ laws on security rights in movables. The Directive on Combating Late Payment (Dir 2000/35) prescribes at the level of the conflict of laws the mutual recognition of retentions of ownership. If assets, for which a retention of ownership had been effectively agreed upon in one Member State, are later moved to another Member State—eg by export or in transit—then this other Member State must recognize the retention of ownership (Art 4). This provision has been retained in the revision of the directive effected in 2011 (now Dir 2011/7/EU Art 9). However, the ECJ (Case C-302/05 – Commission v Italy  ECR I‑10597) had interpreted former Art 4 narrowly: the duty of recognition does not cover the effects as against third parties; rather, in this regard the requirements of the new lex rei sitae must be observed. Whether one may overcome this dilemma by relying upon the freedom of movement of goods according to Art 36 TFEU/30 EC—as repeatedly claimed by scholars (Kieninger, von Wilmowsky)—is still open because publicity by registration is, in fact, territorially limited. Of more practical importance are the substantive rules of the Directive on Financial Collateral Arrangements of 2002, which regulate this modern type of security right very liberally; however, its personal scope of application differs significantly from Member State to Member State (financial collateral). In terms of substance it is limited to bank deposits and financial instruments. The 2009 revised version of the directive extends the substantive scope of application to credit claims (ie claims by financial institutions (Art 2(2) s 2). A substantive innovation is the control of rights, especially accounts, which replaces the notice to the third party debtor. Technically, also the irregular pledge (see 3. below) is used here.
3. Basic substantive rules
The basic substantive rules for security rights are mainly implied in the preceding section as concerns the various types and models of regulation. Enforceability against third parties requires, in cases of a possessory pledge, the transfer of possession to the pledgee; in cases of financial securities, the control by the creditor; and in cases of non-possessory pledges, observance of the rules regarding the correct registration in the respective register, if any. In case of non-registered security rights, which are based on the security provider’s ownership, the transfer of ownership to the creditor according to general rules is required. In general, the pledgee may not dispose of the pledged asset. Within narrow limits, practice also accepts a so-called irregular pledge, in particular with respect to fungible assets, such as money and securities: if the pledgee mixes such assets with its own property, the pledge generally ceases to exist. But the creditor, upon satisfaction of the secured obligation, is obliged to return an equivalent amount of the same assets to the debtor (see 2. above).
The enforcement of a security right is governed by the special rules regarding the enforcement of a pledge. These rules apply directly to the possessory pledge and by analogy for those legal systems that accept the transfer of ownership for security purposes. The pledgee is primarily entitled to the proceeds of the enforcement; the security provider is only entitled to any surplus. By contrast, the seller of an asset that was delivered under a retention of ownership may take back the asset and dispose of it.
The law on security in movables has not yet been consolidated and is still in motion. For the near future several trends can be observed.
a) One can already observe a strong tendency to extend the substantive scope of application regarding the secured assets beyond the corporeal assets that were prominent so far and on to neglected or newly invented rights. This applies first of all to numerous rights in intellectual creations (intellectual property), especially copyrights as well as patents, trademarks, designs, trade names and symbols. For these developments, it is significant that the Legislative Guide for Secured Transactions of 2007 prepared by UNCITRAL is supplemented by an extensive appendix covering security rights in intellectual property. In addition, developments of the substantive law also contribute to the extension of intangible rights. This applies in particular to the replacement of indirectly held securities by a global share, in which all parties (only) hold shares, or even the complete dematerialization of securities which are replaced by ‘book-entry securities.’ In this way, the traditional institution of the pledge of monetary claims is extended to many new rights. Where a third party holds the encumbered asset, such as money or securities held by a bank in corporeal or incorporeal form (as a book-entry account), notice to the third party practically implies control by the third party.
b) A second trend aims at the substantive unification of the multiple special statutes enacted in many countries during the past 150 years for non-possessory security rights relating to different types of assets. They should be and increasingly are reduced to one general security right. The present French ‘solution’, however, is only a small step because the some 10 special statutes will remain and, without changes in substance, have been distributed among three larger bodies of law. The unified security right in Art 9 of the American UCC is the successful counter-model. The basic approach has been adopted in equivalent legislation enacted in Canada (including Quebec), New Zealand and very recently also in Australia.
However, care must be taken that in this process of internal unification, functional differences between different economic needs and interests are not obliterated. In particular, it is necessary to clearly distinguish between two different economic purposes that security rights serve, namely the financing of the acquisition of goods and rights on the one hand, and the financing of current business operations on the other. Security rights for the financing of acquisitions are granted a significantly better legal position in all jurisdictions. The distinction between this privileged security right on the one hand and the security for credits for general business operations on the other is legally expressed by the preferential treatment of retention of ownership as compared to security for general financing established through the creation of a non-possessory pledge, the security transfer of ownership and comparable legal institutions. This even applies to the seemingly uniform security right of Art 9 UCC and its equivalents outside the US. Here, the privilege of the security right for acquisition credits within the uniform security right is achieved through certain special rules with a privileging effect for security covering acquisition financing. In view of the current structure of insolvency laws, however, only security which is based on the security creditor’s ownership can guarantee the preferential treatment of security for acquisition credits in the critical stage of the debtor’s insolvency.
c) The substantive reduction and simplification to two functional basic types of security rights is also a prerequisite for regional harmonization and unification of collateral security. Regionally, the security law of most of the francophone African states, created by the Organisation pour l’Harmonisation en Afrique du Droit des Affaires (OHADA), stands out; its uniformity is guaranteed by a special supranational court. The approaches in Latin America are less extensive: while under the auspices of the Organization of American States (OAS), a uniform outline inspired by Art 9 UCC was adopted in 2002, its transformation into national laws has been very slow. Whether a broad effect will be achieved is still uncertain. A similar approach has also been developed by the author in the framework of the European Common Frame of Reference (CFR), but with a precise division between the general security right on the one hand and the retention of ownership (including comparable instruments such as financial leasing) on the other (see Book IX DCFR).
d) On the universal level, the UNCITRAL Legislative Guide for Secured Transactions (2007) deserves to be mentioned. It is strongly inspired by Art 9 UCC, but is more detailed and offers the double-track solution (supra lit. b) as an alternative.
This brief overview demonstrates that security rights in movable assets still have a great potential for development. This is confirmed by the contemporary development of the economy in all countries, regions and the world at large: conclusive evidence of the fruitful and firm interaction between law and economy.
Wolfgang Hromadka, ‘Die Entwicklung des Faustpfandprinzips im 18. und 19. Jahrhundert’ (1971) 17 Forschungen zur Neueren Privatrechtsgeschichte; Rolf Serick, Eigentumsvorbehalt und Sicherungsübertragung I–VI (1963–1986); Pierre Crocq, Propriété et Garantie (1995); Peter von Wilmowsky, Europäisches Kreditsicherungsrecht (1996); Eva-Maria Kieninger, Mobiliarsicherheiten im Europäischen Binnenmarkt (1996); Anna Veneziano, Le Garanzie Mobiliari Non Possessorie (2000); Eva-Maria Kieninger, Security Rights in Movable Property in European Private Law (2004); Peter Bülow, Recht der Kreditsicherheiten (7th edn, 2007); Hugh Beale and others, The Law of Personal Property Security (2007); Philipp R Wood, Comparative Law of Security Interests and Title Finance (2nd edn, 2007); Roy Goode and Louise Gullifer (eds), Goode on Legal Problems of Credit and Security (4th edn, 2008); William Johnston (ed), Security over Receivables. An International Handbook (2008).