Home Law Implementing the Cape Town Convention and the Domestic Laws on Secured Transactions
The Root of the Problem and the Effect of the Cape Town Convention
One of the main distinctions in the English law of personal property (as distinguished from real property) is between security interests and title-retention agreements or, as alternatively known, “quasi-security” interests. Both terms will be used interchangeably.
English law divides the former category to interests which are created consensually and interests which are created by operation of law. Consensually-created security interests comprise of the following four which are subject to the numerus clausus principle: pledges, contractual liens, (legal or equitable) mortgages and (equitable, fixed or floating) charges. Interests created by operation of law are not subject to the numerus clausus principle. In the words of Professor McKendrick “[n]o useful purpose would be served by trying to catalogue all these (legal) securities, but they may be divided into five principal categories: the [possessory, equitable, maritime or statutory] lien, the equitable right of set-off, the equitable right to trace and, finally, a group of what may be conveniently termed procedural securities”.
Title-retention agreements comprise of finance leases, conditional sales agreements, hire-purchase agreements and retention of title clauses. What they have in common is that they “do not involve the taking of security but...have a similar economic function, in that a party that provides credit retains property rights over assets that in practice are being purchased by the debtor with the credit provided”.
The similarity of function between security interests and title-retention agreements is not a good enough reason for English law to treat them in the same manner with respect to registration. In sharp contrast to Article 9 of the Uniform Commercial
Code (UCC) and a number of common law jurisdictions, English law retains its focus on the form of the agreement rather than its function. As a result, it only provides for the registration of security interests. Title-retention agreements are not subject to registration. This discrepancy has been the subject of academic criticism, yet as at the time of writing no such requirement is imposed.
The Law Commission of England and Wales initially was supportive of registering title-retention agreements. The main argument in favour of the registration was that “it may be difficult for other creditors or buyers dealing with a company to find out which goods on a company’s premises belong to it, and which still belong to the supplier under a conditional sale, hire-purchase agreement or finance lease”. The Commission even suggested that operating leases of over 1 year, which do not have a security purpose, should be registered in order to enhance the transparency of transactions over assets. Yet, the Commission in its final recommendations backed down from their initial proposal following the lukewarm reception of the suggestion by financiers and practitioners who expressed concerns about the complexity of introducing such a scheme.
The irony of this (non) development is that English law is left with an uncertain system. The requirement to register (or not) the relevant interest depends on the characterisation of the agreement in question. Most structures will be taken at face value. Yet, English courts tend to take a good look into sophisticated structures of sale and lease/buy-back agreements or retention of title clauses of goods (e.g. proceeds of sale clauses or product clauses). Their main concern is to check whether the structure in question contains the incidents of security, the most important of which are: (i) the debtor’s right to redeem the asset in question when the obligation is discharged (equity of redemption); (ii) accounting any profit achieved by the creditor upon realising the asset in question to the debtor; and (iii) not discharging the liability of the debtor for any shortfall upon the realisation of the asset in ques- tion. When they are convinced that this is the case, English courts will recharacterise them as security interests which are subject to registration. By re-characterising them, courts in essence devoid them of any meaning, since the deadline for registration of the re-characterised security interests (21 days from the day of its creation) most probably would have passed.
In that respect, English law has a circular structure: it retains the formal division between security interests and “quasi-security” interests and it treats them differently with respect to registration. Yet, at the same time it looks into the substance of the agreement to decide its proper characterisation and consequently whether it shall be registered or not.
As such, English law falls into the category of States which treat conditional sellers and lessors of aircraft as full owners (subject to the qualifications referred to in the previous paragraph). For the purposes of Art. 2(2) of the Convention, English law differentiates among interests granted by the chargor under a security agreement [Art. 2(2)(a)], interests vested in a person who is a conditional seller under a title reservation agreement [Art. 2(2)(b)] and interests vested in a person who is the lessor under the leasing agreement [Art. 2(2)(c)].
In the first category, English law classifies mortgages or charges over an aircraft to secure a loan. In the second category, English law classifies hire-purchase agreements, conditional sales agreements and finance leases. In broad terms, in all three structures, the owner/seller/lessor retains title over the aircraft. What differentiates the first two structures is that in hire-purchases the hirer has the option to purchase the aircraft upon payment of the price, whereas in conditional sales the buyer is bound to purchase it upon payment of the price. Finance leases usually entail the leasing out of the aircraft for the entirety of its life to the lessee. The lessor retains nominal ownership with the lessee being the de facto owner and enjoying “substantially all the risks and rewards associated with the ownership of the asset”. Finance leases can take many forms with varied provisions on the rights of the lessee to create property rights on the leased aircraft or the fate of any residual value of the aircraft. For the purposes of our discussion, their legal classification depends on the availability of the option to purchase the aircraft: (i) if the lease contains no such option/obligation, it will qualify as a contract of hire; (ii) if it contains an option to purchase the aircraft, it will qualify as a hire-purchase; and (iii) if it contains an obligation to purchase the aircraft, it will qualify as a conditional sale.
In the third category, English law includes operational leases of aircraft. These do not have a security or a “quasi-security” function, since they transfer possessory rights (as distinguished from proprietary rights) over the aircraft for a portion of its life. The implications of this feature of operating leases were recently explained by Hamblen J.:
...[the lessor] retains a very real interest in the Aircraft themselves, including their proper maintenance, the extent of their use, their condition, and their rental and resale value. Possession of the Aircraft will revert to it at a time when the bulk of their economic life is still to run.. .[The lessor] therefore retains many of the risks and rewards of ownership.
In that respect, the rental is calculated on the basis of “the prevailing supply and demand for aircraft of this type” rather than on “recouping the cost of the Aircraft together with interest and profit” as is the case with finance leases.
Under English law it is only the interests that fall into the first category of Art. 2(2) of the Cape Town Convention that require registration. Conditional sales, hire- purchases, finance leases and operating leases of aircraft are not subject to any compulsory or voluntary registration regime, unless they are judicially re-characterised as security instruments. The implementation of the Cape Town Convention into English law by virtue of The International Interests in Aircraft Equipment (Cape Town Convention) Regulations 2015 increases its transparency, since all said interests are subject to registration in the International Registry. Furthermore, it provides for the “back-door” realisation of the initial proposals of the Law Commission on the registration of “quasi-security” interests and operating leases, albeit in the limited context of aircraft finance.
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