The nature of security created under a security document does not always match its description in the document. Charlotte Drake explains how this recharacterisation risk can apply to security assignments.
Is an "absolute" security assignment legal or equitable?
Legal assignments – key requirements
Lenders commonly take security over "choses in action" (such as debts or rights under contracts) by way of assignment. An assignment involves the transfer of either legal ownership (legal assignment) or equitable ownership (equitable assignment).
Section 136 of the Law of Property Act 1925 dictates the formalities for taking a legal assignment. It requires that a legal assignment must (among other things):
- be in writing;
- be executed by the assignor;
- be "absolute";
- not be expressed to be "by way of charge" only; and
- be notified in writing to the person against whom the assignor could enforce the assigned rights (the third party).
Legal assignments by way of security
There has been much case law on what "absolute" means. An assignment will not be absolute if it is conditional, or of part of a debt. However, a security assignment can qualify (provided it is not "by way of charge"): the fact the assignor has an equity of redemption under a security assignment does not of itself prevent the assignment from being "absolute". Security assignments sometimes use the term "absolute" to make clear they are intended to be legal assignments. However, the terminology used is not decisive. An assignment will not be "absolute" unless the third party can then deal with the assignee alone in respect of the assigned rights. The assignee owes an obligation to the assignor to reassign the rights on discharge of the secured liability. But the third party can continue to deal with the assignee until it receives notice of that reassignment.
In practice, this usually presents a considerable stumbling block to taking security by way of a legal assignment. Security assignments often allow the assignor to continue to deal with the third party, which commercially suits assignor, assignee and third party alike. However, such an assignment will not be "absolute" and so will take effect in equity only, even if the security document claims to effect a legal assignment.
The recent case of Ardila Investments NV v. ENRC NV and another1 highlighted this. The judge accepted that the assignment clause in the document used "the words of a legal assignment". However, he pointed to other clauses in the assignment document which suggested the parties had intended it to take effect in equity rather than law. One of these clauses obliged the assignor to "pursue its rights" under the assigned contracts, which is clearly inconsistent with an absolute assignment.
Legal or equitable – does it matter?
Often not. A notified equitable assignment has as strong a priority against other interests in the assigned rights as a legal assignment.
One advantage of a legal assignment is that a legal assignee can sue the third party without the assignor's involvement. Received wisdom used to be that an equitable assignee could not sue alone and the assignor (as owner of the legal interest) must be joined in as party to proceedings (either as co-plaintiff if willing, or as co-defendant if not).
In Ardila the judge held that the assignment took effect in equity and that both assignor and assignee should join in the proceedings as co-claimants. As it happened, when the hearing took place, the assignor had been joined as co-claimant anyway. In other cases, an equitable assignee has been able to sue the third party alone. As a purely practical matter, even if the assignor does need to be joined into proceedings this is unlikely to be more than an inconvenience.
Could a security assignment be "floating" security?
Could there be another, more unpalatable, result of control remaining with the assignor following a security assignment? In Re Spectrum Plus2 , the House of Lords of course held that a charge over a debt will be floating, not fixed, if the security holder fails to exercise control over the debt proceeds. Is a security assignment of a debt or similar contractual right also at risk of being recharacterised in this way? This is far from a settled point, but these obiter comments from Lord Scott in Re Spectrum Plus (at paragraph 107) suggest so:
"Suppose, for example, a case where an express assignment of a specific debt by way of security were accompanied by a provision that reserved to the assignor the right, terminable by written notice from the assignee, to collect the debt and to use the proceeds for its (the assignor's) business purposes, ie, a right, terminable on notice, for the assignor to withdraw the proceeds of the debt from the security. This security would, in my opinion, be a floating security notwithstanding the express assignment."
There is some logic in this approach. If it were possible to "solve" Re Spectrum Plus by renaming all charges over debts as security assignments, the case would not have taken on the significance that it has. The risk of this type of recharacterisation is most obvious in a UK insolvency, where there is a clear distinction between the application of fixed and floating recoveries. In this context, at least, the "fixed/floating" distinction is likely to be more of a concern to a lender than whether its security assignment is "legal" rather than "equitable".
Common law and equity
There are four types of assignment:
A brief knowledge of English legal history is helpful in understanding the dichotomy between legal and equitable assignments. Legal rights derive from the common law of England which was conceived and developed during the period between the Norman Conquest and the fourteenth century. The common law was administered by the King's Justices on circuit through the three common law courts of King's Bench, Common Pleas and Exchequer. There were no courts of equity.
However, because of restrictions placed on the continued development of the common law, not least the baronial intimidation of the common law courts and their juries, plaintiffs in search of justice began to petition the King in Council for a resolution of their disputes pursuant to the King's inherent judicial powers. Eventually this practice led to the petitions being referred to the King's Chancellor who initially discharged this function in the name of the King but who subsequently established the Courts of Chancery as an independent tribunal from the King in Council.
The jurisdiction of the Courts of Chancery were based on the cannon law concept of ‘conscience’ and ultimately developed into the rules of equity. England therefore had two court systems, the Common Law Courts and the Courts of Chancery, each developing their own rules of law. This separation was abolished by statute in 1875, which replaced the old court structure with the present day structure of the Supreme Court of Judicature. Nevertheless the rules of equity remain distinct from the common law.
 Legal assignments of choses in action
The right to make a legal assignment is now governed by statute – section 136 of the Law of Property Act 1925. Sub-section 1 of section 136 provides:
'Any absolute assignment by writing under the hand of the assignor (not purporting to be by way of charge only) of any debt or other legal thing in action, of which express notice in writing has been given to the debtor, trustee or other person from whom the assignor would have been entitled to claim such debt or thing in action, is effectual in law (subject to equities having priority over the right of the assignee) to pass and transfer from the date of such notice:
- (a) the legal right to such debt or thing in action;
- (b) all legal and other remedies for the same; and
- (c) the power to give a good discharge for the same without the concurrence of the assignor.’
It will be apparent from the wording of the sub-section that certain legal formalities must be complied with if an assignment is to be an effective legal assignment. These formalities are:
- An absolute assignment in writing signed by the assignor;
- A debt or other legal thing in action; and
- Express notice in writing to the debtor.
An absolute assignment does not include the assignment of part of a debt of thing in action whether or not the part assigned is ascertained or unascertained.
In Walter and Sullivan Ltd v J Murphy & Sons Ltd, WS were plasteringsub-contractors who commenced legal proceedings against M for the sum of £1808 alleged to be due in respect of a sub-contract for plastering works. After the commencement of the proceedings, WS, who were indebted to a third party H & Co, notified M that M were 'to pay to H & Co the sum of £1558 17s 8d from monies owing by you to us.. the receipt of H & Co shall be good and sufficient discharge to you in respect of payment made hereunder'.
By a second document, H & Co agreed with WS that in consideration of the irrevocable authority given by them to M ‘we will pay over to you any monies which are paid to us by (the Defendants)... after your debt to us … has been fully repaid .’ The court held that the arrangement between WS and H & Co was an assignment of part of a debt and therefore did not satisfy the requirements of sub-section 1 of section 136 of the Act.
An assignment that purports to be by way of charge only is not an absolute assignment. This is a complex legal concept. Suffice it to say that the relevant test is to decide whether the assignment merely gives a right to the assignee to payment out of a particular fund by way of security rather than an unconditional transfer of the fund to the assignee. In the Walter and Sullivan case, as well as being an assignment of part of a debt the court also held that the assignment purported to be by way of charge.
By way of contrast, it was held in Tancred v Delagoa Bay Company that an assignment by way of mortgage was absolute because there was a condition for re-assignment on payment of the loan. It is the substance of the transaction and not the titles of documents that determines the nature of the assignment.
An assignment which is qualified by conditions cannot be a legal assignment. In Re Williams, Williams v Ball the assignor purported to transfer the benefit of a life insurance policy but made it conditional upon the assignee surviving the assignor. This was held to be a conditional assignment falling outside section 136 of the Act. The judicial reasoning behind the requirement for an absolute assignment is that the debtor should not be put in doubt or jeopardy by the arrangements between the assignor and the assignee as to whom he is to discharge his obligations. In the cases of Walter and Sullivan and Williams there were such doubts, but not in the case of Tancred where the re-assignment on repayment of the loan would have to be notified to the debtor.
To create a legal assignment there must be a written document signed by the assignor. Signature by an agent would not appear to be sufficient. Any form of wording may be used provided there is a clear intention to make an absolute assignment. The assignment may be a document passing between the assignor and the assignee, or a written demand from the assignor to the debtor that the debtor pays or discharges his obligations to the assignee.
In the latter case, in order to be an effective assignment rather than merely an authority to pay a third party, there must be evidence that the assignee consented to the arrangement between the assignor and the debtor (see Curran v Newpark Cinemas Ltd). Unlike an assignment, an authority to pay can be revoked prior to the actual payment.
A debt or other legal thing in action includes both legal choses and equitable choses. The purpose of section 136 of the Act, which replaced but substantially re-enacted section 25, sub-Section 6 of the Judicature Act 1873, was procedural and not intended to create new forms of choses or things in action.
To create a valid legal assignment, written notice of the assignment must be given to the debtor. No particular form of wording is required; indeed a document can constitute notice even though it was not intended to be a notice.
In Van Lynn Developments Ltd v Pelias Construction Co Ltd P's bank overdraft was paid off by Van Lynn in consideration of P assigning the debt to Van Lynn. The assignment was dated 26 June. By a letter dated 27 June, Van Lynn demanded payment from P. In their letter Van Lynn stated, incorrectly, that notice of the assignment had previously been given to P. The court held that a notice of assignment was still good notice to the debtor even though it did not refer to the date of the assignment.
Further, as regards Van Lynns letter dated 27 June, the incorrect statement as to a notice could be ignored as 'an inaccurate surplusage' and it was immaterial that the letter was not written with the intention that it should perform the function of giving notice under the Act. It is not necessary for the notice to the debtor to be given by the assignor or the assignee; it may be given by a third party. In Bateman v Hunt, a valid notice was given by the executor of a deceased sub-assignee. In Herkules Piling Ltd and Another v Tilbury Construction Ltd, purported notice to the debtor by way of disclosure of documents in legal proceedings in which the debtor was a party, was considered to be insufficient notice of a legal or equitable assignment.
Once there has been an assignment which complies with the formalities of section 136, there is a transfer to the assignee of the legal right to the chose in action and the assignee can give good discharge upon payment or satisfaction by the debtor. It follows that the assignor has no right to sue in respect of the chose in action unless of course there is a re-assignment to the assignor. The same rules apply to intermediate assignments, thus creating a potential problem where a tenantassigns to a sub-tenant part of the demised property.
An assignment within the statute does not require consideration, thus voluntary assignments are enforceable between the assignor and the assignee and between the assignee and the debtor.
 Equitable assignments
A failure to comply with the formalities of section 136 of the Act is not necessarily fatal to the transaction; a defective legal assignment may operate as an equitable assignment (see William Brandts Sons & Co v Dunlop Rubber Co). Indeed a defective legal assignment which takes effect as an equitable assignment may subsequently become a legal assignment if the defect is removed; for example, where an equitable assignee of a defective legal assignment subsequently serves written notice on the debtor to perfect the legal assignment.
There may be an equitable assignment of an equitable chose or an equitable assignment of a legal chose. No consideration is required for the assignment of an equitable chose provided that the assignor has, at the material time, done all that he can to perfect the gift (see Letts v Inland Revenue Commissioners). It is suggested that the better view is that the same rule applies to equitable assignments of legal choses although there are judicial dicta to the contrary.
An equitable assignment may be in writing or oral. Any words will suffice provided they are unambiguous. Referring to the form of an equitable assignment Lord Macnaghten in the William Brandts case stated:
'It may be addressed to the debtor. It may be couched in the language of commerce. It may be a courteous request. It may assume the form of mere permission. The language is immaterial if the meaning is plain. All that is necessary is that the debtor should be given to understand that the debt has been made over by the creditor to some third person.’
Lord Macnaghten's judgment in William Brandt referred to notice to the debtor. In law there may be a binding equitable assignment between assignor and assignee without notice to the debtor. However, as a matter of practice, notice to the debtor is very important for three reasons. Firstly, in the absence of notice the debtor is entitled to discharge his obligations to the assignor and not to the assignee, whereas if he has notice he does so at his own peril and he may well be required to discharge the obligation a second time to the assignee with no entitlement to recovery from the assignor (see Walter & Sullivan Ltd).
Secondly, the giving of notice to the debtor has an effect on prior equities (see below). Thirdly, the date of notice establishes the order of priority as between successive assignees (see Dearie v Hall). The notice may be written or oral and the wording of the notice may be informal, although casual conversations may not be sufficient notice (Re Croggon ex parte Carbis). Indeed in the case of Lloyd v Banks, the court held that a newspaper article was sufficient notice to the debtor.
An equitable assignment may operate by way of a charge only or be of part of the debt or chose (see Walter & Sullivan Ltd). Thus, where a developer wishes to dispose of the completed building to more than one purchaser or tenant, it is submitted that he will only be in a position to give each individual purchaser or tenant an equitable assignment of the benefits arising under the principal design and construction contracts.
If a legal assignment is required, then the draftsman of the principal contracts should take care to impose an obligation on the designers and contractors to provide a sufficient number of collateral warranties to satisfy the requirements of multi-occupation.
 Procedural differences between legal and equitable assignment
Substantively legal and equitable assignments (provided notice has been given to the debtor) are essentially the same. In the Herkules Piling case, it was considered that an arbitration clause in the FCEC form of sub-contract could be assigned by a legal assignment by reason of the wording of section 136 of the Law of Property Act 1925, which stipulated that all attendant remedies were transferred, but not by an equitable assignment as the arbitration clause conferred discrete rights and obligations between the original contracting parties. There are however important procedural differences.
A legal assignment within the Act transfers a legal right in the chose to the assignee. Consequently the assignee sues the debtor in his own name. If there is an equitable assignment of an equitable chose in action the assignment being absolute, then again the assignee is entitled to sue in his own name. However, if there is an equitable assignment of a legal chose in action or an equitable chose which is not absolute, for example a part of the debt, the assignor must be joined into the action either as claimant, if he co-operates, or as defendant if he does not.
If the assignor is not joined as a party, the assignee's action may well fail although it is important to stress that these requirements are procedural and are not substantive, therefore the courts have a discretion to dispense with joinder of the assignor if they are satisfied that there is no prospect of a further claim by the assignor (see The Aiolos). Also note that under the Civil Procedure Rules Part 19, the Supreme Court has a wide discretion to order that additional parties should be joined to an action.
 Prior equities
The effect of an assignment, whether it is a legal assignment or an equitable assignment, is to place the assignee in the shoes of the assignor in respect of the benefits (but not the burdens) arising under the original transaction with the debtor. Consequently the assignee cannot by the assignment obtain a more advantageous position vis-à-vis the original debtor than that which was occupied by the assignor. In Business Computers Ltd v Anglo African Leasing Ltd, Templeman J stated that:
'a debt which accrues due before notice of an assignment is received, whether or not it is payable before that date, or a debt which arises out of the same contract as that which gives rise to the assigned debt, or is closely connected with that contract, may be set off against the assignee.’
It is important to note that if the set-off arises independently from the original contract between the assignor and the debtor, then it cannot be set off against the assignee if the liability (as distinct from the actual payment) accrued after the date of receipt of a notice of assignment. The giving of notice of assignment is however irrelevant to claims by way of set-off or counterclaim that arise from the original contract or a contract which is closely connected to the original contract.
For example, A is the developer, B the architect appointed by A, C the first purchaser of the development from A and D the second purchaser from C. The contract between A and B provides for design works to be carried out by B and payment therefore to be made by A. B also enters into a collateral warranty undertaking to C that he will carry out his design works with reasonable skill and care. C assigns the benefit of the collateral warranty to D. A has not paid all of B's professional fees.
In the event that B is in breach of his collateral warranty, if D brings proceedings against B then B will be able to set off the amount of the unpaid fees against D's claims regardless of whether the entitlement to the fees arose after the date of D's notice of assignment to B. This is because the collateral warranty and the original contract between A and B are closely connected contracts.
In the above example the same right of set-off arises as between B and C if C were the ultimate purchaser who took an assignment of A's benefits under the original contract with C. In this latter example, the rights of set-off and counterclaim would arise from the same contract.
A counterclaim for unliquidated damages may be set off by the debtor against any claims brought by the assignee (see Phoenix Assurance Co Ltd v Earls Court Ltd).
The debtor's right to counterclaim against the assignee is limited to defending the claims brought by the assignee, the counterclaim being set off in extinction or diminution of the assignee's claims. It does not entitle the debtor to bring positive counterclaims against the assignee, i.e for sums in excess of the assignee's claims. This is because, as stated above, the assignee only takes the benefit and not the burden of the original contract.
 Intermediate assignees
It would appear that where there have been successive assignments the debtor is not entitled to set off against claims brought by the ultimate assignee, counterclaims which the debtor has against intermediate assignees (see The Raven).