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Security assignments - not always what they say they are?

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 another 1  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 Plus 2  , 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".

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Bulletins | January 30, 2018

Assignment by way of security – beware of giving away more than you bargained for.

Construction

Assignment by way of security is a concept that comes up on many construction projects; typically as a condition of providing finance a funder will require an assignment by way of security of key construction documents, including building contracts and appointments, with the intention that if the borrower defaults on the loan, the assignment will be perfected and the funder will be entitled to enforce its rights under the constructions documents. How and when exactly such assignment takes place and the interplay with an employer’s rights under its contracts on a project was brought into focus in last year’s case of Mailbox (Birmingham) Limited v Galliford Try Construction Limited ([2017] EWHC 67 (TCC)).

Mailbox (Birmingham) Limited (“Mailbox”), the claimant special purpose vehicle set up to develop the Mailbox in Birmingham (“the Property”), a high-end mixed used development, boasting a Harvey Nichols and the base for BBC Birmingham, engaged Galliford Try Construction Limited (“Galliford”) for refurbishment works at the Property under a building contract dated 23 December 2013. A dispute arose between the parties regarding responsibility for delay, the final account, liquidated damages and Mailbox’s termination which was referred to adjudication, where Galliford were ordered to pay Mailbox £2,477,152.86 plus 75% of the adjudicator’s costs. Galliford did not pay the sums ordered, so Mailbox sought enforcement of the adjudicator’s decision in the High Court.

Did Mailbox have a right to bring an adjudication?

Galliford’s primary defence to the enforcement was that Mailbox had no right to bring the claim, as it had assigned the benefit of the building contract with Galliford to Aareal Bank AG Wiesbaden (“Aareal”) in accordance with the requirements of a debenture dated 10 May 2011. Mailbox raised three defences:

• The building contract was not in existence at the time of the assignment referred to in the debenture. Therefore there could be no assignment;
• Alternatively, any assignment was by way of charge rather than a legal assignment; or
• The contract had been re-assigned from Aareal to Mailbox before Mailbox commenced adjudication proceedings.

Mailbox failed on the first two defences, but won on the third so was able to enforce the adjudicator’s award. However, it was the analysis of the first and second defences and Mrs Justice O’Farrell’s review of the requirements for legal assignment under Section 138 of the Law of Property Act 1925 that are of particular note.

It was held that the wording of the debenture covered future contracts, including the building contract in question. The wording “each chargor with full title guarantee assigns absolutely by way of security in favour of the security trustee” amounted to a full legal assignment rather than an assignment by way of charge and/or a conditional assignment. Further, there was a requirement for notice of the assignment to be served and specific reference to rights being re-assigned, both of which were more akin to an absolute assignment. Express notice was given to Galliford, again consistent with an absolute assignment.  Thankfully for Mailbox, on the day it commenced the adjudication, Aareal had re-assigned the rights under the building contract to Mailbox. If it had not done so, or done so after the adjudication had been commenced, Mailbox would not have been entitled to commence the adjudication.

Practical Tips

When obtaining finance for a project it is crucial to understand what the funder really requires in relation to security over construction documents. If all rights are assigned, the employer no longer has the ability to enforce such rights and may have given away more than he bargained for.

It may be that the use of collateral warranties or third party rights together with a charge will suffice but if not (which is unfortunately still the common position), it is important that any such rights are re-assigned before the employer commences an adjudication or any other proceedings.

Related Content

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Assignment (by way of security) definition

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What Is an Assignment & Security Agreement?

by Brian Bass

Published on 26 Sep 2017

An assignment and security agreement is a contract that deals with the legal transfer of rights of ownership. Both an assignment and a security agreement are individual components of contract law. While an assignment and a security agreement can overlap, you should generally consider both of these legal concepts separate legal agreements.

Security Agreement

A security agreement is a part of contract law that covers financial transactions. These transactions, also known as secured transactions, involve a grantor promising collateral to a grantee. The security agreement in contract law does not cover actual land or real estate. Rather, a security agreement typically covers a vehicle, stock, livestock or some other form of personal property. In a security agreement, if the grantee already possesses the collateral, the grantor may secure the transaction verbally. However, a written security agreement is always preferable to a verbal security agreement in case of a disagreement between parties.

Assignment is part of common law that deals with transferring rights from one individual or party to another. The assignment agreement usually shows up in real estate dealings but can also exist in other contexts as well. However, an assignment is only the contractual transfer of benefits that have accrued or will accrue. With an assignment, the obligations do not transfer alongside the benefits. The obligations will always remain with the assignor. As with a security agreement, a verbal assignment while legally binding, does not provide either party with the legal protections of a written assignment agreement.

What the Agreements Cover

Both types of agreements, or one agreement including both an assignment and a security agreement, can apply to a range of property rights. For example, these agreements could cover the transfer of the rights to stock investments or the promise to use the stocks as collateral. It is also possible for these agreements to cover less tangible types of property. For example, these agreements could apply to creative rights, such as written works or a film production. In the case of creative rights, the benefits typically include future revenues earned from the sale or distribution of said works.

Drafting an Agreement

Although the parties involved may agree on each type of contract verbally, a written contract is always preferred. You can hire an attorney to draft a legal assignment and security agreement for you. However, there are also less expensive services that you can use to assist you in drafting your own contracts. For example, you can purchase software that uses a template to generate assignment and security agreements, or you could purchase a book or generic contract forms at your local bookstore. Unless you have specific legal knowledge about assignments and security agreements, however, you should always consult with an attorney before using any self-generated contract forms. Both assignment and security agreements are complex areas of contract law.

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Assignments and Security Interests Under UCC Article 9: A Worthy Decision

The March 2020 Commentary and its accompanying amendments to the Official Comments are critical steps in getting the commercial finance industry and, more importantly, courts aligned on how 9-406 and 9-607 work in concert.

December 16, 2022 at 10:30 AM

11 minute read

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The basic definitions of Article 9 align with this approach of applying to both an assignment of payment rights and a security interest in such assets. “[S]ecurity interest” in UCC Article 1, §1-201(b)(35) (General Definitions), includes “any interest of a … buyer of accounts, chattel paper, a payment intangible or a promissory note in a transaction that is subject to Article 9.” The definition of “secured party” in Article 9, §9-102(a)(73) (Definitions and Index of Definitions), includes a “person in whose favor a security interest is created or provided for under a security agreement,” as well as a “person to which accounts, chattel paper, payment intangibles or promissory notes have been sold.” Finally, the definition of “debtor” in Article 9, §9-102(a)(28), includes both a “person having an interest, other than a security interest or other lien, in the collateral” and a “seller of accounts, chattel paper, payment intangibles or promissory notes.”

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Assignment of Lease: How It Works and Parties Involved

Jump to section, what is an assignment of lease.

The assignment of lease is a title document that transfers all rights possessed by a lessee or tenant to a property to another party. The assignee takes the assignor’s place in the landlord-tenant relationship.

You can view an example of a lease assignment here .

How Lease Assignment Works

In cases where a tenant wants to or needs to get out of their lease before it expires, lease assignment provides a legal option to assign or transfer rights of the lease to someone else. For instance, if in a commercial lease a business leases a place for 12 months but the business moves or shuts down after 10 months, the person can transfer the lease to someone else through an assignment of the lease. In this case, they will not have to pay rent for the last two months as the new assigned tenant will be responsible for that.

However, before the original tenant can be released of any responsibilities associated with the lease, other requirements need to be satisfied. The landlord needs to consent to the lease transfer through a “License to Assign” document. It is crucial to complete this document before moving on to the assignment of lease as the landlord may refuse to approve the assignment.

Difference Between Assignment of Lease and Subletting

A transfer of the remaining interest in a lease, also known as assignment, is possible when implied rights to assign exist. Some leases do not allow assignment or sharing of possessions or property under a lease. An assignment ensures the complete transfer of the rights to the property from one tenant to another.

The assignor is no longer responsible for rent or utilities and other costs that they might have had under the lease. Here, the assignee becomes the tenant and takes over all responsibilities such as rent. However, unless the assignee is released of all liabilities by the landlord, they remain responsible if the new tenant defaults.

A sublease is a new lease agreement between the tenant (or the sublessor) and a third-party (or the sublessee) for a portion of the lease. The original lease agreement between the landlord and the sublessor (or original tenant) still remains in place. The original tenant still remains responsible for all duties set under the lease.

Here are some key differences between subletting and assigning a lease:

• Under a sublease, the original lease agreement still remains in place.
• The original tenant retains all responsibilities under a sublease agreement.
• A sublease can be for less than all of the property, such as for a room, general area, portion of the leased premises, etc.
• Subleasing can be for a portion of the lease term. For instance, a tenant can sublease the property for a month and then retain it after the third-party completes their month-long sublet.
• Since the sublease agreement is between the tenant and the third-party, rent is often negotiable, based on the term of the sublease and other circumstances.
• The third-party in a sublease agreement does not have a direct relationship with the landlord.
• The subtenant will need to seek consent of both the tenant and the landlord to make any repairs or changes to the property during their sublease.

Here is more on an assignment of lease here .

Parties Involved in Lease Assignment

There are three parties involved in a lease assignment – the landlord or owner of the property, the assignor and the assignee. The original lease agreement is between the landlord and the tenant, or the assignor. The lease agreement outlines the duties and responsibilities of both parties when it comes to renting the property. Now, when the tenant decides to assign the lease to a third-party, the third-party is known as the assignee. The assignee takes on the responsibilities laid under the original lease agreement between the assignor and the landlord. The landlord must consent to the assignment of the lease prior to the assignment.

For example, Jake is renting a commercial property for his business from Paul for two years beginning January 2013 up until January 2015. In January 2014, Jake suffers a financial crisis and has to close down his business to move to a different city. Jake doesn’t want to continue paying rent on the property as he will not be using it for a year left of the lease. Jake’s friend, John would soon be turning his digital business into a brick-and-mortar store. John has been looking for a space to kick start his venture. Jake can assign his space for the rest of the lease term to John through an assignment of lease. Jake will need to seek the approval of his landlord and then begin the assignment process. Here, Jake will be the assignor who transfers all his lease related duties and responsibilities to John, who will be the assignee.

You can read more on lease agreements here .

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Assignment of Lease From Seller to Buyer

In case of a residential property, a landlord can assign his leases to the new buyer of the building. The landlord will assign the right to collect rent to the buyer. This will allow the buyer to collect any and all rent from existing tenants in that property. This assignment can also include the assignment of security deposits, if the parties agree to it. This type of assignment provides protection to the buyer so they can collect rent on the property.

The assignment of a lease from the seller to a buyer also requires that all tenants are made aware of the sale of the property. The buyer-seller should give proper notice to the tenants along with a notice of assignment of lease signed by both the buyer and the seller. Tenants should also be informed about the contact information of the new landlord and the payment methods to be used to pay rent to the new landlord.

You can read more on buyer-seller lease assignments here .

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Matt practices law in the areas of commercial finance, contract law, business & corporate law, and residential and commercial real estate (with a particular emphasis on retail shopping centers and office buildings). He has extensive experience in negotiating and structuring complex commercial loan, asset acquisition, asset disposition, leasing and real estate transactions. Matt additionally works on various general matters for clients such as forming LLCs and corporations, preparing various LLC and corporation documents and drafting and reviewing various types of contracts and agreements for clients and providing advice regarding same. Matt provides clients with extensive and timely communication on their matters and ensures that his clients are well represented and highly satisfied with their legal representation and the work product provided. Matt offers all potential clients a free initial consultation to discuss their legal matters prior to engaging his firm to represent them. Prior to opening his law firm Matt worked for many years in the New York City office of a large international law firm where he counseled large multi-national businesses, financial institutions, investment groups and individuals on highly sophisticated business, financial and real estate transactions. Matt provides his clients with diligent legal representation on their matters with a very personal approach.

With over 15 years of legal experience, I was admitted to the bar in 2008 and have since cultivated a diverse legal background. My expertise spans family law, estate planning, healthcare regulatory matters, and business law. I have a particular knack for crafting meticulous contracts. My approach is client-centric, ensuring that every individual receives personalized, knowledgeable guidance tailored to their unique situation. Partner with me, and let's navigate the complexities of the law together. www.downslawla.com

I am a business organization, IP and data privacy attorney with over 19 years of experience, as well as a Certified Information Privacy Professional. I have successfully worked in both the public and private sectors, contribute to academia in all of my areas of expertise, and hold leadership positions with key organizations in the legal industry. Some sample agreements/documents with which I have drafting and negotiating expertise include: Business Formation Agreements Privacy Policies Information Security Policies and Documentation Master Services Agreements Joint Venture Agreements Non-Disclosure & Confidentiality Agreements Software Licensing Agreements Employment Contracts Distribution Agreements Equipment Lease Agreements All forms of Entertainment Legal Agreements M&A Due Diligence Checklists EDiscovery Protocols Legal Hold Documentation Outsourcing Agreements Real Estate Purchase & Sale Agreements Subcontracting Agreements Software Development Agreements for Mobile Apps IP Licensing and Royality Agreements Loan Agreements & Documentation Insurance Policy Reviews Employee Handbooks & Policies E-Commerce Terms & Conditions Sponsorship Agreements All forms of Digital Creator Agreements Subscription Agreements & Policies Agency Agreements Supply Chain & Logistics Agreements And more...

Copyright, trademark, and intellectual property contracts and licenses. General Business contracts. Practical and comprehensive advice and contract drafting in an efficient, no-nonsense manner. She routinely represents clients needing copyright, trademark, and intellectual property contracts and licenses in the book publishing industry, music publishing, and all aspects of art and entertainment. She has represented both sides of the table - creators and authors and corporations and businesses. After 40 years of experience she has seen most business models and structures and has worked with many general contracts in different industries.

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I’m planning on leasing land from a church. Putting a gym on the property. And leasing it back to the school.

Ok; first step is that you will need a leasing contract with the church. Ask them to prepare one for you so you would just need an attorney to review the agreement and that should cost less than if you had to be the party to pay a lawyer to draft it from scratch. You need to ensure that the purpose of the lease is clearly stated - that you plan to put a gym on the land so that there are no issues if the church leadership changes. Step 2 - you will need a lease agreement with the school that your leasing it do (hopefully one that is similar to the original one your received from the church). Again, please ensure that all the terms that you discuss and agree to are in the document; including length of time, price and how to resolve disputes if you have one. I hope this is helpful. If you would like me to assist you further, you can contact me on Contracts Counsel and we can discuss a fee for my services. Regards, Donya Ramsay (Gordon)

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Attaching and Perfecting a Security Interest Under the UCC

A security interest is a powerful tool to wield. learn the rules for how to attach and perfect a security interest under article 9 of the ucc to strengthen your rights..

If your business has taken out a loan , you might be familiar with a security interest. Many lenders require businesses, especially newer ones, to promise collateral to get a loan. This requirement allows the lender to take the collateral if the business doesn't make the required loan payments. When collateral is offered in exchange for something (like a loan), you've created a "secured transaction" where the lender has a security interest in the collateral.

Article 9 of the Uniform Commercial Code (UCC) provides rules for secured transactions, including how a security interest can attach and be perfected. Here we'll look at both attachment and perfection of security interests.

What Is a Secured Transaction?

A secured transaction is a loan or purchase that's secured by collateral. Collateral is anything the debtor agrees to give up if they can't make the required payments on the loan or purchase. Generally, a secured transaction involves:

• a borrower or buyer, technically known as the "debtor," and
• a lender or seller, technically known as the " creditor ," and more specifically known as the "secured party."

Common secured transactions include a bank loaning a business money so the business can buy inventory, or a company selling a business equipment on credit. In these transactions, you'd have the following roles:

• the business as the debtor, and
• the bank or the selling company as the creditor.

Most likely, the inventory or equipment will be at least part of the collateral. But the lender or selling company might require the business to offer something else as collateral.

Attachment of a security interest. Under the UCC, in order for a creditor to become a secured party—that is, a party with a legal right to take possession of the collateral if the debtor fails to pay—the creditor must take special steps (discussed below). These steps are known as "attachment of a security interest."

Perfecting a security interest. Moreover, in order for a secured party to more fully ensure its legal rights if other parties are asserting an interest in the same piece of collateral, the secured party must take additional steps (discussed later). These additional steps are known as "perfecting a security interest."

Attachment of a Security Interest in Collateral

A creditor has a security interest in collateral—and becomes a secured party—if and when a security interest "attaches." Under the UCC, a security interest generally doesn't attach unless three basic requirements are met:

• value is given for the security interest
• the debtor has rights in the collateral (or power to transfer the collateral to a secured party), and
• the debtor "authenticates" a security agreement.

Let's briefly look at each of these requirements.

Value is Given for the Security Interest

A secured transaction is a contract between the debtor and the secured party. Like most contracts, there must be an exchange of consideration between the parties. In other words, there must be an exchange of value.

In the case of secured transactions, the value given by the secured party is usually obvious. For example, a bank gives value to a debtor when it loans money to the debtor to buy inventory. Similarly, a seller gives value to a debtor when it sells the equipment to the debtor.

For the debtor's part, they give the secured party a security interest in the collateral.

Debtor Has Rights in the Collateral

A business might have rights in collateral either by:

• owning the collateral prior to the secured transaction, or
• purchasing the collateral as part of a secured transaction.

Owning the collateral prior to the transaction. When a business already owns certain property, it should be clear that the business has rights in that property, and can use it as collateral. For example, if the business uses its real estate as collateral, it should have a corresponding deed . If the business wants to use its vehicle as collateral, it should have a bill of sale and title to the vehicle.

Purchasing the collateral as part of the transaction. In other cases, a business will buy items (materials, inventory, machinery, and so on) on credit and want to use those same items as collateral. In such cases, the business will sign a conditional sales contract—which is also considered a security agreement. Under UCC sales rules, the contract will give the business the necessary rights in the purchased items to use as collateral. (Note: The alternative option of having the "power to transfer" the collateral often involves relatively unusual circumstances and isn't covered here.)

The Debtor Authenticates a Security Agreement

For purposes of attachment, the debtor must "authenticate" a security agreement. In other words, the debtor must sign the written agreement that gives the secured party an interest in the collateral. (The UCC uses the term "authenticate" to include the possibility of electronic signatures.)

A security agreement normally will contain a clear statement that the debtor is granting the secured party a security interest in specified goods. The agreement also must provide a description of the collateral. Section 9-108 of the UCC says that, generally, a description of collateral is acceptable if the description reasonably identifies the collateral.

The same section then goes on to provide a half-dozen different possibilities for a reasonable identification, such as:

• a "specific listing" (for example, the address or property description of a real estate parcel)
• a "category" (for instance, power tools), or
• a "quantity" (like 10 HVAC units).

(U.C.C. § 9-108(b).)

While the description of collateral in a security agreement might not need to be finely detailed, the UCC prohibits descriptions of collateral that are "supergeneric," such as "all the debtor's assets" or "all the debtor's personal property."

The three requirements to attach a security interest apply to the most common types of collateral, such as equipment, inventory, and even payments due under a contract. However, for certain less common types of collateral, the requirements relating to an authenticated security agreement can vary.

Perfecting a Security Interest

A secured party perfects a security interest to help assure that no other party—such as another creditor or a bankruptcy trustee—will be able to claim the same collateral if the debtor becomes insolvent . By perfecting its security interest, a secured party seeks to gain priority over other parties regarding the collateral.

The precise details of how to perfect a security interest depend in part on the local jurisdiction where the collateral is located. However, generally speaking, the primary ways for a secured party to perfect a security interest are:

• by filing a financing statement with the appropriate public office
• by possessing the collateral
• by "controlling" the collateral; or
• it's done automatically when the security interest attaches.

Of these four listed items, the first—filing a financing statement—is by far the most common and important to understand.

Filing a Financing Statement to Perfect the Security Interest

Security interests for most types of collateral are usually perfected by filing a document simply called a "financing statement." You'll usually file this form with the secretary of state or other public office. The purpose of the financing statement is to put other people on notice of the secured party's security interest in the collateral.

The UCC specifies what must be contained in a financing statement:

• the name of the debtor
• the name of the secured party, and
• an indication of the collateral.

Name of the debtor. Regarding the first of these items, it's important that the name of the debtor be sufficiently specific and accurate because financing statements are filed under the debtor's name. If the name on the statement is wrong, the statement will fail to provide adequate notice to others, and will not succeed in perfecting the security interest.

Section 9-503 of the UCC provides various, more specific rules about how to specifically identify the debtor on a financing statement. For example, if the debtor is a "registered organization"—which might mean a state-registered corporation or limited liability company —then the name on the financing statement must match the name the debtor registers with the state.

Name of the secured party. The second required item on the statement, the name of the secured party, is generally a straightforward matter. Since the secured party is completing the form, there's less chance of error. If the secured party is an individual, they should use their legal name. If they're a registered company, the secured party should use the same name they have registered with their state.

Indication of the collateral. Finally, as to the third item, the rules for indication of collateral on the financing statement are largely the same as for the description of collateral on a security agreement (see above). However, unlike with a security agreement, on a financing statement, it is acceptable to use a "supergeneric" description of the collateral.

A standard form, known as Form UCC-1, is widely used by secured parties to file a financing statement. You can easily find a sample UCC-1 online—usually on your secretary of state's website. While many financing statements must be filed with the secretary of state, you should check your own state's laws for more information.

As a final point, be aware that a financing statement can be, and sometimes is, filed before a security interest has attached. Creditors file early in anticipation of creating a security interest to make sure that the interest is perfected immediately upon attachment.

Possessing the Collateral to Perfect the Security Interest

As a secured party, you can perfect your security interest in some types of collateral by possessing it. The types of collateral where the security interest can be perfected by possession are:

• negotiable instruments (such as promissory notes and checks)
• tangible chattel paper .

However, so-called "intangible" collateral, such as accounts receivable, can't be perfected by possession. Possessing intangible collateral doesn't usually equate to possessing anything of value or that can be redeemed.

While "possession" isn't directly defined by the UCC in this context, it does appear to include possession not only by the secured party but also by an agent of the secured party.

Controlling the Collateral to Perfect the Security Interest

Under the UCC, a secured party can perfect their security interest in certain collateral by controlling that collateral. The types of collateral that can be perfected by control include:

• investment property
• deposit accounts
• letter-of-credit rights, and
• electronic chattel paper.

The meaning of "control" can vary depending on which type of collateral is involved. For example, a secured party might have control of a deposit account if the bank, the debtor, and the secured party have all agreed that the secured party can handle the funds in that account "without further consent by the debtor." (U.C.C. § 9-104.)

As another example, a secured party has control over investment property, such as securities (shares of stock or the like), if the property is delivered to the secured party, and, if necessary, endorsed (signed) to the secured party.

Security Interest Perfects Automatically When It Attaches

The most important type of security interest that's perfected immediately upon attachment is what's known as a "purchase-money security interest (PMSI) in consumer goods."

A PMSI generally involves either:

• a debtor buying an item on credit from a seller where the seller will be the secured party; or
• a debtor using a loan from a bank directly to buy an item from a seller, where the bank will be the secured party.

When the debtor in one of these circumstances is buying consumer goods—goods to be used for personal or household purposes—the secured party (seller or bank) doesn't need to file a financing statement to perfect the security interest.

Not all security interests in PMSIs are automatically perfected. Note that, while it might not be necessary to file a financing statement, not all security interests in PMSIs in consumer goods are perfected upon attachment. For example, some laws about certificates of title (such as for cars) require that a security interest be indicated on the certificate in order for the interest to be perfected.

Automatic perfection applies to other collateral. Finally, be aware that under the UCC, perfection occurs automatically upon attachment for about a dozen other relatively unusual types of collateral. For more information, check UCC Section 9-309 .

Having covered the main ways to perfect a security interest, it's important to note that there could be situations where a secured party with a perfected security interest might not have priority. In that case, the secured party would have their interest subordinated (or come second) to some other party. However, in most cases, perfecting a security interest provides very substantial protection of that interest.

Attaching and Perfecting a Security Interest: FAQ

The world of secured transactions is a complex one. With so much terminology to learn and relationships to understand, it can be hard to keep everything straight. You can refer to our frequently asked questions for quick answers to common questions.

Is a security interest the same as a lien?

Yes and no. A security interest is a type of lien . A lien is a creditor's legal claim to a debtor's property. Liens can be voluntary or involuntary. A security interest is a voluntary lien. With a security interest, the debtor has agreed to give the creditor (or secured party) an interest in their collateral (their property). So the creditor has a lien against the collateral.

But a lien can be involuntary—and therefore, not a security interest. For example, if a business doesn't pay its federal taxes, the IRS can put a tax lien on the business's property without the business's consent. So, the IRS would have an interest in the business's property and the ability to act on this interest and take the property to satisfy the tax debt.

Liens and security interests are often used interchangeably. Usually, people refer to voluntary liens as security interests and involuntary liens—like judgments and tax liens—as liens. Also, liens are more commonly related to real property.

What are the two types of security interests?

Security interests can be possessory and non-possessory. A possessory security interest is one where the secured party has possession of the collateral; a non-possessory security interest is one where the debtor has possession of the collateral.

Non-possessory security interests are much more common because the debtor usually already owns and continues to possess the collateral or purchases and comes to possess the collateral during the secured transaction. Moreover, the debtor doesn't get much benefit if they don't possess the collateral—particularly if the collateral includes inventory, vehicles, equipment, and real estate.

What's the difference between a perfected and unperfected security interest?

A security interest that hasn't been perfected is an unperfected security interest. A secured party has an unperfected security interest when they haven't satisfied one of the ways to perfect their security interest—including filing a financing statement, possessing or controlling the collateral, or qualifying for automatic perfection.

A perfected security interest is preferred to an unperfected security interest because perfecting a security interest gives the secured party more protection, namely, priority over other creditors.

When there are multiple interests in the same piece of collateral (such as other creditors having a security interest in the collateral), a perfected security interest will give that secured party priority over the other creditors who have unperfected security interests. So, a secured party with a perfected security interest can claim the collateral over a secured party with an unperfected security interest.

Additional Guidance on UCC Article 9

All states have adopted Article 9 of the UCC. However, states might use different wording in their laws or follow different precedent when applying these rules. You should always check your own state's commercial code for the most accurate information.

However, these state laws can get pretty dense and confusing. If you need help interpreting specific laws or need guidance on your specific situation, consider talking to a business attorney. They can advise you on your rights in the collateral, draft a security agreement, and help you perfect your security interest.

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Out-Law Guide 4 min. read

Assignment and novation

19 Aug 2011, 4:40 pm

Assignment involves the transfer of an interest or benefit from one person to another. However the 'burden', or obligations, under a contract cannot be transferred.

Assignment in construction contracts

As noted above only the benefits of a contract can be assigned - not the burden. In the context of a building contract:

• the employer may assign its right to have the works constructed, and its right to sue the contractor in the event that the works are defective – but not its obligation to pay for the works;
• the contractor may assign its right to payment of the contract sum - but not its obligation to construct the works in accordance with the building contract or its obligation to meet any valid claims, for example for defects.

After assignment, the assignee is entitled to the benefit of the contract and to bring proceedings against the other contracting party to enforce its rights. The assignor still owes obligations to the other contracting party, and will remain liable to perform any part of the contract that still has to be fulfilled since the burden cannot be assigned. In practice, what usually happens is that the assignee takes over the performance of the contract with effect from assignment and the assignor will generally ask to be indemnified against any breach or failure to perform by the assignee.  The assignor will remain liable for any past liabilities incurred before the assignment.

In construction contracts, the issue of assignment often arises in looking at whether collateral warranties granted to parties outside of the main construction contract can be assigned.

Funders may require the developer to assign contractual rights against the contractor and the design team as security to the funder, as well as the benefit of performance bonds and parent company guarantees. The developer may assign such rights to the purchaser either during or after completion of the construction phase.

Contractual assignment provisions

Many contracts exclude or qualify the right to assignment, and the courts have confirmed that a clause which provides that a party to a contract may not assign the benefit of that contract without the consent of the other party is legally effective and will extend to all rights and benefits arising under the contract, including the right to any remedies. Other common qualifications on the right to assign include:

• a restriction on assignment without the consent of the other party, whether or not such consent is not to be unreasonably withheld or delayed;
• only one of the parties may assign;
• only certain rights may be assigned – for example, warranties and indemnities may be excluded;
• a limit on the number of assignments - as is almost always the case in respect of collateral warranties;
• a right to assign only to a named assignee or class of assignee.

Note that in some agreements where there is a prohibition on assignment, it is sometimes possible to find the reservation of specific rights to create a trust or establish security over the subject matter of the agreement instead.

Legal and equitable assignment

The Law of Property Act creates the ability to legally assign a debt or any other chose in action where the debtor, trustee or other relevant person is notified in writing. If the assignment complied with the formalities in the Act it is a legal assignment, otherwise it will be an equitable assignment.

Some transfers can only take effect as an equitable assignment, for example:

• an oral assignment;
• an assignment by way of charge;
• an assignment of only part of the chosen in action;
• an assignment of which notice has not been given to the debtor;
• an agreement to assign.

If the assignment is equitable rather than legal, the assignor cannot enforce the assigned property in its own name and to do so must join the assignee in any action. This is designed to protect the debtor from later proceedings brought by the assignor or another assignee from enforcing the action without notice of the earlier assignment.

Security assignments

Using assignment as a way of taking security requires special care, as follows:

• if the assignment is by way of charge, the assignor retains the right to sue for any loss it suffers caused by a breach of the other contract party;
• if there is an outright assignment coupled with an entitlement to a re-assignment back once the secured obligation has been performed, it is an assignment by way of legal mortgage.

Please see our separate Out-Law guide for more information on types of security.

Restrictions on assignment

There are restrictions on the assignment of certain types of interest on public policy grounds, as follows:

• certain personal contracts – for example, a contract for the employment of a personal servant or for the benefit of a motor insurance policy cannot be assigned;
• a bare cause of action or 'right to sue' where the assignee has no commercial interest in the subject matter of the underlying transaction cannot be assigned;
• certain rights conferred by statute – for example, a liquidator's powers to bring wrongful trading proceedings against a director – cannot be assigned;
• an assignment of a contract may not necessarily transfer the benefit of an arbitration agreement contained in the contract;
• the assignment of certain rights is regulated – for example, the assignment of company shares or copyright.

If you want to transfer the burden of a contract as well as the benefits under it, you have to novate. Like assignment, novation transfers the benefits under a contract but unlike assignment, novation transfers the burden under a contract as well.

In a novation the original contract is extinguished and is replaced by a new one in which a third party takes up rights and obligations which duplicate those of one of the original parties to the contract. Novation does not cancel past rights and obligations under the original contract, although the parties can agree to novate these as well.

Novation is only possible with the consent of the original contracting parties as well as the new party. Consideration (the 'price' paid, whether financial or otherwise, by the new party in return for the contract being novated to it) must be provided for this new contract unless the novation is documented in a deed signed by all three parties.

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Assignments: why you need to serve a notice of assignment

Catherine phillips.

PSL Principal Associate

It's the day of completion; security is taken, assignments are completed and funds move. Everyone breathes a sigh of relief. At this point, no-one wants to create unnecessary paperwork - not even the lawyers! Notices of assignment are, in some circumstances, optional. However, in other transactions they could be crucial to a lender's enforcement strategy. In the article below, we have given you the facts you need to consider when deciding whether or not you need to serve notice of assignment.

What issues are there with serving notice of assignment?

Assignments are useful tools for adding flexibility to banking transactions. They enable the transfer of one party's rights under a contract to a new party (for example, the right to receive an income stream or a debt) and allow security to be taken over intangible assets which might be unsuitable targets for a fixed charge. A lender's security net will often include assignments over contracts (such as insurance or material contracts), intellectual property rights, investments or receivables.

An assignment can be a legal assignment or an equitable assignment. If a legal assignment is required, the assignment must comply with a set of formalities set out in s136 of the Law of Property Act 1925, which include the requirement to give notice to the contract counterparty.

The main difference between legal and equitable assignments (other than the formalities required to create them) is that with a legal assignment, the assignee can usually bring an action against the contract counterparty in its own name following assignment. However, with an equitable assignment, the assignee will usually be required to join in proceedings with the assignor (unless the assignee has been granted specific powers to circumvent that). That may be problematic if the assignor is no longer available or interested in participating.

Why should we serve a notice of assignment?

The legal status of the assignment may affect the credit scoring that can be given to a particular class of assets. It may also affect a lender's ability to effect part of its exit strategy if that strategy requires the lender to be able to deal directly with the contract counterparty.

The case of General Nutrition Investment Company (GNIC) v Holland and Barrett International Ltd and another (H&B) provides an example of an equitable assignee being unable to deal directly with a contract counterparty as a result of a failure to provide a notice of assignment.

The case concerned the assignment of a trade mark licence to GNIC . The other party to the licence agreement was H&B. H&B had not received notice of the assignment. GNIC tried to terminate the licence agreement for breach by serving a notice of termination. H&B disputed the termination. By this point in time the original licensor had been dissolved and so was unable to assist.

At a hearing of preliminary issues, the High Court held that the notices of termination served by GNIC , as an equitable assignee, were invalid, because no notice of the assignment had been given to the licensee. Although only a High Court decision, this follows a Court of Appeal decision in the Warner Bros Records Inc v Rollgreen Ltd case, which was decided in the context of the attempt to exercise an option.

In both cases, an equitable assignee attempted to exercise a contractual right that would change the contractual relationship between the parties (i.e. by terminating the contractual relationship or exercising an option to extend the term of a licence). The judge in GNIC felt that "in each case, the counterparty (the recipient of the relevant notice) is entitled to see that the potential change in his contractual position is brought about by a person who is entitled, and whom he can see to be entitled, to bring about that change".

In a security context, this could hamper the ability of a lender to maximise the value of the secured assets but yet is a constraint that, in most transactions, could be easily avoided.

Why not serve notice?

Sometimes it's just not necessary or desirable. For example:

• If security is being taken over a large number of low value receivables or contracts, the time and cost involved in giving notice may be disproportionate to the additional value gained by obtaining a legal rather than an equitable assignment.
• If enforcement action were required, the equitable assignee typically has the option to join in the assignor to any proceedings (if it could not be waived by the court) and provision could be made in the assignment deed for the assignor to assist in such situations. Powers of attorney are also typically granted so that a lender can bring an action in the assignor's name.
• Enforcement is often not considered to be a significant issue given that the vast majority of assignees will never need to bring claims against the contract counterparty.

Care should however, be taken in all circumstances where the underlying contract contains a ban on assignment, as the contract counterparty would not have to recognise an assignment that is made in contravention of that ban. Furthermore, that contravention in itself may trigger termination and/or other rights in the assigned contract, that could affect the value of any underlying security.

What about acknowledgements of notices?

A simple acknowledgement of service of notice is simply evidence of the notice having been received. However, these documents often contain commitments or assurances by the contract counterparty which increase their value to the assignee.

Best practice for serving notice of assignment

Each transaction is different and the weighting given to each element of the security package will depend upon the nature of the debt and the borrower's business. The service of a notice of assignment may be a necessity or an optional extra. In each case, the question of whether to serve notice is best considered with your advisers at the start of a transaction to allow time for the lender's priorities to be highlighted to the borrowers and captured within the documents.

For further advice on serving notice of assignment please contact Kirsty Barnes or Catherine Phillips  from our Banking & Finance team.

NOT LEGAL ADVICE. Information made available on this website in any form is for information purposes only. It is not, and should not be taken as, legal advice. You should not rely on, or take or fail to take any action based upon this information. Never disregard professional legal advice or delay in seeking legal advice because of something you have read on this website. Gowling WLG professionals will be pleased to discuss resolutions to specific legal concerns you may have.

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Assignment of Rents – What, Why, and How?

Article by:

Madelaine prescott, esq., share this post:.

• November 29, 2023

These days, almost all commercial loans include an Assignment of Rents as part of the Deed of Trust or Mortgage. But what is an Assignment of Rents, why is this such an important tool, and how are they enforced?

An Assignment of Rents (“AOR”) is used to grant the lender on a transaction a security interest in existing and future leases, rents, issues, or profits generated by the secured property, including cash proceeds, in the event a borrower defaults on their loan. The lender can use the AOR to step in and directly collect rental payments made by the tenant. For an AOR to be effective, the lender’s interest must be perfected, which has a few fairly simple requirements. The AOR must be in writing, executed by the borrower, and recorded with the county where the property is located. Including an AOR in the recorded Deed of Trust or Mortgage is the easiest and most common way to ensure the AOR meets these requirements should it ever need to be utilized.

When a borrower defaults, lenders can take advantage of AORs as an alternative to foreclosure to recoup their investment. With a shorter timeline and significantly lower costs, it is certainly an attractive option for lenders looking to get defaulted borrowers back on track with payments, without the potential of having to take back a property and attempting to either manage it or sell it in hopes of getting your money back out of the property. AORs can be a quick and easy way for the lender to get profits generated by the property with the goal of bringing the borrower out of default. But lenders should carefully monitor how much is owed versus how much has been collected. If the AOR generates enough funds so that the borrower is no longer in default, the lender must stop collecting rents generated by the property.

Enforcement of an AOR can also incentivize borrowers to work with the lender to formulate a plan, as many borrowers rely on rental income to cover expenses related to the property or their businesses. Borrowers are generally more willing to come to the table and negotiate a mutual, amicable resolution with the lender in order to protect their own investment. A word of warning to lenders though: since rental income is frequently used to pay expenses on the property, such as the property manager, maintenance, taxes, and other expenses, the lender needs to ensure they do not unintentionally hurt the value of the property by letting these important expenses fall behind. This may hurt the lender’s investment as well, as the property value could suffer, liens could be placed on the property, or the property may fall into disrepair if not properly maintained. It is also important for lenders to be aware of the statutes surrounding the payment of these expenses when an AOR is being used, as some state’s statutes require the lender to pay certain property expenses out of the collected rents if requested by the borrower.

In addition to being shorter and cheaper than foreclosure, AORs can be much easier to enforce. In California, the enforcement of an AOR is governed by California Civil Code §2938. This statute specifies enforcement methods lenders can use and restrictions on use of these funds by the lender, among other things. Under CA Civil Code §2938(c), there are 4 ways to enforce an AOR:

• The appointment of a receiver;
• Obtaining possession of the rents, issues, profits;
• Delivery to tenant of a written demand for turnover of rents, issues, and profits in the correct form; or
• Delivery to assignor of a written demand for the rents, issues, or profits.

One or more of these methods can be used to enforce an AOR. First, a receiver can be appointed by the court, and granted specific powers related to the AOR such as managing the property and collecting rents. They can have additional powers though; it just depends on what the court orders. This is not the simplest or easiest option as it requires court involvement, but this is used to enforce an AOR, especially when borrowers or tenants are uncooperative. Next is obtaining possession of the rents, issues, profits, which is exactly as it seems; lenders can simply obtain actual possession of these and apply the funds to the loan under their AOR.

The third and fourth options each require delivery of a written demand to certain parties, directing them to pay rent to the lender instead of to the landlord. Once the demand is made, the tenant pays their rent directly to the lender, who then applies the funds to the defaulted loan. These are both great pre-litigation options, with advantages over the first two enforcement methods since actual possession can be difficult to obtain and courts move slowly with high costs to litigate. The written demands require a specific form to follow called the “Demand To Pay Rent to Party Other Than Landlord”, as found at CA Civil Code §2938(k). There are other notice requirements to be followed here, so it is essential to consult with an experienced attorney if you are considering either of these options. California Civil Code §2938 specifically provides that none of the four enforcement methods violate California’s One Action Rule nor the Anti-Deficiency Rule, so lenders can confidently enforce their AORs using the above methods with peace of mind that they are not violating other California laws.

Whether you are looking to originate a new loan, or you are facing a default by your borrower, understanding what an Assignment of Rents is and how it operates can be extremely beneficial. Enforcing an AOR can be an easier option than foreclosure and can help promote a good relationship with your borrower when handled correctly. If you have any questions about AORs, or need further details on how to enforce them, Geraci is here to help.

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