Published date01 December 1993
Date01 December 1993
Citation(1993) 5 SAcLJ 170

THE onset of corporate insolvency proceedings often brings along unforeseen and unwanted consequences to creditors of a company. In particular, creditors who are unsecured frequently discover that they are only able to recover a small fraction of the debts owing to them by the insolvent company. Accordingly, creditors who wish to insulate themselves from the consequences of a debtor company’s insolvency bargain for security whenever possible.

In Bristol Airport Plc v. Powdrill2 Browne-Wilkinson V.-C. accepted the following statement as an adequate description of a security interest:

“Security is created where a person (‘the creditor’) to whom an obligation is owed by another (‘the debtor’) by statute or contract, in addition to the personal promise of the debtor to discharge the obligation, obtains rights exercisable against some property in which the debtor has an interest in order to enforce the discharge of the debtor’s obligation to the creditor.”3

This description brings out the most important aspect of a security interest. It gives the creditor a proprietary interest in an asset belonging to another (‘the debtor’). This can be contrasted with the unsecured creditor who only has a personal claim against the debtor and has no right to proceed against any asset of the debtor.

This distinction between a proprietary interest in an asset of the debtor and a personal claim against the debtor gives rise to several important consequences.4 First, because the unsecured creditor has no interest in the property of the debtor, he cannot in general complain about the way the debtor deals with his assets.5 Thus even if a charge is unregistered, it is still valid as against unsecured creditors.6 It is only where the liquidator is appointed that such a charge is effectively void against all creditors because

the liquidator takes over the management of the company and gets in the assets of the company for the benefit of the general body of creditors.7 Although this is somewhat anomalous, it is illustrative of the wider principle that where a company is insolvent, its creditors are the ones properly regarded as having an interest in its property.8

Second, by virtue of his proprietary interest in the encumbered asset, the secured creditor has the right to resort to the asset to satisfy his claim. This right is a major exception to the pari passu principle of distribution which the collective insolvency procedure imposes upon creditors. Its primary effect is to confer priority on the secured creditor over the claims of unsecured creditors in the event of default by the debtor of its obligations.

Third, the right to the encumbered asset also extends to what it has become substituted for. The task of the court in such circumstances is to identify the new thing into which the original security survives. Therefore, provided the proceeds or products of the asset are sufficiently identifiable, the secured creditor can trace the original security to such proceeds or products into the hands of any third party.9

Although there is some debate on the matter, it is generally assumed that English and Singapore law only recognise 4 types of consensual security, namely the mortgage, charge, pledge and contractual lien.10 There are also non-consensual security interests, e.g. various types of liens which arise by operation of law.


Because the insolvency of a debtor is always a possibility, a creditor should always aim to obtain security. However, there may be occasions when this is not a viable option and the creditor has nonetheless decided to take the commercial risk of lending money or providing credit on an unsecured basis.12

There are many reasons why the provision of security may not be possible. The debtor may not have any unencumbered assets which can be granted as security. Alternatively, the debtor may be unwilling to grant security. Or it may simply be that the debtor has entered into a negative pledge covenant which prohibits him from granting security to a third party. We see an example of this in the case of Thai Chee Ken & Ors. (Liquidators of Pan-Electric Industries Ltd.) v. Banque Paribas.13 In that case Pan Electric Industries Ltd. (“Pan-El”) agreed to purchase certain shares. Not having the funds to complete the purchase, Pan-El requested Banque Paribas to grant it a loan facility. The security was to be a pledge of the shares. The loan was approved. Subsequently, the financial controller of Pan-El informed Banque Paribas that because of a negative pledge covenant given to other banks, Pan-El did not wish to take the loan but would instead raise the funds by way of a sale and repurchase of the shares in question. This involved selling the shares to Banque Paribas and agreeing to repurchase it at an agreed date, the repurchase price factoring in the interest income and other sums payable to Banque Paribas if the transaction had been a loan. The liquidators argued that the label of a sale and repurchase did not accurately reflect the true nature of the transaction and that in reality it was a loan agreement secured by an unregistered charge over the shares.14 His Honour Justice Lai Kew Chai rejected the argument.

Although such creditors do not have security, it is possible for them to mitigate their exposure to the debtor’s insolvency by bargaining for certain remedies or devices which have the effect of placing them in a superior position compared to other unsecured creditors in the event of the debtor company’s insolvent liquidation. These remedies do not amount to security interests because they do not vest the creditor with any proprietary interest in the debtor’s assets. The creditor does not, by virtue of these remedies, obtain any mortgage, charge, pledge, or lien over the debtor’s assets. However, insofar as they are capable of insulating certain creditors from the full effects of their debtor’s insolvency, they “behave”15 like, or have some of the effects of, security interests. Hence in this paper they are referred to as “quasi-security interests”.

While these remedies arise from an underlying contractual relationship between the debtor and creditor, it is possible to outline two broad categories of quasi-security interests. The first category arises where ownership of property remains with the provider (or where it doesn’t, does not pass to the debtor) to secure the performance of the debtor’s obligations e.g. retention of title clauses, hire-purchase, and the Quistclose trust. Property does not pass to the debtor and so never becomes part of the debtor’s assets available

for distribution to creditors upon the debtor’s insolvency. The second category arises where the debtor and unsecured creditor enter into an arrangement giving the latter certain self-help remedies which have the effect of providing him with some measure of protection in the event of the debtor’s insolvency, e.g. flawed asset arrangements, contractual set-off and the negative pledge. No security interests are created, however, because these arrangements only give rise to purely personal rights exercisable by virtue of contract.16

This paper will focus on the negative pledge clause and the Quistclose trust in the context of a loan agreement. Brief mention of flawed asset arrangements and set-off agreements will, however, be useful.


A flawed asset arrangement is one where A deposits money with a bank, B, on terms which restrict A’s right to withdraw the sums on deposit. Usually, the right to withdraw is made conditional upon a third party, C, discharging its obligation to B. Such deposits are known as flawed assets, the conditional right to repayment being regarded as a “flaw”. In most cases, A would have entered into the arrangement as part of an agreement for B to advance money to C. C would usually be a subsidiary or associate company. Thus B may stipulate that sums deposited by A with it shall not be repayable until money due from C is fully paid, or shall only be repayable to the extent that the debt from C is paid. Alternatively, at the request of A, B may have given a letter of credit or a performance bond to a third party and wishes to make A’s contingent liability to reimburse B more assured. A therefore deposits money with B and agrees that the money shall not be repayable until A has paid its indemnity to the bank.

There may be several reasons why a flawed asset arrangement is entered into. First, a charge-back of the deposit with B back to B may not be possible on the authority of Re Charge Card Services Ltd.18 Second, even if such a charge is possible, A may have entered into a negative pledge clause which it is not prepared to breach. Since the flawed asset arrangement is not a security interest, it may not contravene the terms of the negative pledge.19

However, there are at least two potential problems with flawed asset arrangements. First, there is a danger that a flawed asset arrangement may

be regarded as a charge.20 This is because A’s right to recover his deposit is dependent on the payment of another debt. Such an arrangement resembles a charge in that the chargor can get his asset back from the chargee only when the secured debt is paid. It has been said (correctly), however, that this is to confuse rights in the asset of another, which is the essence of a charge, and the conditional right to repayment of a debt.21 A flawed asset arrangement is not a charge because the bank obtains no interest in the deposit; all the bank obtains is a right to withhold payment until obligations to the bank are discharged. Still, even though a flawed asset arrangement does not give rise to a security interest, the mere ability to withhold payment of the deposit provides B with a measure of protection. The “security” function of the arrangement will also be enhanced if B is given extensive rights of set-off against the deposit.22...

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