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 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...