Currently, a recognized component of an effective regime for security transactions (including pledges) is the existence of a security rights registry.
A security rights registry is an umbrella term for a registry containing information about the potential existence of an encumbrance in the form of a security right (including a pledge) over certain property. The entry of such information into the registry and its publication therein is a means by which security becomes effective against third parties.
The security rights registry is intended to ensure the publicity of securities created or that may be created over property. In this respect, the security rights registry system differs from a title registration system (e.g., a real estate rights registry, a registry of exclusive rights to intellectual property and means of individualization) in that it does not have a constitutive (title-confirming) nature.
The publicity of securities guarantees openness and clarity for market participants regarding the potential existence of security over property, which, in turn, is one of the factors in making a positive decision to enter into business relations with a particular person.
Effectiveness of Security Against Third Parties from the Moment it is Deemed Public Knowledge
Publicity (public nature) of a security right encumbering property is one of the necessary conditions for its effectiveness. By virtue of the principle of publicity, a security right encumbering property is effective against third parties only if it has become known to such third parties (has become "public").
Thus, the traditional method of ensuring the publicity of a pledge is the transfer of possession of the property to the pledgee. This explains, in particular, the until-recently existing (and still preserved in some legislations) requirement in various jurisdictions' laws to transfer the pledged asset into the possession of the pledgee for the pledge right to be valid. In this case, possession serves as a kind of signal to the public about the existence of relevant relations concerning the property.
Furthermore, with the emergence of title registries for a number of types of property (primarily real estate objects), as well as company registries, the publicity of an encumbrance is ensured by special notes in such registries.
However, these registries have very narrow application (due to being created for specific types of property) or limited use (because a third party cannot obtain the necessary information promptly enough). The limited list of property for which information on the existence (potential existence) of security can be obtained, and the insufficient accessibility of such information (including low speed of obtaining it based on an official request), do not meet the needs of modern commerce, whose volume and speed of transactions are constantly increasing.
In response to these demands, the security rights registry emerged (first in the US states, then in a more advanced form in Canadian provinces, and subsequently in many other countries), into which information on securities over all types of property is entered (except for those for which special registries exist that were not abolished after the creation of the security rights registry). A simplified procedure based on the concept of a financing statement (notice of security) is used for entering information into the security rights registry.
Notice, Not Confirmation of the Security Right
The security rights registry is based on the entry of information that constitutes a notice (to third parties) of the potential existence of security over property. This means that entering information into the security rights registry is not a condition for creating such a right between the parties to the security transaction (e.g., between the pledgor and the pledgee), nor does it have any significance for resolving the issue of validity or confirming the existence of the security right or other matters, except for determining the ranking (priority) of the rights of creditors whose claims are secured by a security right in the property (secured creditors) (see below).
This design of the security registry system is explained by its goal: to provide third parties with information about an encumbrance on property in the form of a security right that is effective against them (i.e., security against which they cannot raise a defense of "lack of knowledge" of its existence in the future). But the entry into the registry and the provision of this information should not be associated with the limitations and costs inherent in the mandatory registration of rights and encumbrances on property.
A title registration system (a system that registers security by analogy with property ownership rights) involves significant costs and expenses for the parties to the security transaction and for the state maintaining the title registration system, because (a) to register security in it, the parties must undergo a formal procedure of submission and review of transaction documents by an authorized body; (b) they must disclose the commercial terms of their arrangements. The need to register security by analogy with property title registration may be justified where registries for registering rights to property already exist or are being created (e.g., shareholder registries, securities holder registries), but is completely unjustified for all other property. In the latter case, neither the transaction parties nor the state are interested in creating a cumbersome title registry system for all property; it is sufficient to create a registry that allows establishing securities effective against third parties, while other entitlements (including the ownership rights of the person providing security) regarding the property can be established by the parties through negotiations between themselves.
The security rights registry does not and should not regulate the rights and obligations of the parties to the security transaction. This registry (a) notifies of the potential existence of security over property and (b) provides information on where more detailed information about such security can be obtained (the registry contains information about the grantor of the security and the person in whose favor the security is granted).
Determining the Ranking (Priority) of Secured Creditors' Rights
The entry of information about security into the security rights registry (provided the registry ensures its publicity to any person) is significant only for determining when the encumbrance of property is deemed to have become public for third parties, i.e., for determining the ranking (priority) of the rights of secured creditors.
For example, a pledgee in whose favor pledge information was entered into the security rights registry earlier (e.g., June 1, 2012, 10:00 AM) has priority over a pledgee in whose favor pledge information was entered later (e.g., June 1, 2012, 10:05 AM). This conclusion is not affected by when the pledge agreement was concluded with each pledgee (the so-called "first-to-file rule"). For instance, the first pledgee will have priority even if the second pledgee concluded a pledge agreement with the pledgor earlier than the first pledgee.
A higher priority of a secured creditor, including a pledgee, means that such secured creditor has a preferential right over other secured creditors who were provided security over the same property as the higher-priority secured creditor to obtain satisfaction of their claims from this property.
For example, if a pledgee registered a notice of pledge in its favor in the security rights registry before others (senior pledgee), then upon enforcement against the pledged asset by another pledgee who registered the pledge later (junior pledgee), the senior pledgee has the right to demand the termination of such procedure and to independently enforce against the pledged asset (in case of out-of-court enforcement) or to receive satisfaction of its claims from the proceeds of the sale of the pledged asset preferentially over the junior pledgee (in case of judicial enforcement).
The Impact of a Person's Actual Knowledge of the Security on Determining the Priority of the Security Right
Under a system of registering security in a security rights registry, a person's actual knowledge of the existence of security should not matter for determining the priority of a secured creditor's right. This approach is explained by the need to make the process of determining the priority of security rights objective, thereby reducing the number of disputes when resolving the issue of priority. Furthermore, this approach significantly reduces uncertainty for acquirers of encumbered property. In particular, when a third party acquires a pledged asset for which no pledge entry has been made in the security rights registry, that person acquires the property free of the pledge right—regardless of whether they knew about the pledge or not.
The Relationship Between Filing Information on Security in the Security Rights Registry and Other Methods of Notifying Third Parties (Obtaining Priority)
Filing information on security in the security rights registry is one way of notifying third parties of the (potential) existence of a security right over property, alongside methods such as transfer of possession, registration of security (for property whose rights are registered in a special title registry), and (for financial assets, including securities) control.
Registration in a title registry and obtaining control are special methods for property defined in special legislation, whereas transfer of possession and registration in the security rights registry are general, universal in nature (applying to all property for which no special legislation on fixing rights and encumbrances has been created). Consequently, competition may arise between these last two methods of notifying third parties: transfer of possession may occur before registration in the security rights registry, and vice versa. In such a case, the issue of which secured creditor has higher priority is resolved differently in different jurisdictions. For example, in Serbia and France, possession and registration in the security rights registry are equivalent as methods of obtaining priority, and the rights of pledgees are determined by the date of transfer of possession and the date of registration in the security rights registry (depending on which date occurred earlier). Conversely, in Moldova, registration in the security rights registry takes precedence over transfer of possession, meaning a secured creditor who obtained priority by filing an entry in the registry has higher priority over a secured creditor who obtained priority through transfer of possession (even if possession was transferred before registration).
Significance of the Security Rights Registry
The security rights registry is very important for commerce and attracting financing, as such a registry ensures the publicity of security rights, on the basis of which securities become effective against all third parties. Such publicity of securities ensures openness and clarity for market participants regarding the potential existence of an encumbrance on property (in the form of a security right), which, in turn, is one of the factors in making a positive decision to enter into business relations with a particular person.
In particular, the publicity of securities allows involving a large volume of property, rights to which are not registered in specially created (title) registries, into commerce as collateral for obligations under attracted financing (e.g., loans or bonds).
Thus, according to estimates by the International Finance Corporation (IFC), in states where security legislation is underdeveloped and no security rights registry exists, real estate constitutes the main share of accepted collateral, whereas in states with developed security legislation and a functioning security rights registry, movable property is regarded as valuable collateral, which financing organizations accept as security when providing loans without a significant discount in their valuation (discounting) due to legal uncertainty regarding obtaining priority as a result of concluding a pledge agreement for such property.
Scope of Application of the Security Rights Registry and the Functional Approach
Registration of security in the security rights registry can be general in nature, implying the possibility of registering in such a registry any right that is functionally security in nature. For example, in relation to Russian law, rights that are functionally security in nature include retention of title by the seller, leasing, and security assignment.
The general nature of the security rights registry is created in those states whose legislation is transitioning from regulating each type of security with separate norms to universal regulation, according to which all former security rights over property, previously subject to various rules, receive uniform regulations. The criterion determining the application of security legislation is the functional purpose of the relevant right: if the functional purpose of the right is to provide security over property, then it is subject to the regime of unified security legislation.
One of the most prominent and first examples of applying the functional approach is Article 9 of the Uniform Commercial Code of the United States of America. Under this Article 9, all security devices of common law, equity, and statute were generalized into the common concept of a "security agreement" creating a "security interest."
This approach has been adopted by a number of legislations and some international organizations supporting states in developing new security legislation. In particular, the UNCITRAL Legislative Guide on Secured Transactions (2010) contains a recommendation that, to the greatest extent possible, all transactions that create rights in any type of property for the purpose of securing the performance of an obligation (i.e., that perform security functions) should be treated as security transactions and governed by the same rules applicable to security, or at least by similar principles. According to the functional approach, similar rules should apply to transactions performing security functions, at a minimum, regarding creation, effectiveness against third parties, priority (ranking), and enforcement.
Universal Characteristics of the Security Rights Registry
States use various terms and mechanisms for the system of registering security in the security rights registry.
However, the universal best practice is that this system is built on the basis of a registry, i.e., a centralized, public, and publicly accessible collection of data on the potential existence of security rights or (in states not using the functional approach) on the potential existence of a pledge.
The security rights registries being created today are electronic. The electronic form of the registry allows for quick and effortless filing of information into the registry (via the registry website), accessibility and openness of the registry data (via the registry website), as well as cost efficiency in maintaining the security rights registry system (particularly due to the absence of the need to accept and store paper documents).
Furthermore, security rights registries previously created on a paper basis are gradually transitioning to electronic form (information is entered using information and communication technologies, stored in electronic format, requests for information are made electronically using ICT, and requested information is provided in electronic format).
To file information on security into the security rights registry, it is not required to submit transaction documents, including the secured obligation or the agreement creating the security, for review by any person. It is sufficient to fill out a standard form on the registry website containing the data fields necessary for entering a notice of security into the registry in accordance with the law (information necessary to notify third parties of the potential existence of security over property). Typically, such fields are the name (corporate name) and other necessary identification data of the grantor, the secured creditor, and a description of the collateral. The registry functions in such a way that the system does not allow an entry to be made if not all fields are filled, thereby eliminating the need to involve any "registrars" to check the correctness of form filling.
The filing of a notice of security in the registry, as well as its search, is conducted against (i.e., based on the criterion of) the unique identification data of the grantor. Additionally, a search in the registry can also be conducted by property when it has a unique serial number (e.g., vehicles with a VIN).
The principle of filing a notice of security in the security rights registry and searching for it based on the criterion of "unique identification data of the grantor" is explained by the fact that the majority of movable property to which the registry applies lacks any unique identifying features, other than belonging to a specific person, that would allow any person searching the registry to determine which property's encumbrance the entry relates to.
The security rights registry allows any person to search for entries on encumbrances. Typically, such a search is conducted without charging any fee.
The security rights registry is not a means of replenishing the budget or generating profit; fees for its services are set at a minimum level to ensure access to its services for everyone.
Russian Experience
In Russia, the idea of creating a registry is discussed only in relation to information about pledges (a registry of pledge notices).
In particular, the Ministry of Finance of the Russian Federation developed a draft Federal Law "On the Registration of Notices of Pledge of Movable Property" (a new version of the draft was presented in October 2011; work on it has been ongoing since September 2006).
Also, the Ministry of Economic Development is preparing a draft Federal Law "On the Registration of Pledges of Movable Property," based on the Concept "Registration System in Russia," which contains the main requirements for the future pledge registry in Russia.