The English Law Pledge
by Alex Monk and Rachel Turner
The English law pledge offers a well-rehearsed and flexible mechanism to confer security over goods in favour of lenders. Provided the lender has a valid pledge, he should be able to enforce his security by exercising a power of sale of the goods following the occurrence of a default under his credit facility. The Qingdao experience, whilst the product of particular Chinese circumstances, makes it worthwhile to remind oneself of the key features of a valid and enforceable pledge under English law.
The pledge is the most suitable English law instrument in trade finance transactions for achieving security over goods located for a period of time in a warehouse or other storage facility or where documents of title related to goods in transit (most commonly bills of lading) are available. An effective pledge is a possessory security interest which removes the asset subject to the pledge from the assets available to a liquidator of a company and therefore other creditors, including secured creditors holding fixed or floating charges. From a technical legal perspective, the lender is generally expressed as holding a “special interest” in the pledged goods, whilst the borrower retains a “general interest” in the goods, or ownership. The “special interest” falls somewhere between a personal right (simply to detain and sell the goods) and a proprietary interest in the goods, capable of assignment and transfer.
Other than there being an intention to create a pledge, which is usually documented in a letter of pledge or equivalent instrument, the critical element required for there to be an effective pledge is possession of the assets in question.
For goods or products in storage, for practical reasons, possession is most frequently achieved by “constructive possession” rather than actual possession. Lenders are not typically in the business of operating storage facilities so unless the goods are suited to being kept in a bank vault such as in the case of precious gems or fine art, warehouse companies or collateral managers will be engaged by the lender, with the agreement of (and usually at the cost of) the borrower, to take and keep possession of the goods on the lender’s behalf. The leading English case law refers to third parties being the “holder of the keys” to the storage premises and having an irrevocable right of access to those premises, in combination with acknowledging (or “attorning”) that they are holding the goods on behalf of the lender and acting on the lender’s instructions in relation to such goods, to the exclusion of instructions from the borrower. These arrangements are most commonly documented by way of warehouse agreement or collateral management agreement. Notwithstanding the terms of such agreements, it is equally important that operationally speaking the exclusive control is demonstrable and is actually carried out in practice.
In contrast to physical goods, actual possession of bills of lading representing goods in transit by sea is the most common means by which lenders secure a pledge where such documents are available. In order to effect efficient commercial transactions, lenders will, however, often allow their borrower to hold the bills of lading for the benefit of the lender pursuant to a trust receipt which allows the borrower to effect the sale of the goods as the lender’s “mercantile agent” by transfer of the bill by the borrower to the purchaser with the sale proceeds being the beneficial property of the lender. It is important to remember that pledges of documents will only be of value to a lender if the documents are recognised by the courts as being documents of title. English law views warehouse receipts, for example, as being “merely tokens of an authority to receive possession”. Such receipts have no value in themselves other than as pieces of paper. Letters of indemnity issued in the absence of possession of the bill of lading are also not title documents and are not suitable for a pledge (a security assignment of the contractual rights pursuant to the indemnity would be more suitable). Another common misconception arises around the role of the trust receipt. The trust receipt is a means to continue the effectiveness of an existing pledge notwithstanding the sale process. It cannot work alone without a pledge being in existence as well.
The above principles have been well established since the early twentieth century. These principles have recently been reaffirmed in the case of Bassano v Toft  EWHC 377 (QB), where it was also confirmed that once a lender has obtained actual or constructive possession of the assets, the lender will not lose its security interest in the goods unless it voluntarily surrenders possession in the legal sense. A mere parting with possession of the goods in circumstances inconsistent with giving up one’s special interest in the pledged goods (for example releasing an item to a dealer to show to a potential buyer) does not constitute legal surrender of possession.