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UNIVERSITY OF LAGOS

SCHOOL OF POSTGRADUATE STUDIES

FACULTY OF LAW

PPL 813 – SECURED CREDIT TRANSACTIONS 1 - 2010/2011

BEING A SEMINAR PRESENTATION IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE AWARD OF LL.M DEGREE

PROGRAMME

TOPIC: CREATION AND ENFORCEMENT OF HYPOTHECATION AS A FROM OF SECURITY IN NIGERIA

BY

DURU, GEORGE -

NJOKU, CALLISTUS -

IWEZE, ODIAKACHUKWU VINCENT - 109061111

OJEDOKUN, OLUSHOLA -

OLOYEDE, TEMITAYO OLAMIDE -

SODJE, P IUS E. -

UGBO, NOSAYABA -

LECTURER: DR. AMOKAYE

MARCH 3, 2011TABLE OF CONTENTS

PART 1

1. INTRODUCTION

1.1 Proem

1.2 Definition

1.3 History

PART 2

2. CREATION OF HYPOTHECATION IN NIGERIA

PART 3

3.ENFORCEMENT

PART 4

4.CONCLUSION

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PART 1

1. INTRODUCTION

1.1 PROEM

Due to the increase in commercial activities and the difficulties in

securing a loan with fixed assets such as land which at times is

unavailable to the borrower, the use of other forms of security have

evolved. Goods of various kinds, fixtures and growing crops when

assigned or charged separately, may be the subject matter of

security. Trade machinery and other corporeal moveable may also

qualify under this head as personal chattels security.

A Creditor who takes personal chattels as security has certain

problems to contend with because by the very nature of personal

chattels they are movables. Generally, personal chattels have no

title deeds which may be appropriated by the creditor to forestall

further dealings in such chattels by the debtor. Further, the

debtor’s possession of the chattel despite the creditor’s interest

enables the debtor to represent that he is still the owner and thus

able to sell the chattels or obtain false credit from others.1

As grave as these problems may appear, the creditor can

nonetheless overcome them by taking possession of the chattels or

have same registered. Possession typically ensures physical control

thereby denying the borrower the opportunity to use the chattels to 1 I.O. Smith ‘Nigerian Law of Secured Credit’ p.147

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the detriment of the lender. Registration on the other hand, gives

prospective purchasers or creditors notice of encumbrance over the

chattel. This can be done by pledge of chattel or the creation of a

mortgage bill of sale2

With respect to Hypothecation which is one of the forms of security

over chattel, the lender can actually sell the consignment where the

bill of lading is endorsed in his name.

1.2 DEFINITION

We shall start this discourse by stating that like most legal terms,

there are several definitions of Hypothecation. This term is used

principally in the civil law jurisdictions. The Black’s Law Dictionary

defined the term as “the pledging of something as security

without delivery of title or possession”3.The term has further

been defined to mean “a collaterizing arrangement which

neither the possession nor the title but only the right to sell

an asset or property passes on to the creditor or lender”4.

According to Professor Smith, “Hypothecation involves the

passing of neither property in the goods nor the possession

of them to the lender”5. In other words, the goods remain in the

possession of the borrower or a third party while security over them

2 Ibid3Black Law Dictionary,8th Edition at Page 759.4 See BusinessDictionary.com5 I.O Smith, Op. Cit, page 210

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is granted by means of a letter of Hypothecation6. The term has

further been described as the practice where a borrower pledges

collateral to secure a debt. The borrower retains ownership of the

collateral, but it is "hypothetically" controlled by the creditor in that

they have the right to seize possession if the borrower defaults. It

therefore means that where; for example, goods are contained in

the borrower’s warehouse which cannot be sealed off to enable

lender become pledgee of them or where it is impracticable for the

lender to have the possession of the goods, the lender can resort to

this term.

It must be noted however that under common law, cases of

hypothecation, in the strict sense of the civil law, that is, a pledge of

a chattel without possession by the pledgee, are scarcely to be

found. Cases of bonds and claims for seamen's wages against ships

are the nearest approach to it; but these are liens and privileges

rather than hypothecations.

1.3 HISTORY

The security of hypothecation was borrowed from the Civil Law. It

marked the final stage of the right in rem which the Roman

jurisprudence gradually developed and recognized. The earliest

form of the Roman security, called fiduciae, may be regarded as the

prototype of the English mortgage. In this security an actual

conveyance was executed by the debtor to the creditor on condition 6 Ibid

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(contractus fiduciae) that if the purchase money were repaid by the

day named, the creditor would re-convey the property to the debtor.

In this of security credit transaction, the debtor naturally ran a great

risk for having parted with his ownership; he had only a personal

action against the creditor. The intervention of the proctor was only

a matter of time.

The law was next modified by an edict declaring that while the

creditor retained possession of the property, its ownership remained

with the debtor. This is Pignus and marked the second stage in the

history of civil mortgages. But the creditor did not always care to

take possession of the thing pledged, nor did the debtor always wish

to part with the possession. And so Servius dispensed with the

transfer of possession and thus arose the hypotheca or pledga of a

thing by mere agreement, without any formality and without the

delivery of possession. Servius gave the creditor remedy not only

against the debtor, but against all other persons, and thus

established a true right in rem. The creditor’s remedies in a

hypothecation were (a) rights in rem, i.e., he could recover the very

thing pledged (b) the right of sale. As regards the latter right

Justinian enacted that if the creditor had possession of the

hypotheca he could not sue without giving a previous formal notice

to the debtor, and if he had no possession he must obtain a judicial

decree. In either case he could not sell except after two years from

either the notice or the decree.

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The security given by the debtor was collateral to his own personal

security, which was not determined by sale of the hypotheca except

insofar as the amount obtained sufficed. Hypothecation, as such has

long since ceased to exist except that it survives only in a modified

form in cases of holders of bonds and of seamen in merchant

service in respect of their unpaid wages and who have a claim

against the ship in rem. But even these cases are, strictly speaking,

cases of liens rather than of hypothecation. A mortgage of movable

property without possession is perhaps the nearest survival of this

form of absolute security.

However, the first recorded case in respect of Hypothecation is Re

Hamilton Young & Co7, a bank made advances to its customers

who gave the bank “letters of lien (hypothecation)” accompanied by

bleacher’s receipts. The letter of lien was couched as follows; “We

beg to advise having drawn a cheque on you for £_____, which

amount please place to the debit of our loan account, as a loan on

the security of goods in course of preparation for the shipment to

the east. As security for this advance, we hold on your account and

under lien to you the under mentioned goods in the hands of (here

followed list of goods and names of bleachers) as per their receipt

inclosed. These goods when ready will be shipped to Calcutta and

the bills of lading duly indorsed will be handed to you, and we

undertake to repay the above advance”. The bank gave notice of

the transaction to the bleachers. Upon the customer becoming 7 (1905) 2 K.B.

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bankrupt, it was held that the charge in favour of the bank was valid

and therefore, the creditor had priority over the customer’s

assignees in bankrupty.

PART 2

2. CREATION OF HYPOTHECATION IN NIGERIA

Hypothecation is quite often regarded as an alternative name for a

charge. Thus, it is an equitable interest in a secured chattel entitling

the chargee to attach that chattel or the proceeds there from for the

settlement of debt owed upon default of the chargor. This could be

through insolvency. 8 Although quite often than not, hypothecation

and lien have been used by some scholars interchangeably, we believe

that it will be a misnomer to describe “hypothecation” as a “lien” and

ipso facto “letters of hypothecation” as “letters of lien”. While both

concepts share a common denominator in the sense of creating an

8 Jelili Omotola, The law of secured credit, Evans Publishers, p 113.

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incumberance over the goods in question as opposed to a transfer of

either a proprietary or possessory interest in them, both concepts arise

under different scenarios in the sense that; while Hypothecation arises

mainly from the acts of the parties, a lien generally arises by operation

of law or rules of equity from the relations between the parties.9

Therefore, no hypothecation can be created unless by the ACT OF THE

PARTIES.

In the creation of hypothecation by the act of the parties, no special or

particular form is required and may therefore be by a letter instructing

the borrower’s banker to hypothecate the chattels to the borrower’s

indebtedness. To however qualify as hypothecation, the following must

be in existence:

1. The said letter must be couched in such a manner as to constitute a

document used in the ordinary course of that business as proof of

possession or control of the goods.

2. The chattels must also have been in existence as at the time of the

transaction.

3. The list of goods or chattels to be hypothecated must also be made

available for purposes of attachments upon debtor’s default or

bankruptcy.

9 I.O Smith “Secured Credit Transaction” Chap.9

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As stated earlier, the concept of hypothecation has its origin in the

Roman idea of the pignus and the hypotheca, both of which apparently

were hardly different from each other in the Roman legal theory.10 A

proper understanding of Hypothecation is to view it as a specie of

charge. A Charge generally arises from an agreement between a

creditor and a debtor whereby assets or class of assets belonging to

the debtor are appropriated to the satisfaction of the debt, so that the

creditor is entitled to have recourse to the assets or the proceeds

thereof to discharge the indebtedness.11 The creditor secured by a

charge claims priority over claims of unsecured creditors and junior

encumbrancers. Since the charge does not transfer ownership to the

creditor, it could be described merely as an encumbrance, a weight

hanging on the asset. This weight travels with the assets into the

hands of third parties, other than a bonafide purchaser without notice.

The nature of rights transferred by the concept of hypothecation has

constantly raged among scholars. There has not been a consensus

whether the security transfers proprietary nor possessory rights

already in existence at the time of creation. Skyes position is that

although a charge “does not comprise any of the rights which make

up the bundle of ownership, it is proprietary because in the event of

bankruptcy of the guarantor, the creditor has not merely a claim to

proof of debt, but a right to exercise remedies against the thing

10 Jelili Omotola, The Law of Secured Credit, Evans Publishers 2006 p.11311 Ibid p. 121

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itself and to withdraw it to that extent from the net cast by the

trustee in bankruptcy” 12 As a result, Skyes believes that a charge

for which Hypothecation is a specie, is proprietary. In disagreeing

with Skyes, Smith posits that the real nature of proprietary security

created by act of parties involves originally parting with ownership

of the property at the time of creation, to be re-conveyed upon

repayment. The true nature of hypothecation does not involve such

transfer of ownership rather; it is an agreement to appropriate the

asset to discharge the debt.13

R.M. Goode commenting on the nature of this type of security,

describes it as merely an encumbrance or rather a weight on the

asset which travels with it into the hands of third parties, except a

bonafide purchaser without notice. This description in our view is a

more concise way of describing this security. This is so because

possession is with the chargor and he can easily dispose off the

goods to third party fraudulently to avoid his obligation of

repayment under the loan transaction. However, no matter the

arguments on the nature of rights (whether proprietary or

possessory) one common denominator of this type of security is

that whatever rights created automatically terminate on repayment

of the loan. Thus where a borrower liquidates the loan, the

encumbrance hanging on the assets automatically disappears

12 Skyes. ‘The Law of Securities 5th ed p18 cited in I.O. Smith ‘Nigerian Law of Secured Credit’ p211-21213 I.O. Smith ‘Nigerian Law of Secured Credit’ p.212.

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without any conscious effort at reconveying same, since there was

no conveyance of proprietary interest in the chattels originally.14

In Nigeria, there are dearth of authorities on the form of creation of

hypothecation. The reason for this can be deduced from the fact

that this area of the law of security is yet to develop. However, one

certainty is that the creation of hypothecation is by the deliberate

act of the parties as against creation by law. A borrower who

desires to obtain loan may charge certain chattels either in his

possession or with a bailee in favour of the lender for the purpose of

appropriation in the event of the borrower’s default or bankruptcy.

The formality of achieving this is simple. It need not be in a

particular legal form. It usually takes the form of a letter instructing

the borrower’s banker to hypothecate the chattels to the borrower’s

indebtedness. However, care must be taken to ensure that it does

not come within the ambit of the Bills of Sale Act, so as to avoid the

trouble of complying with the law as to form and registration. To

qualify as a letter of Hypothecation outside the ambit of the Bill of

Sale Act, the letter must be couched in such a way as to constitute a

document used in the ordinary course of business as proof of

possession or control of the goods; as opposed to a situation where

the lender’s title to the security is derived from the document itself.

If the title is derived from the document then it is a bill of sale

transaction and must come under the Act. Whether an intended

letter of hypothecation comes within the purview of the Bill of Sale 14 Ibid.

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Act, is a question of construction. In Brown v Bateman (1867)

LL.R. 2 C.P. p.27215, the court held that a document creating a

charge is not a bill of sale on the ground that it was not an

assurance on chattels. However, in Edwards v Edwards

(1986)Ch. D P.291, the court held an agreement to assign chattels

contained in a deed was a bill of sale which required registration.

Where a document is caught by the Act, the effect is that it is only

valid where it complies with the statutory form and registered as a

bill of sale otherwise, it is void for all purposes.16 There are two

situations where letter of hypothecation will be exempted from the

Bill of Sale Act, they are:

i. Where the goods mentioned in the letter of hypothecation are

abroad or on board a vessel on the sea. In R v Townsend

(18186)16 QBD p.532, a customer applied for an advance.

He used certain goods consigned to him which were at sea as

security. He gave to the banker an instrument referred to as

hypothecation note. By the said note, he undertook to hold

the goods in trust for the bank and to hand over the proceeds

in due course. The court held that although the instrument

was a declaration of trust without transfer and would have

qualified as a bill of sale. However, since it was in relation to a

bill of sale in foreign parts or at sea, it fell within the

exceptions highlighted by the Act.

15 Cited in I.O. Smith ‘Nigerian law of Secured Credit’16 Bill of Sale Act 1882 S.9

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ii. A letter of hypothecation will also be exempted from the Bills

of Sale Act if by its nature, it is one that is used in the ordinary

course of business as proof of the possession or control of

goods. This is not a clear cut exception. In Re Hamilton Young

& Co17, a bank made advances to its customers who gave the

bank a letter accompanied by bleachers receipt for the

goods. The bank gave notice of the transaction to the

bleachers. Upon the customer becoming bankrupt, it was

held that the charge in favor of the bank was valid and

therefore, the creditor had priority over customer’s assignees

in bankruptcy. Although the letter of hypothecation was

called ‘letter of lien’ it is our position that this is a misnomer

as the means of creation in the two securities are different. In

the Re Hamilton case the document used was clearly in the

ordinary course of business. Other situations may not be as

clear as the Hamilton case. In National Provincial and Union

Bank of England Ltd v Linsell (1922)1 KB p.21 a letter signed

by the debtor was held not to be a document used in the

ordinary course of business as proof of the possession or

control of the goods. From the foregoing, the test would seem

to be whether the document is that which is regularly used by

merchants in that trade. As against a singular transaction by

one merchant. It is pertinent to state that the course of

business is that of the lender not the borrower.

17 Supra

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It appears that from the authorities so far, the letter of hypothecation in

Hamilton Young’s case appears to be the standard form. Thus, where a

party desires to extricate the letter of hypothecation from the ‘claws’ of

the Bill of Sale Act, he should use the instrument similar to that in

Hamilton Young’s case.

PART 3

3. ENFORCEMENT OF HYPOTHECATION

It must be stated that unlike a mortgage or pledge where the creditor

can foreclose since he has some degree of title in the property, there

can be no foreclosure in hypothecation since no interest has passed in

the property. According to the decision in Mathews v. Gooday

(1861) 31 LJ Ch. P.282 however, the only modes of enforcement

open to a creditor in respect of a loan secured by hypothecation over

goods are Judicial sale and Appointment of Receivers.

Where the letter of hypothecation is in respect of goods on board a

vessel and the bill of lading in the creditor’s possession is fully

endorsed in his name, he is entitled to sell the chattels and pass good

title. This position was adopted by Lord Summer in The Prinz

Adalbert (1917) AC P. 586 at 58918. It is pertinent to state here

that the rights of the creditor is subject to the right of the bona fide

purchaser for value without notice of the encumbrance. The nature of

hypothecation, makes its enforceability weak. Since the chattels are in 18 Cited in I.O. Smith ‘Law of Secured Credit’

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possession of the debtor, he can dispose same off before the creditor

can exercise his rights. As a result of the nature of security created by

a letter of Hypothecation, the mode of enforcement no doubt will be

cumbersome. The creditor will have to bring an application. We note

however that where the creditor has a fully endorsed bill of lading in

his possession, he is entitled to sell the chattels and pass good title to

the purchaser without the assent of the debtor.

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PART 3

4. CONCLUSION:

In concluding, we opine that bearing in mind the simple nature of this

form of security, it will not be viable in Nigeria for the following

reasons:

1. Since the chattel or goods pledged are not directly under the

supervision of the lender, it becomes very hard for the lender to

monitor the goods or chattel and to ensure that the borrower

does not in any way interfere or deal in the goods and chattels

that have been used for the security. This has become evident

due to the inadequacy of storage facilities which may also lead to

a depreciation of the price of the goods or chattels.

2. In many cases also, goods hypothecated are at sea on board a

vessel so that the creditor is not given an opportunity of seeing

the condition or doing any proper valuations. The creditor or

lender may discover on arrival of the goods that they do not fit

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the description given when the facility was obtained or that they

are in fact inadequate as security for the credit facility.

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