Blurred liens - recent case brings them into focus

Blurred liens - recent case brings them into focus

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The recent High Court case, Sheianov and another v Sarner International Ltd [2020] EWHC 1214 (QB) raised queries over a party exercising a common law lien and highlights the need to be aware of how a lien can potentially act as security in certain transactions. Although liens do not typically arise in finance transactions (a lender is more likely to take security by way of a charge, mortgage or pledge granted by a borrower or security provider) they can crop up in commercial transactions, particularly when goods are being supplied, repaired or transported.

In terms of finance transactions, lenders should be aware of existing liens that could affect property they wish to take security over. If, for example a lender seeks to take security over some property which a third party has a lien over, the third party will effectively rank ahead of the lender and weaken its security package e.g. in the shipping sector, maritime liens may rank ahead of a lender’s mortgage on a ship.

In the LMA leveraged facility agreement precedent, “Permitted Encumbrances” include “any lien arising by operation of law and in the ordinary course of trading and not as a result of any default or omission by any member of the Group”, and in the LMA investment grade facility agreement precedent, the negative pledge does not restrict “any lien arising by operation of law and in the ordinary course of trading”. In other words, the existence of such liens will not cause any breach of the finance documents and it is anticipated that such liens will effectively rank ahead of any lender security.

What is a lien?

A lien is a type of security interest, a right which entities a party to hold on to assets in its possession pending payment of a debt owed, for example when your car goes into the garage, the garage may hold on to the car until the outstanding bill has been paid. Liens tend to arise by operation of law (or extended by contract) rather than by way of security which is taken in the usual way i.e. security interests granted by a borrower or security provider by way of a charge, mortgage or pledge.

What is a common law lien?

Common law (or legal) liens are created by operation of law or contract. They arise when a party has obtained and retained lawful possession of an asset until the relevant debt is repaid. Common law liens are further classified into:

  • A particular lien where a creditor retains possession of the debtor’s property until the debt relating to that property is repaid; or
  • A general lien, where a creditor retains possession of the debtor’s property until the debtor repays all the monies it owes to that creditor, whether or not those amounts relate to the property in the creditor’s possession. Courts have traditionally been reluctant to find the existence of general liens.

There are also further classes of liens…

Equitable liens are created by operation of law and occur where the courts of equity create an equitable proprietary interest in an asset by way of security without the need for agreement between the creditor and the debtor. There is no need for the creditor to have possession of the asset. An example of an equitable lien could be where a purchaser has entered into a contract with the seller to buy a property and the purchaser has paid a deposit towards the purchase price. If the sale were to fall through due to no fault of the buyer, there would be an equitable lien over the property to secure repayment of the deposit amount.

Statutory liens are conferred by legislation and give the creditor a right to retain possession until the relevant debt is repaid such as goods under the Sale of Goods Act 1979, aircraft under the Civil Aviation 1982 and Transport Act 2000, and insurance policies under the Marine Insurance Act 1906.

Implications of Sheianov case?

The facts of the case were that Sarner International Limited (the “Defendant”) entered into a £1.75million contract with a company where the Defendant agreed to design, create and supply materials for an exhibition, including 27 vintage motorcycles which were lent by third parties for that purpose. However, the Defendant was still due money under the contract and was holding the motorcycles as “security” until that debt was paid. Was the Defendant entitled to exercise a particular lien over the bikes?

Mr Justice Griffiths undertook a comprehensive review of cases dealing with particular liens over the past 200 years. In summary, he identified 5 essential requirements for the exercise of a particular lien:

  1. A particular lien can only operate on something physical, a chattel. It cannot operate on something incorporeal, such as an idea, or intellectual property.
  2. Work must be done “on” the chattel being detained and not merely “with” it or “using” it or “in relation to” it.
  3. The work must improve or give additional value to the chattel in question. Whether it does so is a question of fact.
  4. The improvement need not be physical, but it must be inherent to the chattel itself.
  5. If the agreed work is of a hybrid nature, some of which is apt to create a particular lien and some of which is not, and the work cannot be severed into those two constituent parts, no particular lien is created.

In light of the five requirements mentioned above and based on the facts, it was held that the Defendant did not have a particular lien over the motorbikes in respect of the debt owing to him. The work was not done “on” the bikes, an exhibition was created in which, in the words of the defendant, “the stories that are represented by these motorbikes come to life”. This was not the same as work being done on the bikes. A further argument that the creation of life-sized die cast figures to sit on the bikes and be temporarily attached to them also failed for the same reason. Summary judgement was granted in favour of the claimants as there was no real prospect of the defendant making out its argument.

In summary, whilst liens are unusual and not frequently used in financing transactions, it is important for lenders and borrowers alike to be aware of their existence and how they could operate in everyday transactions. In commercial transactions, the parties should carefully review the contractual terms to ensure they are aware of any lien clauses and seek to negotiate them where necessary.

Jonathan Porteous, head of banking & finance at Stevens & Bolton comments:

"The case favours a traditional and narrow interpretation of when a particular lien may arise, and in particular that it is capable of attaching to an asset only when work is done 'on' that asset, and not 'in respect of it'. It is a decision that will be welcomed by borrowers and lenders alike, as liens are unregistered and typically undocumented. Any extension of the concept of a lien could cause some considerable difficulties for parties who typically operate with valuable assets held by, or passing through the hands of, third parties rendering services to them."

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