PRUEBA EN EL DIFERENCIAL

1.1 Origin of the doctrine of “secret lien”

The famous commercial law Professor Peter Coogan once argued that “the history of commercial law could be deemed as the four-hundred-year struggle by debtors and their secured creditors to create security interests of various sorts in the debtors’ property without affording any notice to other creditors, and the following demands by unsecured creditors for notice when all or part of the debtor’s assets become subject to security interests.”251

Dishonest debtors usually would ask some sophisticated secured creditors to collaborate with them to create “secret liens” (secret interest security) in exchange of higher loan interests or consolidated debtor-creditor relationship.252

The original intellectual underpinnings of the doctrine of “secret lien” could be

251 _{Peter F. Coogan, “Public Notice Under the Uniform Commercial Code and Other Recent Chattel}

Security Laws, Including ‘Notice Filing’,” 47 Iowa L. Rev. 289, 1962, p.289.

252

See e.g., Michael Simokovic, “Secret Lien and the Financial Crisis of 2008,” 83 American Bankruptcy Law Journal 253, 2009, (stating that “in the credit market, banks will compete with themselves to grasp client, especially when the client is a frequent borrower, such as those local main enterprises. Then, the debtors could use this kind of completion between banks to book its false creditworthiness through giving the cooperative bank a higher loan fee, or a heightened loaner-borrower relationship.”)

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dated back to the sixteenth century England.253 In 1517 the England Parliament passed an Anti-Fraudulent Conveyance Statute that is commonly known as the Statute of 13 Elizabeth.254 According to this statute, any property transfers with the intention of hindering, delaying, or defrauding creditors shall be deemed as illegal and void.255 This statue could be considered as the first legislation of “fraudulent law,” from which the general attitude of common law towards debtors’ unfaithful behaviors was clarified. However, the common law doctrine of “secret lien” was developed till the early of the nineteenth century in the case of Clow vs. Woods in Pennsylvanian of the United States.256

In this case, a tanner, Hancock, conveyed security interests on the hides and tanning equipment to his creditors, i.e. Clow and Sharp. However, the secured creditors neither took possession of these collateralized hides and tanning equipment nor recorded the security interest in the public register.In this circumstance, the tanner’s former partner, Poe, sued Hancock for his share of the value as to the firm. Then he obtained a positive judgment, which was then enforced by the local sheriff. In order to fulfil the enforcement, the sheriff auctioned the same hides and equipment that had been collateralized. Then the secured creditors, Clow and Sharp, sued the local sheriff to recover the proceeds of the sale, arguing that their security interest had priority over Poe’s claim.257

The appeal was rejected by the Supreme Court of Pennsylvania. Judge Gibson

253

See M. Simokovic, “Secret Lien and the Financial Crisis of 2008,” 83 American Bankruptcy Law Journal 253, 2009, p.256.

254 _{Douglas G. Baird and Thomas H. Jackson, “Fraudulent Conveyance Law and Its Proper Domain,”}

38 Vanderbilt Law Review 829, 1985, p. 829.

255

See Ibid, Douglas G. Baird and Thomas H. Jackson, fraudulent conveyance law and its proper domain, 38 Vanderbilt law review 829, 1985, (Initially, this statute was passed under the intention of inhibiting a several hundred years practice by the debtors to avoid their debts and deceit their creditors in England. Until the seventeenth century, England had certain sanctuaries into which the King’s writ could not enter. A sanctuary was not merely the interior of a church, but certain precincts defined by custom or royal grant. And the debtor often removed themselves to one of these precincts only after selling their property to friends and relatives for a nominal sum with the tacit understanding that the debtors would reclaim their property after their creditors gave up or compromised their claims. The 13 Elizabeth Statute was passed to limit this practice, providing that the debtors cannot manipulate his affairs in order to shortchange his creditors and pocket the difference, and those who collude with a debtor in these transactions are not protected either.)

256 _{Clow v. Woods, 5 Serg. & Rawle 275, 1819 WL 1895.} 257

See also Jonathan C. Lipson, “Secret and Liens: Verification and Measurement in Commercial Financial Law,” 21 Emory Bankr. Dev. J. 421, 2005, p.4.

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opined: “a creditor ought not be suffered to secure himself by means that may ultimately work an injury to third persons … where possession has been retained without any stipulation in the conveyance, the cases have uniformly declared that to be, not only evidence of fraud, but fraud per se. such a case is not inconsistent with the most perfect honesty; yet a court will not stop to inquire, whether there be actual fraud or not; the law will impute it, at all event, because it would be dangerous to the public to countenance such a transaction under any circumstances. The parties will not be suffered to unravel it, and show that, what seemed fraudulent was not in fact so. Would it be less against sound policy to suffer a vendor to remain in possession, under an agreement to that effect expressed in the conveyance, and thus to create a secret encumbrance on his personal property, when to the world he appears to be the absolute owner, and gains credit as such.”258

This judgment went beyond the sixteenth century anti-fraudulent law because the judges were not required to verify the “fraudulent intention” of the debtors. According to Judge Gibson’s articulation, the “secret” or “un-disclosure” status of the security interests per se constructed “fraud” to other creditors. The tanner’s ownership of his property, ostensibly free and clear of the rights of all others, would induce unwitting, and perhaps unsophisticated, creditor to extend unsecured credit at their peril.259 It is therefore that public disclosure (public notice) became a fundamental requirement in perfecting a security interest in Common law, while the “secret liens” shall be considered void and illegal.

1.2 Functions of the “secret lien” doctrine

The first and foremost function of the “secret lien” doctrine is its role in protecting contracting parties from credit risk of the counterparties. While sophisticated

258 _{Clow v. Woods, 5 Serg. & Rawle 275, 1819 WL 1895., p.280-81.} 259

See J. Lipson, “Secret and liens: verification and measurement in commercial financial law,” 21 Emory Bankr. Dev. J. 421, 2005, p.5. (Also stated that “The emphasis in Clow case on physical possession may seem strange to modern readers. At the time, physical possession and recordation were the two primary means of providing notice of ownership of tangible property. As the economy became more complex and intangible property rights proliferated, the importance of physical possession declined.” )

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creditors usually could require collaterals from the debtors, the less sophisticated creditors, such as small business creditors might not get collaterals when their counterparties are more powerful. Thus, the unsecured creditors will take more dangers of counterparty risk than the secured sophisticated creditors. However, if the debtors have rendered lots of “security liens” on its assets to the sophisticated and collaborative creditors without any record or transfer of possession, then the debtors could appear to be more creditworthy, thereby could get more loans from other creditors. Under this situation, the normal creditors could not accurately estimate the creditworthiness of the debtor, thus granted more loans to the debtor or do more business with the debtor. If the debtor bankrupted, the unsecured creditors would assume the losses while the secured creditors could get repayment from selling the collaterals. In this sense, the “secret lien” doctrine could protect the unsecured creditors from the counterparty risk.

Moreover, the doctrine of “secret lien” is also essential to maintain the healthy and stability of the whole financial system. Credit market is mainly based on confidence. In the aforementioned Clow case Judge Duncan concluded that “a lack

of transparency threatens not only individual creditors, but the financial system as a whole.”260

In fact, if “secret lien” were permitted, the credit loaners will lose confidence to the borrowers, as they could not see the exact credit situation of the borrowers. Thus, the credit cost will arise, as the credit supply in the whole market would decline, if the credit risk rises upside since the opaqueness of the borrowers’ credit situations, which is detrimental to the health of the whole credit market. As argued by Professor M. Simokovic “a secret mortgage to secure a creditor … should be valid and bind the property against creditors … would be a reproach to the law. It ought not, it cannot be so. If it were so, it would put an end to all credit. Credit is given on ‘faith.’ I know not any doctrine that would tend to annihilate all credit, more than the establishment of such a principle.”261

Therefore, the common law

260 _{See M. Simokovic, “Secret Lien and the Financial Crisis of 2008,” 83 American Bankruptcy Law}

Journal 253, p.257

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principle of prohibiting “secret lien” has the function of maintaining the confidence of the credit market, and thus promoted the health and stability of the whole financial system.