Hypothec

Hypothecation is a common feature of consumer contracts involving mortgages – the debtor legally owns the house, but until the mortgage is paid off, the creditor has the right to take ownership (and possibly also possession) – but only if the debtor fails to keep up with repayments.[3] If a consumer takes out an additional loan secured against the value of his mortgage (known colloquially as a "second mortgage", for up to approximately the current value of the house minus outstanding repayments) the consumer is then hypothecating the mortgage itself – the creditor can still seize the house but in this case the creditor then becomes responsible for the outstanding mortgage debt. Sometimes consumer goods and business equipment can be bought on credit agreements involving hypothecation – the goods are legally owned by the borrower, but once again the creditor can seize them if required.

The most common form of hypothecation is a repo transaction: the creditor gives a loan to the debtor and receives in return the possession (not the ownership) of a financial asset until the maturity of the loan. A reverse repo is a hypothecation 'in the reverse direction': creditor and debtor swap roles.

When an investor asks a broker to purchase securities on margin, hypothecation can occur in two senses. First, the purchased assets can be hypothecated so that, if the investor fails to keep up credit repayments, the broker can sell some of the securities;[3] the broker can also sell the securities if they drop in value and the investor fails to respond to a margin call. The second sense is that the original deposit the investor puts down for the margin account can itself be in the form of securities rather than a cash deposit, and again the securities belong to the investor but can be sold by the creditor in the case of a default. In both cases, unlike with consumer or business finance, the borrower does not typically have possession of the securities as they will be in accounts controlled by the broker, however, the borrower does still retain legal ownership.

Rehypothecation can be involved in repurchase agreements, commonly called repos. In a two-party repurchase agreement, one party sells to the other a security at a price with a commitment to buy the security back at a later date for another price. Overnight repurchase agreements, the most commonly used form of this arrangement, comprise a sale which takes place the first day and a repurchase that reverses the transaction the next day. Term repurchase agreements, less commonly used, extend for a fixed period of time that may be as long as three months. Open-ended term repurchase agreements are also possible. A so-called reverse repo is not actually any different from a repo; it merely describes the opposite side of the transaction. The seller of the security who later repurchases it is entering into a repurchase agreement; the purchaser who later re-sells the security enters into a reverse repurchase agreement. Notwithstanding its nominal form as a sale and subsequent repurchase of a security, the economic effect of a repurchase agreement is that of a secured loan.

The law of agricultural hypothec long caused much discontent in Scotland; its operation was restricted by the Hypothec Amendment (Scotland) Act 1867,[7] and by the Hypothec Abolition (Scotland) Act 1880[8] it was enacted that the landlord's right of hypothec for the rent of land, including the rent of any buildings thereon, exceeding two acres (8,000 m²) in extent, let for agriculture or pasture, shall cease and determine. By the same act and by the Agricultural Holdings (Scotland) Act 1883 other rights and remedies for rent, where the right of hypothec had ceased, were given to the landlord.[1]

Under Scots law, landlord's hypothec is a common law right of security enjoyed by landlords over any goods sited on the leased premises, regardless of who owns those goods. The hypothec does not secure all sums which happen to be due to the landlord, only a portion of the rent. Landlord's hypothec is enforced by court proceedings known as sequestration for rent. The Bankruptcy and Diligence etc. (Scotland) Act 2007[9] abolishes the common law diligence of sequestration for rent.

The Scottish Executive felt that such a mechanism had no part to play in a modern enforcement system, not least because a landlord is able to use other diligences to recover unpaid rent, such as attachment sequestration for rent can now be used to sell only goods that are secured by a right known as the landlord's hypothec, which arises automatically whenever there is a qualifying lease.

The Act makes some changes to the hypothec, even though it is not a diligence. For example, it completes the process of abolishing the hypothec over goods in dwelling-houses that was initiated by the Debt Arrangement and Attachment (Scotland) Act 2002 (section 208(3) of the 2007 Act). It also abolishes the hypothec over goods owned by a third party (section 208(4)).

The Act also states that, notwithstanding the abolition of sequestration for rent, landlord's hypothec does continue as a right in security (section 208(2)(a)).

In Quebec law, the word is nevertheless used in translations as an equivalent of hypothèque, which has a much broader meaning and encompasses the common law equivalents of, inter alia, mortgages, non-possessory liens over movables or immovables, and legal or equitable charges. Thus, art. 2660 of the Quebec Civil Code defines hypothec, providing as follows:

A hypothec is a real right on movable or immovable property made liable for the performance of an obligation. It confers on the creditor the right to follow the property into whomsoever's hands it may come, to take possession of it, to take it in payment, to sell it or to cause it to be sold and thus to have a preference upon the proceeds of the sale, according to the rank as determined in this Code.

The Quebec hypothèque, essentially equivalent to an American non-possessory lien or English legal charge, is an elastic, hypothecatory security interest that has all the rights of recourse (jus exigendi) of an American lien-theory mortgage or English mortgage by way of legal charge, may also be taken over movable and/or immovable property alike, and must be perfected (i.e. registered). The types as set forth in the Civil Code are:

• hypothèques conventionnelles (art. 2681) - mortgage lien or legal charge (acting as a mortgage)
  • hypothèque immobilière - American real estate mortgage (REM) or English mortgage of land
  • hypothèque mobilière (art. 2702) - Australian personal property security (PPS)
  • hypothèque mobilière sur une créance (art. 2710) - credit mortgage
  • hypothèque ouverte (art. 2715) - American floating lien or English floating charge (in Europe, hypothèque ouverte refers to an open-end mortgage)
• hypothèques légales (art. 2724) - involuntary lien or equitable charge
  • equivalent to the American tax lien, mechanic's or construction lien, home owner's association lien, and judgment lien.

The Qc. Civ. Code also provides for another real security called a priorité, formerly known as a privilège (as it is still known in France, Louisiana, etc.), defined as follows:

A preferential right allowing a creditor to rank prior to all other concurrent creditors, even prior secured creditors [...] (art. 2650)

More specifically, a Quebec priorité is a non-possessory, indivisible, unregistrable (i.e. un-perfectable) real security arising by operation of law alone merely providing a priority right over the security subject. When attaching to movable property, this security interest most closely matches the hypothec as defined at the head of this article. The primary priorités correspond to the American vendor's lien, lien for court costs, municipal lien, and possessory lien (over movables).

Under California Civil Code Section §2920 (a), a mortgage is a contract by which specific property, including an estate for years in real property, is hypothecated for the performance of an act, without the necessity of a change of possession.