Hypothec (; german: Hypothek, french: hypothèque, pl, hipoteka, from
Lat. ''hypotheca'', from
Gk. : hypothēkē), sometimes tacit hypothec, is a term used in civil law systems (e.g. law of entire
Continental Europe
Continental Europe or mainland Europe is the contiguous continent of Europe, excluding its surrounding islands. It can also be referred to ambiguously as the European continent, – which can conversely mean the whole of Europe – and, by ...
except
Gibraltar
)
, anthem = " God Save the King"
, song = " Gibraltar Anthem"
, image_map = Gibraltar location in Europe.svg
, map_alt = Location of Gibraltar in Europe
, map_caption = United Kingdom shown in pale green
, mapsize =
, image_map2 = Gib ...
) or mixed legal systems (e.g. Scots law, South African law) to refer to a registered non-
possessory {{unsourced, date=September 2018
In legal usage, Possessory forms several compounds.
Conventional meanings
:(1) of or pertaining to a possessor;
:(2) arising from possession (e.g. possessory interest) or
:(3) that is a possessor (e.g. possessory ...
real
security
Security is protection from, or resilience against, potential harm (or other unwanted coercive change) caused by others, by restraining the freedom of others to act. Beneficiaries (technically referents) of security may be of persons and social ...
over
real estate
Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minerals or water; immovable property of this nature; an interest vested in this (also) an item of real property, (more general ...
, but under some jurisdictions it may sometimes also denote security on other
collateral
Collateral may refer to:
Business and finance
* Collateral (finance), a borrower's pledge of specific property to a lender, to secure repayment of a loan
* Marketing collateral, in marketing and sales
Arts, entertainment, and media
* ''Collate ...
s such as
securities
A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
,
intellectual property rights
Intellectual property (IP) is a category of property that includes intangible creations of the human intellect. There are many types of intellectual property, and some countries recognize more than others. The best-known types are patents, cop ...
or corporeal movable property, either ships only (
ship hypothec) as opposed to other movables covered by a different type of right (
pledge
Pledge may refer to:
Promises
* a solemn promise
* Abstinence pledge, a commitment to practice abstinence, usually teetotalism or chastity
* The Pledge (New Hampshire), a promise about taxes by New Hampshire politicians
* Pledge of Allegianc ...
) in the legal systems of some countries, or any movables in legal systems of other countries. The
common law
In law, common law (also known as judicial precedent, judge-made law, or case law) is the body of law created by judges and similar quasi-judicial tribunals by virtue of being stated in written opinions."The common law is not a brooding omnipresen ...
has two equivalents to the term, namely
mortgage
A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any pu ...
and non-possessory
lien
A lien ( or ) is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation. The owner of the property, who grants the lien, is referred to as the ''lienee'' and the pers ...
.
Originating in
Roman law
Roman law is the law, legal system of ancient Rome, including the legal developments spanning over a thousand years of jurisprudence, from the Twelve Tables (c. 449 BC), to the ''Corpus Juris Civilis'' (AD 529) ordered by Eastern Roman emperor J ...
, a ''hypotheca'' was essentially a non-possessory
pledge
Pledge may refer to:
Promises
* a solemn promise
* Abstinence pledge, a commitment to practice abstinence, usually teetotalism or chastity
* The Pledge (New Hampshire), a promise about taxes by New Hampshire politicians
* Pledge of Allegianc ...
over a person's entire estate, but during the
Renaissance
The Renaissance ( , ) , from , with the same meanings. is a period in European history marking the transition from the Middle Ages to modernity and covering the 15th and 16th centuries, characterized by an effort to revive and surpass ideas ...
the device was revived by
civil law legal system
The contemporary national legal systems are generally based on one of four basic systems: civil law, common law, statutory law, religious law or combinations of these. However, the legal system of each country is shaped by its unique history an ...
s as a hypothecatory security interest taken strictly over immovable property and, like the late medieval ''obligatio bonorum'', running with the land (Latin ''jus persequendi'', French ''droit de suite'', Dutch ''zaaksgevolg'', German ''Folgerecht''). However, under a handful of mixed legal systems, the hypothec was imported as a non-possessory real security over movable property (in opposition to the common-law
chattel mortgage
Chattel mortgage, sometimes abbreviated ''CM'', is the legal term for a type of loan contract used in some states with legal systems derived from English law.
Under a typical chattel mortgage, the purchaser borrows funds for the purchase of mov ...
). Whereas a pledge operates by
bailment
Bailment is a legal relationship in common law, where the owner transfers physical Possession (law), possession of personal property ("chattel") for a time, but retains ownership. The owner who surrenders custody to a property is called the "ba ...
and transfers possession on delivery and a chattel mortgage operates by
conveyance and transfers
title
A title is one or more words used before or after a person's name, in certain contexts. It may signify either generation, an official position, or a professional or academic qualification. In some languages, titles may be inserted between the f ...
, a hypothec operates by hypothecation and transfers neither possession nor title.
This real right in security operates by way of hypothecation, often arises by operation of law (generally statute), and gives a
creditor
A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property ...
a preferential
right
Rights are law, legal, social, or ethics, ethical principles of Liberty, freedom or entitlement; that is, rights are the fundamental normative rules about what is allowed of people or owed to people according to some legal system, social convent ...
to have
claims paid out of the hypothecated property as last recourse when the debtor is in
default.
In the hypothec, the property does not pass to the creditor, nor do they get possession, but they acquire a preferential right to have their debt paid out of the hypothecated property; that is, they can sell it and pay themself out of the proceeds, or in default of a purchaser they can become the owner themself.
The name and the principle have passed into
Scotland
Scotland (, ) is a country that is part of the United Kingdom. Covering the northern third of the island of Great Britain, mainland Scotland has a border with England to the southeast and is otherwise surrounded by the Atlantic Ocean to the ...
's
civil law system
Civil law is a legal system originating in mainland Europe and adopted in much of the world. The civil law system is intellectualized within the framework of Roman law, and with core principles codified into a referable system, which serves as t ...
, which distinguishes between conventional hypothecs, as
bottomry A bottomry, or bottomage, is an arrangement in which the master of a ship borrows money upon the ''bottom'' or keel of it, so as to forfeit the ship itself to the creditor, if the money with interest is not paid at the time appointed at the ship's s ...
and
respondentia A bottomry, or bottomage, is an arrangement in which the Master Mariner, master of a ship borrows money upon the ''bottom'' or keel of it, so as to forfeit the ship itself to the creditor, if the money with interest is not paid at the time appointed ...
, and tacit hypothecs established by law. Of the latter the most important is the landlord's hypothec for rent (corresponding to distress in the law of
England
England is a country that is part of the United Kingdom. It shares land borders with Wales to its west and Scotland to its north. The Irish Sea lies northwest and the Celtic Sea to the southwest. It is separated from continental Europe b ...
), which extends over the produce of the land and the cattle and sheep fed on it, and over stock and horses used in husbandry.
Hypothecation
Hypothecation is the practice where a debtor pledges collateral to secure a
debt
Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...
or as a condition precedent to the debt, or a third party pledges collateral for the debtor. A ''letter of hypothecation'' is the usual instrument for carrying out the pledge.
A common example occurs when a debtor enters into a
mortgage agreement, in which the debtor's house becomes collateral until the mortgage loan is paid off.
The debtor retains ownership of the collateral, but the creditor has the right to seize ownership if the debtor defaults.
The main purpose of hypothecation is to mitigate the creditor's credit risk. If the debtor cannot pay, the creditor possesses the collateral and therefore can claim its ownership, sell it and thus compensate the lacking cash inflows. In a default of the obligor without previous hypothecation, the creditor cannot be sure that it can seize sufficient assets of the debtor. Because hypothecation makes it easier to get the debt and potentially decreases its price; the debtor wants to hypothecate as much debt as possible but the isolation of 'good assets' for the collateral reduces the quality of the rest of the debtor's balance sheet and thus its credit worthiness.
The detailed practice and rules regulating ''hypothecation'' vary depending on context and on the jurisdiction where it takes place. In the US, the legal right for the creditor to take ownership of the collateral if the debtor defaults is classified as a lien.
In consumer and business finance
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.
[
]
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.
In the financial industry
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.
In the investment markets
When an investor asks a broker to purchase securities on
margin
Margin may refer to:
Physical or graphical edges
*Margin (typography), the white space that surrounds the content of a page
*Continental margin, the zone of the ocean floor that separates the thin oceanic crust from thick continental crust
*Leaf ...
, hypothecation can occur in two senses. First, the purchased assets can be hypothecated so that, if the investor fails to keep up
credit
Credit (from Latin verb ''credit'', meaning "one believes") is the trust which allows one party to provide money or resources to another party wherein the second party does not reimburse the first party immediately (thereby generating a debt) ...
repayments, the broker can sell some of the
securities
A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
;
the broker can also sell the securities if they drop in value and the investor fails to respond to a
margin call
''Margin Call'' is a 2011 American drama film written and directed by J. C. Chandor in his feature directorial debut. The principal story takes place over a 24-hour period at a large Wall Street investment bank during the initial stages of the ...
. 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
Rehypothecation occurs mainly in the financial markets, where financial firms re-use the collateral to secure their own borrowing. For the creditor the collateral not only mitigates the credit risk but also allows refinancing more easily or at lower rates; in an initial hypothecation contract however, the debtor can restrict such re-use of the collateral.
Re-hypothecation occurs when the ''creditor'' (a bank or
broker-dealer
In financial services, a broker-dealer is a natural person, company or other organization that engages in the business of trading securities for its own account or on behalf of its customers. Broker-dealers are at the heart of the securities and d ...
) re-uses the collateral posted by the debtor (a client such as a hedge fund) to back the broker's own trades and borrowing. This mechanism also enables
leverage
Leverage or leveraged may refer to:
*Leverage (mechanics), mechanical advantage achieved by using a lever
* ''Leverage'' (album), a 2012 album by Lyriel
*Leverage (dance), a type of dance connection
*Leverage (finance), using given resources to ...
in the securities market.
[
]
In the UK, there is no limit on the amount of a client's assets that can be rehypothecated, except if the client has negotiated an agreement with their broker that includes a limit or prohibition. In the US, re-hypothecation is capped at 140% of a client's debit balance.
[
][
]
In 2007, rehypothecation accounted for half the activity in the
shadow banking system
The shadow banking system is a term for the collection of non-bank financial intermediaries (NBFIs) that provide services similar to traditional commercial banks but outside normal banking regulations. Examples of NBFIs include hedge funds, ins ...
. Because the collateral is not cash it does not show up on conventional balance sheet accounting. Before the
Lehman collapse, the
International Monetary Fund
The International Monetary Fund (IMF) is a major financial agency of the United Nations, and an international financial institution, headquartered in Washington, D.C., consisting of 190 countries. Its stated mission is "working to foster globa ...
(IMF) calculated that US banks were receiving over $4 trillion worth of funding by rehypothecation, much of it sourced from the UK where there are no statutory limits governing the reuse of a client's collateral. It is estimated that only $1 trillion of original collateral was being used, meaning that collateral was being rehypothecated several times over, with an estimated churn factor of 4.
Following the
Lehman collapse, large hedge funds in particular became more wary of allowing their collateral to be rehypothecated, and even in the UK they would insist on contracts that limit the amount of their assets that can be reposted, or even prohibit rehypothecation completely. In 2009 the IMF estimated that the funds available to US banks due to rehypothecation had declined by more than half to $2.1 trillion due to both less original collateral being available for rehypothecation in the first place and a lower churn factor.
The possible role of rehypothecation in the
financial crisis of 2007–2008
Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fi ...
and in the shadow banking system was largely overlooked by the mainstream financial press, until Dr.
Gillian Tett
Gillian Tett (born 10 July 1967) is a British author and journalist at the ''Financial Times'', where she is chair of the editorial board and editor-at-large, US. She has written about the financial instruments that were part of the cause of the ...
of the
Financial Times
The ''Financial Times'' (''FT'') is a British daily newspaper printed in broadsheet and published digitally that focuses on business and economic current affairs. Based in London, England, the paper is owned by a Japanese holding company, Nik ...
drew attention in August 2010
to a paper from Manmohan Singh and James Aitken of the
International Monetary Fund
The International Monetary Fund (IMF) is a major financial agency of the United Nations, and an international financial institution, headquartered in Washington, D.C., consisting of 190 countries. Its stated mission is "working to foster globa ...
which examined the issue.
Rehypothecation in repo agreements
Rehypothecation can be involved in
repurchase agreement
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and, by agreement between the two par ...
s, 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.
Hypothec by jurisdiction
Scotland
The law of agricultural hypothec long caused much discontent in Scotland; its operation was restricted by the Hypothec Amendment (Scotland) Act 1867, and by the Hypothec Abolition (Scotland) Act 1880 it was enacted that the landlords right of hypothec for the rent of land, including the rent of any buildings thereon, exceeding two
acre
The acre is a unit of land area used in the imperial
Imperial is that which relates to an empire, emperor, or imperialism.
Imperial or The Imperial may also refer to:
Places
United States
* Imperial, California
* Imperial, Missouri
* Imp ...
s (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.
The
Bankruptcy and Diligence etc. (Scotland) Act 2007
Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debtor ...
Bankruptcy and Diligence etc. (Scotland) Act 2007, section 208
/ref> abolishes the common law diligence of sequestration for rent. 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 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)).
Quebec
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
In law, common law (also known as judicial precedent, judge-made law, or case law) is the body of law created by judges and similar quasi-judicial tribunals by virtue of being stated in written opinions."The common law is not a brooding omnipresen ...
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
The ''Civil Code of Quebec'' (CCQ, french: Code civil du Québec) is the civil code in force in the Canadian province of Quebec, which came into effect on January 1, 1994. It replaced the '' Civil Code of Lower Canada'' (french: Code civil du Bas ...
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
A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any pu ...
(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
A floating charge is a security interest over a fund of changing assets of a company or other legal person. Unlike a fixed charge, which is created over ascertained and definite property, a floating charge is created over property of an ambulator ...
(in Europe, ''hypothèque ouverte'' refers to an open-end mortgage)
* ''hypothèques légales'' (art. 2724) - involuntary lien or equitable charge
In finance, a security interest is a legal right granted by a debtor to a creditor over the debtor's property (usually referred to as the ''collateral'') which enables the creditor to have recourse to the property if the debtor defaults in makin ...
** 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).
See also
* Security interest hypothecation
* Securities lending
In finance, securities lending or stock lending refers to the lending of securities by one party to another.
The terms of the loan will be governed by a "Securities Lending Agreement", which requires that the borrower provides the lender with c ...
*Eurohypothec
The Eurohypothec can be defined as a "common mortgage for Europe"; that is, a common Mortgage law, mortgage instrument to secure loans transnationally and European-wide. Another (but improper) way in calling it is "Euromortgage".
It is currently ...
*Mortgage law
A mortgage is a legal instrument of the common law which is used to create a security interest in real property held by a lender as a security for a debt, usually a mortgage loan. ''Hypothec'' is the corresponding term in civil law jurisdicti ...
*Hypothecated tax
The hypothecation of a tax (also known as the ring-fencing or earmarking of a tax) is the dedication of the revenue from a specific tax for a particular expenditure purpose. This approach differs from the classical method according to which all g ...
External links
Collateral Management article on Financial-edu.com
References
* 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.
** As Hypothicated RE: A developer/lot owner may hypothecate the lot for use by a builder to facilitate action against a line of credit whereas both parties will benefit from the hypotication of the collateral. Gregory Yurco, Lead Lending Officer Geauga Savings Bank, Newbury Ohio.
* ''Please update as necessary.''
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