Debt Finance - Security Flashcards
Why may a borrower grant security to a lender?
It lowers the risk of the lender not being repaid, by allowing the lender to seize the secured assets, sell them and pay themselves out of the proceeds
Type of security and the terms on which it is granted are decided by agreement between the parties
How do different statues define ‘security?’
No consistency in terminology across statutes
- CA 2006 - ‘charge’ is an umbrella term for most types of security + includes mortgage
- Law of Property Act 1925 - ‘mortgage’ is an umbrella term for security and includes ‘any charge or lien on any property’
- Insolvency Act 1986 - ‘security’ is defined as ‘any mortgage, charge, lien or other security’
What types of charges can sole traders, partnerships and LLPs grant?
Sole traders and partnerships cannot grant floating charges, only fixed charges
- Fixed charges are registered at Land Registry if over land
LLPs can grant floating + fixed charges, and registration is like how companies do it
What are the initial considerations for a company before borrowing money + granting security?
Directors must ensure the company has power to borrow and to grant security + to enter a security contract on the company’s behalf
- MAs have no restrictions, but check amended articles
- Check the memorandum of old companies formed before 1st Oct 2009
Will need special resolution to change articles if there are restrictions
What are the initial considerations for a lender when a company wishes to borrow money?
Lender should ensure there are no restrictions on company granting security, that directors have authority and have been properly appointed
They should check Companies House records to see if there are any charges registered already
- Registrar of Companies must include a certified copy of the instrument creating the charge in the register
Check LR if taking a charge over land + company’s title at Intellectual Property Office if taking a charge over IP rights
Conduct a winding up search by telephone at Companies Court to check no insolvency proceedings have been commenced
What assets can be secured?
Virtually all assets the company or LLPs owns may be offered as security
- Land
- Tangible property
- Intangible property (money in an account, shares in other companies, IP rights)
How does a ‘mortgage’ act as a form of security?
Highest form of security, taken over high-quality assets (land, buildings, machinery etc)
Legal ownership transfers to lender (except for land) + they have a right to immediate possession (only exercised on default)
- Title transferred back to borrower on repayment
Separate mortgage needed for each asset
What is the main way that charges differ from mortgages and what are the two main types?
Charges do not transfer legal ownership + don’t give the lender a right to immediate possession
Fixed and floating
Give an overview of fixed charges
Suitable for property like machinery or shares in other companies
Effect of the charge is that lender has control of the asset, so borrower cannot dispose of it without lender’s consent
Borrower will need to keep property in good condition
Lender can sell the asset and be paid out the proceeds before any other claimants if borrower goes into liquidation (right of first claim)
Separate fixed charge for each asset + can have multiple fixed charges on one asset
- 1st charge holder gets paid first and 2nd charge holder can pay itself from the remainder
Give an overview of floating charges
These secure a group of assets, such as stock, which is ever changing
Can create multiple floating charges on the same group of assets
Three basic features:
- (a) they consist of an equitable charge over the whole or a class of the company/LLP’s assets, such as stock;
- (b) the assets subject to the charge are constantly changing; and
- (c) the company/LLP retains the freedom to deal with the assets in the ordinary course of business until the charge ‘crystallises’
The floating charge ‘crystallises’ if:
- Borrower goes into receivership, liquidation, ceases to trade; or
- Any other event specified in charge document occurs
When it crystallises, it means the borrower cannot do what it wants with the assets and it becomes a fixed charge, so the lender can sell the stock for example
What are ‘book debts’ and how do they relate to charges?
These are money owed to the company/LLP by their debtors
They can be charged via floating charge or via fixed charge (only if lender had control over both the debts and proceeds once paid)
What are the advantages and disadvantages of floating charges?
Advantages of floating charges
- Allows borrowers to use those secured assets day-to-day
- Can be taken over the whole business potentially
Disadvantages of floating charges
- Fixed charges take priority over floating charge of the same assets
- Borrower can sell all their stock, meaning the lender has a floating charge over nothing
- Certain ‘preferential’ creditors will have priority over a floating charge, but not over a fixed charge
What other types of security are there?
Personal guarantees – directors may give these and risk losing their personal assets if the business fails
A pledge – asset physically delivered to lender as security until debt paid. Lender can sell it if they give sufficient notice
A lien – lender has a right to physical possession (but not sell) debtor’s goods until the debt is paid
Retention of title – on a sale of goods, buyer does not get full title until they pay the full price; if they default, goods are repossessed
What are the key terms in a charging document and what do they mean?
1) Security – states what the security is and what assets it is charged to
2) Representations and warranties – intended to get borrower to reveal all relevant information about the assets, like if there are any other charges already
3) Covenants – borrower promises various things, such as to maintain the value of the assets
4) Enforcement and powers – circumstances when security becomes enforceable and lender’s powers, such as to sell the assets
5) Procedural matters for companies issuing debentures – board resolution usually sufficient to authorise borrowing and grant of any security; only an issue if some directors are giving personal guarantees
6) Registration – it is voluntary to register charges now, but lenders will do it, to ensure the charge is valid
7) Failure to register at Companies House – failing to register the charge renders it void against a liquidator or administrator of the company.
- This means the company must still repay the debt, but the lender cannot enforce the security, as the liquidator must ignore the original charge
8) Late or inaccurate delivery – if 21-day period for delivery of required documents to CH is missed, the charge will be void against 3rd parties
- Court has a limited power to extend the period if failure was accidental etc + can allow rectification of inaccurate details delivered to Registrar
9) Redemption of the loan – when loan repaid, Form MR04 will be completed (probably by director or lender) and sent to CH to show it has been satisfied
10) Release of charge/sale of property – Form MR04 will be used where the lender decides to release the borrower’s property from the charge or allow them to sell the asset
What is the registration process for a charge?
Within 21 days of creation, any person ‘interested in the charge’ must file at CH a statement of particulars (usually form MR01), a certified copy of the charge instrument + fee
Registrar of Companies must register the charge + includes the certified copy on the register + gives person who delivered the documents a certificate of registration
Form MR01 and certified copy will go on company’s file
If documents correctly delivered in time, the charge is fully valid against other creditors or liquidators
Copy of charging document + Form MR01 should be kept available for inspection at registered office or SAIL
- Criminal offence to not do this, but charge would remain valid
Fixed charge over land must be registered at LR
If all charges are registered properly and there are multiple over the same asset, what is their order of priority?
If all charges are registered properly:
- (a) A fixed charge or mortgage will take priority over a floating charge over the same asset, even if the floating charge was created before the fixed charge or mortgage.
- (b) If there is more than one registered fixed charge or mortgage over the same asset, they have priority in order of their date of creation, not their date of registration.
- (c) If there is more than one registered floating charge over the same asset, they have priority in order of their date of creation, not their date of registration
What is ‘subordination?’
Creditors can enter an agreement between themselves to alter the order of priority of their charges
What is meant by a ‘negative pledge?’
Common for floating charge documentation to include a ‘negative pledge’ clause which prohibits the company from creating later charges with priority over the floating charge, without lender’s permission
A subsequent lender who takes a later charge and has actual knowledge of this clause will have a subordinate fixed charge
- Constructive knowledge insufficient (from seeing the clause on the Form MR01)
- Seeing the certified copy of the charging document on CH is actual knowledge
How must contracts and deeds be executed by a company?
1) Execution of documents - Companies must use the correct execution clause when executing or signing documents or they may be invalid
- They are set out in s43-s46 CA 2006
2) Contracts
- Contracts can be entered by a director on behalf of the company, so acting with authority (express or implied) or with company seal
3) Deeds - Company can execute a deed by:
(i) Affixing its seal; or
(ii) By the signatures of
- two authorised signatories (a director or company secretary); or
- a director of the company in the presence of a witness who attests the signatures
(iii) Document must be delivered as a deed, which means it is clear on the face that it is a deed
