Security

Question 1

What is security?

Answer 1

It is the temporary ownership, possession or other proprietary interest in an asset to ensure that a debt owed is repaid.

Question 2

What is the main benefit of security?

Answer 2

It is to protect the creditor in the event that the borrower enters into a formal insolvency procedure.

Question 3

What is a pledge?

Answer 3

The security provider gives possession of the asset to the creditor until the debt is paid back.

For example, pawning a watch or an item of jewellery is a form of pledge.

Question 4

What is a lien?

Answer 4

The creditor retains possession of the asset until the debt is paid back.

For example a mechanics lien. This arises by operation of law and allows a mechanic to retain possession of a repaired vehicle until the invoice is paid.

Question 5

What is a mortgage?

Answer 5

With a mortgage, the security provider retains possession of the asset but transfers ownership to the creditor. This transfer is subject to:

a. the creditor’s right to take possession of the asset and sell it if the security provider defaults; and

b. the security provider’s right to require the creditor to transfer the asset back to it when the debt is repaid.

This right is known as the ‘equity of redemption’. A type of mortgage (known as a charge by way of legal mortgage) is usually taken over land (although, unusually, ownership will remain vested in the security provider in this case).

Question 6

What is a charge?

Answer 6

As with a mortgage, the security provider retains possession of the asset. However, rather than transferring ownership, a charge simply involves the creation of an equitable proprietary interest in the asset in favour of the creditor.

Question 7

What will the charging document give the lender?

Answer 7

Contractual rights over the asset, for example, to appoint a receiver or administrator to take possession of it and sell it, if the debt is not paid back when it should be.

Question 8

What is a fixed charge?

Answer 8

A fixed charge is normally taken over assets such as machinery and vehicles.

Question 9

Does a creditor of a fixed charge retain control over what the security provider can do with the assets?

Answer 9

Yes.

This is usually done by the security provider undertaking not to dispose of, or create further charges over, the charged assets without the creditor’s consent.

Question 10

If the fixed charge becomes enforceable what does the creditor have the power to do?

Answer 10

Appoint a receiver of that asset or to exercise a power of sale of the asset.

Question 11

What are floating charges?

Answer 11

A floating charge ‘floats’ over the whole of a class of circulating assets. Whatever assets in that class happen to be owned by the security provider at any given time are subject to the floating charge, and the security provider is free to dispose of the assets as it wishes until crystallisation.

Question 12

What is ‘crystallisation’?

Answer 12

Crystallisation means that the floating charge stops floating and fixes to the assets in the relevant class which are owned by the security provider at the time of crystallisation. The creditor thus acquires control of those assets and to this extent a crystallised floating charge is like a fixed charge.

Question 13

When might crystallisation occur?

Answer 13

Crystallisation may occur by operation of law or may be triggered by certain events as contractually agreed between the creditor and security provider.

Question 14

What are the disadvantages of the floating charge?

Answer 14

*As the security provider has freedom to dispose of the assets, the creditor will not be sure of the value of the secured assets – they might all have been sold before crystallisation occurs.

*There is a statutory order of priority of payment of creditors if a company is wound up. A floating charge generally ranks below a fixed charge.

*However, if the floating charge document contained a term prohibiting the creation of a later fixed charge (a ‘negative pledge’ clause) but the company nevertheless created a later fixed charge, the floating charge will have priority if the later fixed charge holder had notice of this restriction.

*Floating charges created on or after 15 September 2003 are subject to a part of the proceeds of the assets being set aside. This is known as the ‘prescribed part fund’ for unsecured creditors.

*Floating charges are capable of being avoided under Insolvency Act 1986.

*An administrator is free to deal with floating charge assets in their control without reference to the charge holder or the court and to pay their remuneration and expenses out of the proceeds of those assets.

Question 15

What are guarantees? Who can they come from?

Answer 15

A guarantee for a loan means an agreement that the guarantor will pay the borrower’s debt if the borrower fails to do so.

Guarantees can come from companies or individuals (such as directors)

Question 16

Do you need to register a charge?

Answer 16

Yes, most security by a company needs to be registered with Companies House.

This includes charges created by an English company over assets located both within the UK and abroad.

Question 17

When must a charge be registered?

Answer 17

Within 21 days beginning with the day after the day on which the charge is created.

Question 18

What is the process for registering a charge including forms etc

Answer 18

Sent Form MR01 detailing:

*the company creating the charge
*the date of creation of the charge
*the persons entitled to the charge; and
*a short description of any land, ships, aircraft or IP registered in the UK which is subject to a fixed charge.

A certified copy of the charge and the relevant fee

The Registrar allocates to the charge a unique reference code and includes it on the register with the certified copy of the charge.

The Registrar must issue a signed/authenticated ‘certificate of registration’ which is conclusive evidence that the charge has been correctly registered.

Question 19

What is the effect of failing to register a charge?

Answer 19

If the charge is not registered at all, or is not registered within the 21-day period:

*the charge is void against a liquidator, administrator and any creditor of the company; and

*the debt becomes immediately payable.

As security is taken as protection against the effects of insolvency, the fact that the charge is not valid as against a liquidator or administrator means that the security will effectively be worthless if not registered.

Question 20

Does a company need to keep records of the charges?

Answer 20

A company must keep available for inspection a copy of every charge and a copy of every instrument that amends or varies any charge. Such copies may be certified copies rather than originals.

Question 21

Where are copies of the charges to be kept?

Answer 21

At the company’s registered office or such other location as permitted under the Companies (Company Records) Regulations 2008.

Question 22

Does a company need to inform Companies House of the place where the charges are kept?

Answer 22

Yes, where such documents are available from inspection and of any changes to that place?

Question 23

Must the charge documents be available for inspection by creditors and members?

Answer 23

These documents must be available for inspection by any creditor or member of the company free of charge and by any other person on payment of a prescribed fee.

Question 24

What happens if a company refuses inspection of charge documents?

Answer 24

If a company refuses such inspection, then the court may order that the company allows an immediate inspection.

Question 25

In relation to the obligations regarding charge documents, what are the consequences if a company does not comply?

Answer 25

Failure to comply with any of the above requirements will be an offence and the company (and every officer of the company who is in default) will be liable to a fine.

Question 26

What is the order of priority between creditors?

Answer 26

Creditors with fixed charges - entitled to the first call on the proceeds from the sale of those assets charged to them under a fixed charge.

Preferential creditors – primarily wages (up to £800 per employee), occupational pensions and certain sums owed to HMRC.

Creditors with floating charges (which will have crystallised, if not before, upon commencement of the winding up). For floating charges created on or after 15 September 2003, a proportion of the proceeds of the floating charge assets will be set aside for payment to unsecured creditors before the floating charge holders are paid from these proceeds. This is commonly referred to as the ’prescribed part fund’.

Unsecured creditors, to the extent not paid off from the prescribed part fund.

Shareholders (according to the rights attaching to their shares).

Question 27

What is the priority among secured creditors?

Answer 27

If more than one creditor has a fixed charge over the same assets, the first fixed charge created has priority.

Similarly, if more than one creditor has a floating charge over the same assets, the first floating charge created has priority (provided it was properly registered).

Question 28

Can the order of secured creditors be varied?

Answer 28

The order can be varied by agreement between the creditors through a document known as a Deed of Priority, an Intercreditor Agreement or a Subordination Agreement. Such an arrangement has the benefit that creditors can make specific provision for the order in which they will rank and do not need to rely on the complex and sometimes uncertain rules mentioned above.

Question 29

What is the order of priority among other categories of creditors and shareholders?

Answer 29

Shareholders, unsecured and preferential creditors rank equally amongst themselves (subject to any preferential rights attached to certain classes of share) within their category.

For example, this means for the category of unsecured creditors it does not matter when the debt was incurred as no one unsecured creditor will take priority within that category upon the distribution of the proceeds of sale of the assets when the company is wound up. It does not change the order of priority as set out above.