Security (5) Flashcards
Is having good security sufficient for a business to be given a loan?
No, regardless of the security the company may offer, they must be able to demonstrate they can repay.
What is the primary source of repayment for a loan?
Surplus cash flows
What is the secondary source of repayment for a loan?
Realising security
What are the 4 features of good security?
1 - Easy to take
2 -Easy to value
3 - Increasing or stable value
4 - Readily realisable (liquid)
What is the most typical scenario when a bank would take security?
When they are funding an asset.
E.g if the bank was lending to a business so they could buy a property, then the bank would take the property as security
When taking charge/security over a property, what rules must the bank comply with?
Mortgages and Home Finance: Conduct of Business Sourcebook (MCOB)
What does MCOB provide when taking charge over a property?
- Dispute resolution procedure
- Scheme of compensation
- Complaints procedure
Who does MCOB apply to?
- Lenders
- Administrators
- Arrangers
- Advisers
What is the difference between an equitable and a legal charge?
- A legal charge involves the use of a full legal charge document
- An Equitable charge gives the lender the power to create a legal charge whenever they decide
What are the types of security you can take over land?
1 - First legal charge
2 - First equitable charge
3 - Second legal charge
4 - Second Equitable charge
what is the difference between freehold and leasehold?
The owner of a freehold property has legal interest over it.
The owner of a leasehold has legal interest over it for a given number of years, after which it reverts to the freeholder
What happens to the value of a lease as it nears maturity/expiry?
It decreases
Therefore lenders must be careful when using leasehold as security
Give an example of a scenario where a bank would have first legal or first equitable charge over a property?
A mortgage
If you own a property without a mortgage, is known as an unencumbered property
If you have a mortgage, does this stop you using your home as security?
No not necessarily
If the home owner has sufficient equity in the property, then the bank can take a second legal charge behind the mortgage provider
The second lender would need consent from the initial mortgage lender
What determines who has priority over a property?
Priority is determined by the charge that was registered with the Land Registry first
Imagine you are trying to get a second legal charge over your property, how do you determine how much the bank will give you over this secondary charge?
Amount = (60% x property value) - what you still owe
Imagine you have a mortgage on a £500,000 house, for which you have £200,000 pf equity.
How much would another bank by willing to lend you as second legal charge?
£500,000 x 0.6 = £300,000
what you ower = £500,00 - £200,000
answer = £100,000
Banks are required to to advise security providers to obtain independent legal advise (ILA).
What are the 3 key features of the ILA?
1 - They must confirm they have explained the security doc
2 - That the security provider is bound by the agreement
3 - The security provider (borrower) must choose their ILA solicitor
What is the difference between direct and third party security?
Direct - you give your own house as security
Third party - someone else give security against your debt. E.g your parents acting as guarantor at university for rent
Imagine Gary Singh is the director of a business that wants to expand and therefore needs a loan.
If Gary uses his own personal home as security for his company’s loan, is this a direct or third party security?
Third party
Imagine you rent a property, and the owner takes out a mortgage on the property.
Would the bank be able to enforce a sale of this property if the owner defaulted?
No, the tenants rights stop them being evicted
If the property had been mortgaged before you started renting then the bank could enforce a sale if the owner defaults
Does commercial property offer good security?
No, its price can fluctuate, particularly in an economic downturn
What are the three important clauses in a bank charge form?
1 - All-monies clause
2 - Continuing security clause
3 - Subsequent charge clause
What does the all monies clause ensure?
That the charge covers all borrowings and liabilities that are owed to the bank at the point of signing
What does the continuing security clause ensure?
That the charge applies to all past, present and future borrowings.
It therefore avoids any dangers arising from Clayton’s case
What is Clayton’s Case?
Imagine you have a £1000 overdraft that has first charge, and a term loan that has £2000 second charge.
Imagine your balance is -400, you then get paid and you’re balance goes to +600. The overdraft is considered as repaid.
You then pay you’re rent and you’re balance goes back down to -500. Even though you are using the same overdraft facility, this new overdrawn amount is considered as “new debt”, and the term loan would have priority over the overdraft now, so the term loan would now rank above the overdraft in a default scenario. This is Clayton’s case.
Having the continuing security clause in your loan agreement will avoid this from happening.
What is the subsequent charge clause?
Stipulates that any new charge holders must notify the first charge holder (the newer charge ranks lower) to agree how much the new charge holder can realise.
What is undue influence?
When one party forces another to do something they do not wish to do
The typical example in terms of security is when someone is forced to act as a guarantor
What form would a bank request from someone who offers to be a guarantor?
Assets, liabilities, income and expenditure (ALIE) form
Undue influence is assumed when the guarantor and guarantee share certain relationships.
Give examples
- Parent and child
- Trustee and beneficiary
- Solictior and client
- Doctor patient
If a guarantee is taken in these cases, it may be set aside
What is a letter of comfort?
Where a parent company pledges to assist a subsidiary in meeting there borrowings/liabilities
Give some other examples of security that the bank must take additional care with?
- Stocks and shares
- Insurance policy
- Blocked deposits
What is a bank debenture?
A security instrument that provides both a fixed and a floating charge over the trading assets of a business
What sort of companies can grant debentures?
Limited liability companies (LLPs)
What determines whether you take a fixed or floating charge over an asset?
You take fixed charge over assets that are not disposed of during the normal course of business (e.g. land or machinery)
A floating charge is an equitable charge over all of a company’s business and assets. You take a floating charge over all other assets, e.g. stock
Can you freely trade assets under a floating charge?
Yes if you own a business that has assets that are under a floating you are still the owner of the assets with full legal title.
Only upon an event such as a default would the floating charge crystallise and you lose the ability the trade these asset.
Describe the two main features of a floating charge?
- It is an equitable charge over current and future assets
- The debenture allows the company to freely trade assets that are under a floating charge
What are the five main features of the enterprise act 2002 which consider companies in administration?
1 - An administrator can be appointed by someone who holds a floating charge. The objective of the administrator is to “secure the company as a going concern”
2 - Administrators can make payments to secured creditors without court approval
3 - Administrators can make payment to unsecured creditors with court approval
4 - The holder of a floating charge is no longer able to appoint an administrative reciever
5 - HMRC loses their preferential status in the event of insolvency
What was the intention of the Enterprise Act 2002?
To make debentures a less power tool to weaken banks claims over business asset so the business would have a great chance to recover
This weakening of debentures of course made them less valuable as security
What is the “prescribed part” with regards to floating charges?
The amount of a floating charge that is ring-fenced for unsecured creditors.
50% of the first £10,000 and 20% between 10k-600k
Imagine you have an asset worth £90,000 which is under floating charge.
Calculate the prescribed part
10k x 50% = £5,000
90k x 20% = £16,000
Total prescribed part is £21,000
Imagine you have an asset worth £1.5M which is under floating charge.
Calculate the prescribed part
(10k x 50%) + (590k x 20%)
= £123,000
What is a hardening period?
When the customer has an overdraft and a floating charge, they repay the overdraft and redrawn back down into the overdraft. They now have a floating charge on this “new debt”. This concludes the “hardening period”.
Think Clayton’s case
What factors must you consider when trying to value a debenture?
- Right of set off
- Contracted debts (in the case of incomplete work e.g construction)
- Inter-company debtors
- Stock (can often only sell for 10% of its purchase value)
Why is it important to establish any registered debentures with Companies House?
This will stop a company who has floating charges over its assets from going to a new bank and opening an account to deposit money.
Although the company may be looking to open a deposit account with the new bank, consider the transactions:
500 Cr
- 200 dr
- 200 dr
The bank with the debenture will come after the new bank for the credit amount at the time (500) and if the debits haven’t gone through the account yet to reduce the credit amount, then the new bank will be out of pocked by 400.
Give some examples of good security?
- Insurance policy (if instalments are paid)
- Gurantees
