#3329 - Security Crib Sheet - Finance and Capital Markets

Security

1. Types of Security

   1. Pledge

      1. Possession is the strongest form of security

         1. Way of creating security by the actual delivery of a tangible movable asset to a creditor to be held until the performance of an obligation

         2. Confers certain implied rights, such as the right to sell the pledged assets to meet a defaulted debt

   2. Lien

      1. Right to retain possession of another person’s property until he settles an obligation

         1. Legal lien requires actual possession of the property but does not confer any right to sell it

         2. Equitable line does not require possession and will give a right of sale through application to the court

   3. Mortgage

      1. Confers ownership to a bank along with a right to sell on default and an obligation to re-transfer title on satisfaction of the debt

         1. Can have a legal mortgage 101 LPA 1925

         2. Can have an equitable mortgage resulting from

            1. A written agreement by a borrower that the property is to be secured by way of equitable mortgage

            2. An agreement to provide a legal mortgage

            3. A mortgage over an equitable interest

            4. A mortgage over property not yet owned by the borrower

            5. A purported legal mortgage that does not comply with all the necessary formalities

               1. Equitable mortgages can be ignored by a bona fide purchaser for the value of the legal title to an asset without notice of the equitable security

   4. Assignment

      1. It will in effect create a legal mortgage if it complies with 136 LPA 1925

         1. In writing and signed by the assignor

         2. Absolute

            1. Walter v Sullivan the whole of the debt/contract needs to be assigned

         3. Notified in writing to any person against whom the assignor could enforce the assigned rights

      2. If it is not a legal assignment, it will be an equitable one

         1. Ranks above a floating charge in an insolvency proceeding

      3. An assignment cannot transfer the assignor’s obligations

         1. There is a danger that any indemnity provisions for increased costs might be unassignable without consent because they are personal

   5. Charge by deed expressed to be by way of legal mortgage

      1. Legal mortgage over land

         1. No transfer of ownership

            1. Freehold property – 3000 year lease

            2. Leasehold property – 1 day less than the length of the lease

   6. Fixed Charge

      1. Gives lender rights over the asset which

         1. Prohibit the borrower from disposing of the asset without permission

         2. Attempt to maintain the asset’s value whilst it is in the borrower’s hands

         3. Allows the bank recourse to the asset in the event of the borrower’s default under the loan

         4. Allows a borrower to use the charged assets unless and until any ‘enforcement event’ occurs as specified in the charge document

   7. Floating Charge

      1. Secures a group of assets which may fluctuate from time to time

      2. Specifically allows the borrower to deal with the charged assets in the ordinary course of business, allowing a borrower to sell its stock and dispose of its other current assets so that it may continue trading and make money which it will eventually use to repay the secured loan

         1. Companies need to be able to utilise the raw materials and sell its products in the daily course of business. A fixed charge over these assets would prevent the company from dealing with or disposing of them without the lender’s consent in its capacity as security trustee under the Security Agreement. This would clearly be impractical given the sheer number and frequency of the transactions involved.

            1. Banks will want some form of security over these assets though

         2. Will allow companies to deal freely with the assets until such time as there is an event of default under the finance documents or if the company become subject to insolvency proceedings

      3. On the occurrence of certain events the floating charge will crystallise and effectively become a fixed charge with respect to any of the assets of which it had previously ‘floated’ and which remain in the borrower’s ownership

         1. Preferential creditors have first call on the proceeds of sale of the companies’ assets and a proportion of the value would be set aside to pay unsecured creditors (ring-fenced fund), the banks’ claim still ranks ahead of that of most of the unsecured creditors

      4. Holder of a floating charge has the right under Para 14, Sch B1 IA 1986 to appoint an administrator over the company if it gets into financial difficulty

2. Priority of security

   1. Fixed charges and mortgages that are properly registered under the CA 2006 rank in order of creation

      1. A fixed charge created prior to a legal mortgage will rank ahead of the legal mortgage, provided that it has been registered within 21 days of its creation

      2. Registration of an equitable fixed charge will constitute notice or constructive notice to anyone who has searched the register or ought to have done so, including another lender wishing to take security over the asset

   2. Priority of assignments is determined by the first assignee to give notice to the third party irrespective of the date of creation, under a common law rule in Dearle v Hall

      1. Assignments registered under 860(7) CA 2006 will constitute constructive notice

      2. If a borrower assigns a contract to a lender and the lender then fails to give notice to the third party, and the borrower later assigns the contract to another assignee, that later assignee will gain priority over the original lender if the subsequence assignee notifies the third party

   3. Floating charge over an asset which is made subject to a fixed charge will rank behind the fixed charge even if the floating charge has been created and properly registered

      1. Here priority is not determined by the date of creation of the charge
         

3. Negative Pledge

   1. Prevents companies being able to give a mortgage or a fixed charge over certain of their assets that would then rank ahead of the floating charge in favour of the syndicate

   2. It is essential that companies do not grant subsequent charges in contravention to the negative pledges in the Security Agreement

      1. Almost certainly trigger an event of default under the Credit Agreement

   3. If a second charge is aware of the negative pledge it could be liable for the tort of inducing a breach of contract and it is arguable that it would hold the security on trust for the syndicate on the grounds that it may not benefit from its own wrongdoing

      1. First charges will guard against this by including reference to the existence of the negative pledge in the security agreement when registering the charge at Companies House, even though a negative pledge is not one of the prescribed particulars that must be registered

         1. There is disagreement as to whether or not this constitutes constructive notice to those who ought to search the register but do not

         2. In reality most potential lenders or their solicitors will carry out a company search before taking security and will therefore have actual notice of the negative pledge

4. Which security for which asset?

   1. Leasehold premises

      1. Charge by deed expressed to be by way of legal mortgage

         1. 52 LPA 1925 Must be by deed

         2. 87 LPA 1925 mortgage over land does not transfer ownership of the property, however the mortgage gives the lender rights equivalent to a lease of 1 day less than the duration of the borrower’s lease

      2. Considerations for the lender:

         1. How long is left before the expiration of the lease?

         2. How much is being paid for the lease and what is the market value of the lease?

            1. If the borrower is paying below market value for the lease, it is a valuable item for security because the lender will be obtaining it less for market value

            2. If the borrower is paying market rate or above, it is not worth taking security over as the bank would not make a profit when selling it on because the bank will not be able to sell it at a premium

         3. Are there limitations on assignment or charging in the lease?

            1. Is consent required under the lease?

   2. Freehold premises

      1. Charge by deed expressed to be by way of legal mortgage

         1. 52 LPA 1925 Must be by deed

         2. 87 LPA 1925 mortgage over land does not transfer ownership of the property but will give the lender rights equivalent to a 3000 year lease over the property

      2. Considerations for the lender:

         1. Is there a pre-existing mortgage on the premises?

            1. Lender should negotiate a subordination or inter-creditor agreement with the existing mortgagee

   3. Supply contracts

      1. Legal Assignment

         1. Best for lucrative and a small number of contracts

         2. Lender has priority over equitable assignment

         3. Lender can sue the third party directly rather than having to join the borrower in an action

         1. Considerations:

            1. Does the borrower want the third parties alerted to the fact that he is refinancing?

            2. Are there many contracts such that it will be a large administrative burden to alert all the third parties?

      2. Equitable assignment

         1. Assignment which falls foul of the conditions for legal assignment

         2. No need to give notice to the third parties

            1. Refinancing can be kept confidential

         3. Assignment can be given to future debts

         1. Considerations:

            1. Third party who owes the borrower money will be discharged from his liability by paying it to the borrower instead of the lender

            2. Right of set-off applies

            3. An equitable assignment does not grant the original lender priority over subsequent lenders who are assigned the contract

            4. Lender will have to join the borrower in an action in order to sue the third party

   4. Book debts

      1. Fixed Charge

         1. Stronger than a floating charge on insolvency of the borrower

         1. Considerations:

            1. Administrative inconvenience. Following Spectrum it remains possible to take a fixed charge over book debt, but lender must show that he has sufficient control over both the book debts and their...