#10488 - Security - Debt Finance

SECURITY

*Memorize this table: often comes up as an exam question!

ASSET	SECURITY INTEREST	PERFECTION¹ All security to be registered at CH under s.859A CA.
Properties	Charge by way of legal mortgage	Registration at the Land Registry.
Machinery	Fixed charge
Shareholdings (subsidiaries)	Legal mortgage/equitable mortgage/fixed charge Equitable mortgage is the most likely type of security taken over shares.	Equitable mortgage/fixed charge: - Share certificates deposited with bank for safekeeping - Undated blank stock transfer form - Power of attorney [in the debenture] so bank can complete the STF Legal mortgage: - Transfer shares into bank’s name (completed stock transfer form) - Issue new share certificates to bank - Register the bank as owner in the register of members of the subsidiaries
Shareholdings (investment portfolio)	Legal mortgage/fixed charge/ equitable mortgage All of the above options assume that the portfolio is not traded frequently. If it was, a floating charge would be more commercially practicable.	See above. Note that if any of the investments are made in foreign companies, local law advice will be needed for perfection requirements. See below for some commercial points to consider when taking security over such investments.
Debtors (intragroup loans)	Fixed charge/legal assignment. Likely to be a fixed charge as debts are not constantly changing; bank will be able to demonstrate control required (Spectrum plus). Need to check if asset/contract in question is assignable – i.e. no prohibitions on assignment.	If legal assignment, notice to debtors will be required under s.136 LPA. If fixed charge, notice is a matter of good practice, not a legal requirement.
Book debts	Fixed charge, but likely to be a floating charge due to Spectrum issues.	Notice is a matter of good practice, not a legal requirement.
Cash at bank	Floating charge Fixed charge if deposit account
Stock	Floating charge
Future property/IP rights (acquired during course of loan)	Fixed charge/equitable mortgage/equitable assignment, where appropriate (can only grant equitable rights) “Further assurances” clause and power of attorney both needed in debenture	As and when property/IP is acquired; registration at IP office or LR for registered property
Insurance policies	Legal assignment/fixed charge	Notice to the insurance company. As a minimum, bank’s interest to be noted on the policy. Ideally, to be listed as ‘co-insured in respect of its separate rights and interests’.
Key contracts	Legal assignment/fixed charge Again, check if contracts contain prohibitions on assignment.	Notice to counterparty (required for legal assignment, preferable for fixed charge) Serving notice may be commercially unattractive to the borrower; compromise may be for it to sign notices and deliver to the lender at the time the security is granted but for the lender to agree only to deliver the notices following an EoD.
Trade marks/patents/registered designs	Assignment/fixed charge	Registration at the IP office – no register for copyright!
Goodwill	Fixed charge
Everything else	Floating charge

Commercial and practical aspects

Consider these points at the outset of the deal (i.e. when negotiating the security package):

1. Value of the security (in an enforcement situation)

Shareholdings – does the value of the security justify the expense of taking security? Is there a ready market for the shares and can the directors of the various companies refuse to register the transfer of shares [i.e. making it difficult to enforce security]? Bank will not want to become a shadow director of companies if it enforces security over the shares; also beware of pension fund liability!
Assignment of contracts – is consent of the counterparty required for the assignment of a key contract?
Land - Risk of environmental liability?
Will each secured asset retain its value?
Is there existing security over any assets? Are there negative pledges in existing loans/security documentation? What priority will this security have?
How does the lender want to enforce its security [asset sale or share sale]? Consider issues of structural subordination if only security over shares taken.

ASSET AND SECURITY INTEREST	SPECIFIC ISSUE
Fixed charges over book debts	Spectrum Plus (case) requires that to create a fixed charge over a book debt, the lender must demonstrate sufficient control over both the debt and its proceeds. Showing control over the debts themselves is easy; showing sufficient control over the proceeds is difficult [must be a genuine blocked account] – and commercially unacceptable to both parties.
Mortgages over shares	Check that the directors do not have the right to refuse to register a transfer and that pre-emption rights do not apply to a transfer of the shares on enforcement. [May require amended AoA before security is granted] Are the shares in an unlimited liability company or does the company operate a defined benefit pension scheme? Potential liabilities for the bank. Shareholders rank below secured and unsecured creditors; not ideal to rely only on this security. Shares in private companies not easily marketable. Legal mortgages: Although this is the strongest type of security interest, the lender will also inherit administrative duties and runs the risk of the liabilities mentioned above. It may also become an ‘associate’ of a company if it has control (1/3 or more of the voting rights) for the purposes of the IA 1986 – not ideal. Hence, taking an equitable mortgage will be preferable.
Assignment by way of security/fixed charge over contractual rights	Check that there are no provisions prohibiting charging or assigning the contract. If there are, borrower must obtain express written consent of counterparty before the security is granted. Always ensure that assignment is notified; commercial consequences are very disadvantageous for a lender!
Assignment by way of security/fixed charge over insurance contracts	Lenders should not be ‘jointly’ insured – they should be ‘co-insured in respect of its separate rights and interests’. Lenders may try to include a clause in the debenture and a specific agreement with the insurer that states that misrepresentation or non-payment of the premium will not invalidate the policy – but will be strongly resisted by the insurer.

2. Foreign advice

Foreign advice may be necessary when the assets are located outside the UK. Consider whether the expense of taking local legal advice justifies taking the security over the particular asset.

Registering security under s.859A-Q CA 2006

Deadline? Charges must be registered at CH within 21 days of the date of creation of the charge (s.859 CA 2006).
Documents? Form MR01 (s.859D statement) + a certified copy of the security document + relevant fee.
What happens next?

Registrar will then allocate to the security a unique reference code, and will include this along with the copy of the security document on the register.
Registrar issues a ‘certificate of registration’ stating that the name and number of the company in repsect of which the security has been registered and the unique reference number allocated to the security (s.859I(3)-(5)) – this is conclusive proof that the security has been correctly registered.

Consequences of failing to register? The charge will be void against the liquidator/administration/creditors of the company and officers in default will be liable to a fine and the loan will become immediately repayable (s.859H)
Who registers? The company has the main obligation to register the charge (s.859A(2)), but in practice it is the bank’s solicitors that will do so.
What records need to be kept? Under s.859P, a company must keep available for inspection a copy of every charge and a copy of every instrument that amends or varies any charge at its registered office/other permitted location. These must be available for inspection free of charge to any creditor/member of the company and to any other person on payment of a prescribed fee.
How to release the security?

Lender must execute a Deed of Release and execute any other documents required (e.g. DS1 for charge by way of legal mortgage)
Company must deliver to the Registrar one of the statements set out in s.859L(2): either Form MR04 (debt satisfied) or Form MR05 (charge released in part) and the particulars listed in s.859L(4)
Registrar, on receipt of either form, must include in the register in relation to the released charge a statement of satisfaction in whole or in part or a statement that all or part of the property or undertaking has been released from the charge (s.859L(5)).

Note: Under the FCA Regulations, security over cash, bonds and shares will not be void for want of registration. However, as there is usually a single security document for all the security, that document will need to be registered for the security over the non-Regulation assets to be valid.

Priority

Fixed charges have priority over floating charges (even if fixed charges are created after floating charges)
Fixed charges rank between themselves in priority according to date of creation
Floating charges rank between themselves in priority according to date of creation
For assets requiring registration in a specialist registry [e.g. Land Registry], it is usually the date of registration in the specialist registry that determines priority

Other points to consider when taking security

Corporate power and authority

If company has restrictions on its...

#10488 - Security - Debt Finance

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