#15477 - Security And Credit Support - Debt Finance

Security and Credit Support

Security

• Fixed charges: creditor controlled what the borrower does with the assets. But borrower can still use the asset in the course of business.

• Floating charges: ‘floats’ over the whole of a class of circulating assets, borrower free to dispose of assets until the charge crystallises. Disadvantages:

  1. Borrower free to dispose so creditor cannot be sure of value of security.

  2. Floating charge ranks below fixed charges in priority

  3. Subject to prescribed part fund for secured creditors

  4. Capable of being avoided under s.245 IA 1986

  5. Administrator can pay his remuneration and expenses from secured assets

• Guarantees: downstream (parent for sub) or upstream (sub for parent)

• Debenture: "document creating the security" separate from the loan agreement.

Priority:

1. Creditors with fixed charges

   • If more than one creditor has a fixed charge over the same assets, the first fixed charge created has priority (provided it was properly registered in accordance with s. 860 or s. 859A CA 2006)

     • 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.

2. Liquidator’s fees and expenses

3. Preferential creditors (wages up to 800 per employee & occupational pensions)

4. Creditors with floating charges

   • 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 —> ’prescribed part fund’.

   • 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).

     • 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.

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

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

   • Shareholders and unsecured and preferential creditors rank equally among themselves (subject to any preferential rights attached to certain classes of share).

• Regulation: Financial Services and Markets Act 2000

  • Private companies can only issue bonds to targeted investors and not to the public indiscriminately - s. 755 CA 2006.

  • If a private company makes an ‘offer to the public’ of bonds within the meaning of s. 85 FSMA and is not exempt, it will be required to produce a prospectus.

Security

• Fixed charge: lender must show sufficient level of control over asset (registration = s. 859A-Q CA 2006).

• Floating charge: borrower able to deal with assets until charge crystallises.

  • Re Yorkshire Woolcombers: floating if;

    1. Over a class of assets present and future

    2. Class would be changing in the ordinary course of business from time to time

    3. Contemplated that until some future step is taken the company will carry on its business in the ordinary way.

  • National Westminster v Spectrum: essential characteristic = "asset subject to the charge is not finally appropriated as security for payment of the debt until the occurrence of some future event. In the meantime, the borrower is left free to use the charged asset and to remove it from the security."

• Mortgages

  • Legal mortgage: involves a transfer of ownership - create by deed --> lender has power of sale under s.101 LPA 1925.

  • Charge by way of legal mortgage: no transfer of ownership, lender gets proprietary rights - used to secure land (s.87 LPA 1925) - register at Companies House & Land Registry.

• Grants the lender the same powers, protection and remedies as if the mortgage had been created by way of a lease for a term of 3,000 years

• Not possible to secure land to be acquired in future (take fixed charge to be later upgraded - backed by power of attorney in lender's favour)

• Equitable mortgage: transfer of beneficial interest only (create by: written agreement, mortgage over equitable interest, property not yet owned by borrower, invalid agreement for legal mortgage)

  • Weakness: equity's darling takes free (important to register at CH)

• Pledge: lender takes actual/constructive delivery of asset until payment of debt (letter of pledge/memorandum of deposit usually provided for certainty) - must give lender control.

  • Lender liable as a bailee - must keep asset safe & insure it.

  • Borrower loses possession of asset for income-generating purposes.

• Lien: automatic right to retain another’s property until that person meets an obligation.

  • Except for a banker's lien - there is no automatic power of sale.

• Assignment by way of security

  • Security over contractual rights (chose in action)

    • Legal assignment = s.136 LPA (equivalent to legal mortgage)

      1. In writing

      2. Absolute assignment (of the whole)

      3. Signed by assignor

      4. Notified to original debtor/contract counterparty

         • Administratively difficult

         • Commercially unattractive

         • Compromise = lender delivers notices on EoD

Security document will contain provision for re-assignment on satisfaction of security.

Equitable assignment if conditions not met.

• Issues:

  • Check no provisions prohibiting charging/assigning (express consent of counterparty)

  • Provisions re-directing payments to lender (generally or on EoD)

  • No notice = not legal assignment under s.136 LPA, counterparty can make payments to borrower, set off amounts owed by borrower against its payments, amend terms of contract by agreement with borrower without the lender's consent.

• Issues where security over insurance contracts: "Keyman" or buildings insurance.

  • Lenders will not want to be jointly insured with borrower

  • Being noted is not sufficient protection (not party to policy - unable to enforce directly)

  • Best option = "co-insured in respect of its separate rights and interests" (cover is composite - i.e. two contracts of insurance)

    • Borrower's interest falls away - lenders interest still remains

  • At the very lease insure bank is notified if policy materially varied, cancelled or not renewed & insurers aware that bank can claim charged monies directly/borrower will hold on trust.

• Fixed charge over contractual rights

  • Assignment usually preferred

  • Register at CH

  • Give notice to counterparty

Documents

• All assets = debenture

  • Bilateral = in favour of lender

  • Syndicated = in favour of security trustee on behalf of all lenders from time to time.

Commercial considerations

• What matters is the value in an enforcement situation - consider if:

  • Consent of counterparty required for assignment

  • Enforce security through share sale or asset sale, or option to do either

  • Will each secured asset retain its value

  • Existing security - negative pledge

  • Can asset be easily sold

  • Unwanted liabilities (e.g. Environmental Protection Act liability/pension deficit liability)

• Fixed charges over book debts

  • Spectrum: in order to create a fixed charge over a book debt, the lender had to demonstrate sufficient control over both the debt and its proceeds (proceeds must be paid into a blocked account which must be operates as such in practice) - substance over form.

    • Although fixed charge over book debts possible - amount of control required likely commercially unacceptable to both parties.

• Mortgages over shares (execute stock transfer form in favour of lender)

  • Check:

    • Directors have no right to refuse the transfer

    • Pre-emption rights will not apply on transfer on enforcement

Amend articles before granting security.

• Unlimited liability company?

• Any amount unpaid on shares?

• Liens over shares?

• Defined benefit pension scheme?

• Risks:

  1. Shareholders rank below unsecured & secured creditors

  2. Unlisted shares are difficult to value and less marketable