Gateley partner James Baird tackles legal approaches to securities on assets
Ever since lenders have loaned their monies to borrowers, creditors have always wanted to ensure that the funds are repaid. Naturally, the risk of non-payment needs to be reduced as much as possible.
Prudent lending entails looking for potential debtors with a low risk of default, and therefore have strong covenants to repay credit.
However, creditors can still prudently lend monies to borrowers with weaker covenants, leading to higher default risks where they can obtain a secondary method of credit repayment.
This article explores some of the more common means of obtaining those secondary sources of repayment, thereby securing the repayment of the funds loaned.
Asset funders and lessors own the assets which they lease. Thus, they have not only contractual rights under the lease or finance agreements they conclude with lessees, but also concurrent property rights, stemming from the funder’s ownership of the assets concerned.
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The proprietary rights flowing from the title to the assets, when married with an immediate right to possess the goods, allows the funder to retake possession of its goods from a defaulting debtor.
The funder can then sell its goods and use the net sale proceeds to repay in full or part, the outstanding credit of the debtor.
Title-backed funders are not technically using a security device but, following a default by the lessee and the consequent withdrawal of consent for the lessee to possess the goods leased, are simply pairing up their ownership rights to the asset leased, with their immediate right to possess the goods. This secondary repayment channel is simple and effective, and is the basis of reducing all asset and leasing agreements’ default risk.
Guarantees and indemnities
The creditor can be further protected in addition to its contractual and title rights, by getting a third party to guarantee the lessee’s obligations and/or indemnifying the lessor against losses caused by the debtor’s default. People and/or companies can give
Guarantees are relatively simple to put in place, but there are a few technicalities which need to be followed to ensure they are valid and enforceable.
Guarantees need to be in writing or evidenced in writing by a note or memorandum of the agreement and signed by the guarantor. Because a guarantee is a special promise by a non-debtor to pay the debts of the debtor, there may be circumstances when the creditor is put on notice that the personal guarantor may not be acting completely freely and without pressure from the debtor.
To prevent any risk of a personal guarantor being unduly influenced to give the guarantee, prudent creditors should ensure that the guarantor takes independent legal advice on the nature and scope of the promise they are giving to the creditor under the guarantee.
A chattel mortgage is a charge over the asset itself. It is distinct from ownership of the asset.
This is an old, well-established security device and governed by various Bills of Sale Acts. There are formalities to follow and a failure to do so will render the security ineffective.
Chattel mortgages can be commercially cumbersome, and their use is waning and falling out of favour with creditors, debtors and regulators.
However in certain sectors, such as ‘logbook loans’ motor funding, they can be useful.
An insurer, in return for a premium, agrees to indemnify the assured on the happening of an agreed event such as a default in repayment. Thus, a contract of insurance is a device often used by creditors and debtors to indemnify the creditor in default scenarios.
A lien flows from possession of an asset which can be maintained against non-payment of certain debts. Liens are quasi-securities, and often funders or related maintenance companies can enforce liens for unpaid repair costs over assets against other security holders and/or the lessee/lessor.
A funder can take security over real estate or other property, or a fund owned by the debtor or third party which contains a power of sale in the event of a default, whereby the proceeds of the sale can be used to repay the credit loaned. There are a few formalities to meet before a legal charge can be valid and it has to be in writing and dated as a deed and registered. If a company is providing the security, any charges need to be registered at Companies House within 21 days of execution. The position of occupiers’ rights needs to be ascertained, along with priorities of any prior security holder.
Fixed and floating charges
Companies can provide security over some or all of its assets, including inventory and income streams. Assets can be either fixed, or in the case of an inventory or income stream, varied and changing in nature. Many asset funders and/or lessors are keen to try to secure rights over all such assets. Doing so can be more detailed and technical than some other forms of security, but can provide a strong incentive on the primary borrower to ensure no default.
As with legal charges, debentures have to be in writing and registered within 21 days at Companies House.
As can be seen from this high-level overview of some of the more common security devices, there are many quasi-security and security methods and options, all with varying degrees of formality and registration requirements.
The Law Commission has looked at streamlining the position to add clarity, and working groups are reviewing the position with a view to developing a single form and registration for securities based on notice filing at a central online registry.
There will always be lenders willing to lend their funds to debtors in return for a commercial margin and upon which to take an assessed default risk.
Lenders have developed numerous devices to mitigate that credit risk, and will continue to use them and innovate in response to actual and perceived credit risk, and the ever-shifting regulatory landscape. <