A Q&A guide to finance in the UK (England and Wales). The Q&A gives a high level overview of the lending market, forms of security over assets, special purpose vehicles in secured lending, quasi-security, guarantees, and loan agreements. It covers creation and registration requirements for security interests; problem assets over which security is difficult to grant; risk areas for lenders; structuring the priority of debt; debt trading and transfer mechanisms; agent and trust concepts; enforcement of security interests and borrower insolvency; cross-border issues on loans; taxes; and proposals for reform.
To compare answers across multiple jurisdictions, visit the Lending and taking security in country Q&A tool.
This article is part of the PLC multi-jurisdictional guide to finance. For a full list of contents visit www.practicallaw.com/finance-mjg.
During 2012, banks and other financial institutions prepared their balance sheets for the implementation of Basel III in the EU, and the more onerous capital requirements this will bring. However, the proposed implementation date of 1 January 2013 was not achieved. The relevant EU bodies are now aiming to implement the new rules on 1 January 2014, but whether this is achievable is still not clear.
This and other factors, such as ongoing uncertainty about the direction of the eurozone, and slow and limited recovery in the global economy generally, have continued to suppress both supply and demand for loans.
Lenders are also operating in the context of an unprecedented level of other regulatory change. For example, from 1 April 2013 the Financial Services Authority's role as the regulator of financial services will be split and shared between two new bodies, the Prudential Regulation Authority and the Financial Conduct Authority.
Despite some high-profile insolvencies (in particular in retail), business failure rates have remained relatively low, largely because of low interest rates. Much of the focus within lending institutions has therefore remained on managing existing loans.
The UK Government and the Bank of England have taken various measures to try to stimulate lending, particularly to small- and medium-sized businesses. For example, in August 2012 the Funding for Lending Scheme was launched, allowing banks and building societies to borrow at cheaper rates from the Bank of England.
On larger financings, the use of debt capital markets funding with loans is a continuing trend.
Real estate is land, and any building, structure or other thing permanently affixed to land.
You can own real estate in one of three ways:
Freehold, which means absolute ownership.
Leasehold, which means ownership for a period of time at a rent.
Commonhold, which was introduced in 2002 as an alternative to leasehold ownership for residential apartments, offices and other multi-occupied buildings and estates. However, many consider the commonhold system to be unworkable and very few commonhold schemes have been created.
Title to most real estate in England and Wales is registered at the Land Registry. The rest has unregistered title, which is proved by title deeds. A transfer of unregistered land, or a grant of a first legal mortgage over it, triggers an obligation to register the title.
The most common forms of security over real estate are:
Legal mortgages. A lender will usually prefer to take a legal mortgage over real estate of significant value: it gives the best protection against other interests (including other security interests) in the same asset. A legal mortgage can only be granted over real estate that the security provider currently owns.
Equitable mortgages and fixed charges. Though there are technical differences between the nature of an equitable mortgage and a fixed charge, there are few practical differences between them. Both can be granted over current and future-owned assets. They are also both easier to create than legal mortgages as there are fewer formalities involved (see below). Equitable mortgages over real estate usually arise when a mortgage is granted, but the lender chooses not to, or fails to, complete the formalities necessary for it to become a legal mortgage.
Fixed charges over real estate most commonly arise as part of an “all asset” security package. Lenders often take a fixed charge over any real estate acquired after the security has been granted.
Provided no other competing interests in the asset arise, the advantages of a legal mortgage are less significant. In an insolvency of the security provider, all three types of security interest will ensure the lender receives any net sale proceeds from the asset in priority to unsecured creditors. Outside insolvency, a legal mortgage does provide some enforcement rights not enjoyed, or in some cases, not automatically enjoyed, by the holder of an equitable mortgage or charge. But if the relevant security document has been properly drafted and executed as a deed, the most likely enforcement options will also be available to the holder of an equitable mortgage or fixed charge.
Legal mortgages. A legal mortgage must be in writing and executed as a deed by the mortgagor. To take effect as a legal mortgage, a mortgage over registered title must be registered at the Land Registry. If the security is not registered, it will usually take effect as an equitable mortgage.
Equitable mortgages and fixed charges. These must be in writing and signed by the security provider. They do not have to be executed as deeds by the security provider, but almost always are as the security will be weaker if they are not. If the security is intended to cover real estate not yet owned by the security provider, the security document must also be signed by the security holder.
A notice of an equitable mortgage or fixed charge over registered title can be registered at the Land Registry. This protects the priority of the security against subsequent security interests, though not earlier ones. However, it is not compulsory to register and lenders often choose not to.
Any mortgage or charge over real estate granted by a UK company or LLP must be registered at Companies House in the 21-day period immediately after the security is created or it will be void on insolvency and against other creditors.
The English law term for tangible movable property is chattels. If an asset becomes permanently affixed to land or buildings it can cease to be a chattel and become real estate (land) (see Question 2). For example, this may happen to a gas turbine installed into the fabric of a power station.
Examples of chattels include:
Plant and machinery.
Stock and inventory.
Rolling stock, motor vehicles and shipping containers.
Ships and aircraft.
The most common forms of security over tangible movable property are:
Fixed charges. Generally, a fixed charge over chattels charges specific chattels or a class of chattels. The chargee has, and exercises in practice, enough control over those assets to prevent the chargor from dealing with them free from the fixed charge. This means it is rare to take fixed security over stock and other assets a company needs to deal with freely (see Question 8).
Floating charges. A floating charge can be created without restricting the chargor's right to deal with the charged assets free from the charge. Usually that right will end on an event of default.
For information on the priority between fixed and floating charges, see Question 24.
Chattel mortgages. A lender may also take a chattel mortgage. However, in practice, this is rare except in the case of ships and aircraft, which have their own special statutory mortgage regimes. Both regimes allow the lender to take a legal mortgage and to register it at a specialist register.
A chattel is mortgaged by transferring legal title to the chattel to the mortgagee by way of security. The mortgagor is entitled to a retransfer of that title once the secured obligations have been discharged.
Rolling stock is usually leased rather than financed by secured lending. Leasing is also common for other large chattels and for equipment (such as cars and computers) the lessee will use over the medium to long term.
Security over chattels is usually created in writing and executed as a deed. If granted by a UK company or limited liability partnership (LLP), it must be registered at Companies House in the 21-day period immediately after it is created or the security will be void on insolvency and against other creditors.
Sometimes the lender will require the security provider to attach a nameplate to the charged asset to notify its security to third parties. Nameplates are not fraudster-proof.
The financial instruments over which security is most commonly granted are shares and debt securities (including bonds, notes and commercial paper). Security can be granted over the security provider's rights in:
Directly held financial instruments, which would include certificated securities (such as shares in private companies) and dematerialised securities (such as shares in listed companies traded on CREST) owned by the security provider.
Indirectly held (or book entry) financial instruments. Bonds and other tradeable debt securities are often held in this way through intermediaries.
Common forms of security include:
Certificated shares and debt securities. It is possible to take a legal mortgage, but as this involves transferring the legal title to the securities to the mortgagee (or its nominee) there are legal and practical disadvantages. Equitable mortgages and fixed charges are therefore more common.
Dematerialised registered shares. If the chargor holds an account with Euroclear UK & Ireland (CREST), it is possible to take either legal or equitable security over shares held in the CREST account.
Indirectly held financial instruments. If shares or debt securities are held indirectly, the nature of the chargor's interest in them will dictate what security interest the chargor can grant. However, it is common to take a fixed or floating charge over the chargor's proprietary interest in the securities account in which the relevant securities are held (and any related cash account), plus an assignment of (or charge over) the security provider's rights under its investment or custody agreement with its intermediary.
The formalities for creating the common forms of security over financial instruments are as follows:
Certificated shares and debt securities:
legal mortgage: title to the securities must be transferred to the mortgagee (or its nominee), who will appear as the holder of record;
equitable mortgage: this can be created in a number of ways, including by the owner's delivery of the title certificate to the security holder (provided the intention to create security is clear) or by its agreement to grant a legal mortgage to the security holder;
charge: all that is needed is evidence of the intention to create the security.
In practice, equitable mortgages and charges over certificated shares are usually created in writing and executed as deeds. The security holder will also usually take possession of the shares certificates and a stock transfer form executed by the security provider but with the transferee details left blank. This should enable it to upgrade its security to a legal mortgage (by transferring title to itself or a nominee) independently, as a prelude to exercising its power of sale.
Equitable security (whether by way of equitable mortgage or charge) over shares is vulnerable to a sale to a third party with no notice of the security. The security holder's possession of the share certificate may reduce the risk of such a sale. However, this may not prevent a fraudulent chargor from claiming to have lost its certificate and obtaining a replacement from the company for this purpose. It is possible for a holder of equitable security over shares to apply to court to serve a “stop notice” on a company to protect against wrongful dealings in the shares, although this procedure is rarely used in practice.
Dematerialised registered shares. The CREST system allows CREST members to grant legal and equitable mortgages over their shares held in CREST. The following can be created:
a legal mortgage, where the mortgagor transfers the shares to the CREST account of the mortgagee or, if the mortgagee does not have a CREST account, to the account of the mortgagee's nominee;
an equitable mortgage, where the mortgagor transfers the shares into an escrow account. The mortgagee has control over the shares and must consent to any dealings in them.
Indirectly held financial instruments. The nature of the security will dictate the formalities. For example, where a chargor has granted an assignment of (or charge over) its rights under its investment or custody agreement with an intermediary, notice of that assignment would usually be given to the intermediary. See Question 5.
The Financial Collateral Arrangements (No.2) Regulations 2003 (Regulations) disapply any other statutory requirement to register a security interest that constitutes a “security financial collateral arrangement”. This includes most fixed security over financial instruments that may otherwise be registrable at Companies House. However, the extent to which this disapplies the requirement to register floating charges over financial instruments, or over “related rights” such as rights to dividends, is unclear. Under the Regulations, “security financial collateral arrangements” expressly include floating charges over financial instruments, but only if the security assets are in the possession or under the control of the security holder. This is often not the case with floating charges.
In practice, security interests in financial instruments granted by UK companies and LLPs are often registered at Companies House, in part because of these uncertainties.
Common types of claims and receivables include:
Debts and other rights to the payment of money.
Rights to require (in project financing, for example) performance of a non-financial obligation.
Rights to claim under insurances.
Cash deposited with banks (see Question 6).
Common forms of security over claims and receivables are:
Security assignment (or mortgage).
The security will almost always be in writing. The security must be executed as a deed if it grants the lender a power of attorney. A lender taking a security assignment may require that assignment to comply with section 136 Law of Property Act 1925. The key advantage this compliance brings is that the assignee can bring a court action to enforce the assigned right without joining the assignor in the proceedings. There are other ways of obtaining that ability. For example, the assignment or charge may grant the lender a power of attorney to bring court proceedings in the assignor's (or chargor's) name. Alternatively, it might authorise the lender to appoint a receiver to enforce the assigned (or charged) rights in the security provider's name but at the lender's direction. Nevertheless, lenders tend to prefer that their security assignments comply with section 136 where possible.
To comply with section 136, an assignment must be:
In writing signed by the assignor.
Of the whole right.
Expressed as an assignment (that is, a title transfer) rather than a charge (that is, the mere appropriation of an asset without transferring its title).
Notified in writing to the debtor or other person against whom the assigned right is enforceable.
Of legal rather than equitable rights (such as future property).
Whether rights are future property is a complex question under English law. An assignment of all rights to claim under an existing insurance policy is, for example, regarded as future property. Future property may be assigned or charged under English law, but if it is assigned the assignment will not comply with section 136.
To perfect the security assignment or charge, it is advisable (though not always commercially possible) to notify the debtor or other obligor. Priority between multiple assignments of the same right is (broadly) determined by the order in which the debtor or other obligor receives notice of each assignment. To benefit from this rule a notifying assignor must, among other things:
Give value for its assignment.
Not have had notice of a previous assignment when it took its own assignment.
A security assignment or charge of claims or receivables granted by a UK company or LLP must be registered at Companies House in the 21-day period immediately after the security is created or it will be void on insolvency and against other creditors.
English law regards a cash deposit as a debt payable by the account bank to the account holder. It is common to grant security over that debt by charging or assigning the deposit in favour of the lender. If the lender is also the account bank, the deposit should be charged in its favour rather than assigned to it.
Where the lender is the account bank, it is common to reinforce that charge by both:
Express set-off rights against the deposit in favour of the lender.
A flawed asset clause.
The flawed asset clause will provide that the charged deposit will not accrue due for repayment until the secured obligations have been discharged. This should prevent unsecured judgment creditors of the depositor from being able to attach the deposit under an enforcement procedure known as a third party debt order.
If the security is being granted to the account bank in its capacity as a security trustee for multiple creditors, it would be common to charge the deposit in its favour. If the security holder is not the account bank, it is preferable to assign the deposit to it and notify that assignment to the account bank.
As with other circulating assets (see Question 8), a security holder wishing to take fixed security over a cash deposit must take active steps to control it. If the security provider is entitled to access any part of the deposit (directly or indirectly) there is a risk the security will be treated as a floating charge, regardless of how it is expressed in the security document.
Whether the security is a security assignment or charge it will be:
Signed by or on behalf of the assignor or chargor.
Usually executed as a deed.
Fixed security over cash deposited with a bank is probably not registrable at Companies House. The extent to which the Regulations disapply the requirement to register a floating charge over a cash deposit is unclear (see Question 4, Registration). Given this uncertainty, and the risk that “fixed” security may be recharacterised as floating, cash security granted by UK companies and LLPs is very commonly registered at Companies House.
The main types of intellectual property are:
Security can be granted over intellectual property by way of either:
Mortgages (usually expressed as assignments).
Fixed or floating charges.
It is unusual for a lender to take a legal mortgage over intellectual property. If a lender does so, it will usually have to grant an exclusive licence back to the mortgagor immediately, to enable the mortgagor to use the intellectual property in its business. Although a legal mortgage is the most robust form of security, a properly drafted, executed and perfected fixed charge over intellectual property also provides the most important of its benefits.
Some types of security over intellectual property must be in writing and signed by the security provider. All types of security over intellectual property are usually in writing and executed as a deed by the security provider.
Security over intellectual property granted by a UK company or LLP must be registered at Companies House in the 21-day period immediately after the security is created, or it will be void on insolvency and against other creditors.
Title to patents, registered trade marks and registered design rights is registered at the Intellectual Property Office (IPO). To create a legal mortgage over registered intellectual property, title transfer to the mortgagee must be recorded at the IPO.
A charge over registered intellectual property can also be registered at the IPO. Failure to register does not affect the validity of the security, but may make the security more vulnerable to other subsequent interests. However, registration at Companies House is often considered sufficient protection. For example, it should protect the priority of a fixed charge over a patent or registered trade mark against the interests of subsequent security holders.
There are no types of assets over which security cannot be granted or which can only be granted with difficulty under English law. This includes future assets and fungible assets. However, the type of asset may dictate the nature of the security interest that can be obtained.
It is not possible to take a legal mortgage over future assets (that is, assets not yet in existence or not yet owned by the security provider).
It is possible to take a charge or other equitable security over future assets. This can be particularly useful to ensure circulating assets of a company fall within a security package. However, there may be other limitations on the type of security that can be taken over these types of asset (see Circulating assets and Other assets).
For a fixed charge over an asset to take effect as such, the security holder must have practical control over the asset. If the chargor is left free to dispose of the asset, or to “use it up” in running its business, the charge is likely to be recharacterised as a floating charge. Establishing sufficient control over circulating assets of a company, such as inventory and receivables, can be difficult. Lenders will therefore often be prepared to accept a floating charge over these types of asset.
A party to a contract can effectively prohibit the assignment by another party of its rights under the contract. When taking security over contractual rights (including rights under a lease), it may be necessary to check whether there are any relevant prohibitions or restrictions of this type in the contract and, if so, obtain the contract counterparty's consent.
Security is usually released by deed.
When a legal mortgage over registered real estate is released, the lender must also execute and file the appropriate Land Registry form (usually a Form DS1).
When security granted by a UK company is released, the company will usually wish the release to be recorded at Companies House. However, a failure to do so does not affect the validity of the release.
When an asset subject to a floating charge is sold, a release of the charge is not usually necessary. However, the buyer may request a letter of non-crystallisation from the charge holder. This is to ensure the buyer takes the asset free from the charge.
It is common to take security over the shares of an SPV borrower, but lenders often take security over the SPV's assets too. The share security is likely to be taken to provide an alternative enforcement option. For example, there may be tax advantages for a buyer in acquiring the entity rather than its assets.
In a simple sale and leaseback, the owner of equipment sells that equipment to a financier who leases the equipment back to the seller. Variations on this structure are for:
The initial sale to be to a dealer, who on-sells to a financier, who leases back to the original seller.
The financier to let the equipment back to another company in the seller's group, rather than to the original seller.
If (following the simple structure summarised above) a purchaser of goods leases them back to their seller, the purchaser faces the following two key risks:
The seller may give good title to the goods to a third party under section 24 Sale of Goods Act 1979.
If the leaseback requires the seller to re-purchase the goods, or gives it an option to do so, the arrangement may be recharacterised as a loan secured on the goods, with the rechacterised security void if not registered at Companies House.
Someone who sells but retains possession of goods (or documents of title to those goods) after the sale, may give title to those goods to anyone who receives them in good faith and without notice of the previous sale (section 24, Sale of Goods Act 1979). Section 24 does not apply if the seller does not continuously possess the goods from the time it sells them to the financier until it sells them to a third party. It is not completely clear how long an interruption of the seller's possession must last to prevent section 24 from applying.
Where the seller has an obligation or option to regain title to the goods it sold, by paying an option price or a final rental under a lease back, there is a risk a court will recharacterise this arrangement as a secured loan. Generally however, the English courts are unlikely to recharacterise these transactions as secured loans without evidence that the parties did not intend the sale and leaseback documents to record their true intentions.
In factoring, the financier buys its customer's receivables from time to time. The customer's debtors may be notified of the purchases, although often they are not. The financier may collect payment from the customer's debtors direct. Often the customer will collect for the financier. The financier may require recourse to its customer if the debtors do not pay the receivables.
The main risks for the financier are those flowing from:
Not notifying the receivables purchase.
Defective performance by the customer so that the receivables do not become due or due in full from the debtors.
Allowing the customer to collect the receivables.
The receivables purchase being recharacterised as a secured loan, with that security void for lack of registration at Companies House.
If the purchases are not notified:
The financier may lose priority to other purchasers who notify receivables purchases they have made without notice of the factor's purchases.
The customer's debtors will get a good discharge if they pay the customer rather than the financier.
The customer and its debtors are free, as between themselves, to amend or terminate their contract so that the sold receivables do not fall due.
The factor may be bound by certain types of set-off the debtor has against the customer that would have been cut off if the factor's receivables purchases been notified to the debtor.
However, if defective performance by the customer under, or in very close connection with, the contract generating the receivable, gives the debtor a set-off against the customer in relation to a sold receivable, notice will not prevent the debtor from asserting this type of set-off against the factor. However, the factor may invoke any enforceable no-set-off language in the contract generating the receivable against the debtor to collect free of set-off.
If the customer collects the receivables on behalf of the factor, the customer may dispose of the collections free of the factor's ownership. For this reason, the factor may require collections to be paid into a charged or trust account. In addition, it may only be willing for trusted customers to make collections.
The risk of a bona fide factoring transaction using a standard structure being recharacterised as a secured loan is low.
Under a hire purchase agreement (HPA), the owner of goods leases them to a lessee and grants the lessee an option to purchase the goods at the end of the lease. Conditional sale agreements (CSAs) are similar to HPAs. However, under a CSA, the lessee must take title to the leased equipment by paying the final rental under the CSA. HPAs and CSAs are not, of themselves, liable to recharacterisation as secured loans (see also Sale and leaseback).
A lessor of a motor vehicle under an HPA or CSA faces the risk, under the Hire Purchase Act 1964, that its lessee may (in some circumstances) sell the vehicle, before the lessee has itself acquired title from the lessor, but still be able to give good title to the vehicle to an innocent purchaser. Vehicle lessors commonly register their ownership at a commercially run register to try to mitigate this risk.
A lessee of goods under a CSA (that is not regulated by the consumer credit legislation) may, in some circumstances, give good title to those goods to an innocent purchaser despite the lessee not having acquired title to them from its lessor (section 9, Factors Act 1889 and section 25, Sale of Goods Act 1979). These sections do not apply to HPAs.
Among other things, lessors under both HPAs and CSAs face the following two risks that are inherent in equipment leasing:
The courts have a discretion (known as relief from forfeiture) to prevent the lessor from repossessing the leased equipment following a lessee default if (broadly) the lessee can show it is ready, willing and able to cure its breach of the lease. This risk is very low if the lease is an operating lease.
Depending on, among other things, the lease's drafting, the lessor may not be able to recover all amounts expressed to be due from the lessee on a default termination of the lease if those amounts are penal. Those amounts may be penal if they were not a genuine pre-estimate, when the parties executed the lease, of the losses the lessee's breach may cause the lessor and were not justified on other grounds. Broadly, the risk of a termination sum being regarded as penal is lower under a CSA than under an HPA.
Under a simple title retention structure, the seller retains title to goods it sells until it receives their purchase price. Broadly, the English courts will enforce this arrangement and not treat it as a registrable secured transaction. The courts may treat more complex structures as unregistered secured financings (for example, structures that involve title retention despite on-sales, or in relation to products made from the initially sold goods).
Broadly, contractual set-off arrangements are enforceable unless inconsistent with the Insolvency Rules 1986 and other insolvency laws. The 1986 rules impose a mandatory insolvency set-off regime when a company goes into liquidation, or is in administration once the administrator has given notice of an intention to make a distribution to creditors. Under that regime the claims and cross-claims to be set-off must be mutual. This requires the insolvent company and its counterparty to each, among other things:
Beneficially own their claims against each other.
Own their claims against each in the same capacity as they are subject to cross-claims from each other.
Close-out netting of a type contemplated by, for example, derivatives transactions under an ISDA Master Agreement is generally considered enforceable in English law. If these arrangements were to fail due to inconsistency with the Insolvency Rules 1986 (or other insolvency laws), the insolvency set-off regime those rules impose would tend to produce a similar result (but not necessarily identical net figures) to that contemplated by the ISDA close-out netting arrangements.
Finance leases are not, of themselves, liable to recharacterisation as secured loans (see Sale and leaseback). See Hire purchase for a summary of relief from forfeiture and of the possibility of a termination sum being irrecoverable as penal.
Guarantees are common in lending transactions. For a guarantee to be enforceable, either its main terms must be in writing and signed by or on behalf of the guarantor, or the guarantor (or its agent) must sign a note of those terms.
The beneficiary of the guarantee must also provide consideration for the guarantor's promise, unless the guarantor executes the guarantee as a deed. The consideration need not be described in writing.
Loan agreements and other finance documents are subject to general contractual principles. These may affect specific terms. For example, a very high default rate of interest could be treated as a penalty and so be unenforceable. Lenders therefore usually only require a modest uplift in the interest rate on overdue amounts. Some laws may have a more general effect on the structure of a loan transaction (see below).
A public company or its subsidiaries (whether public or private companies) cannot provide “financial assistance” in relation to the acquisition of that public company (Companies Act 2006). Financial assistance includes giving guarantees or security for any acquisition funding. On a debt-financed acquisition of a public company, the company will therefore often re-register as a private company. The statutory financial assistance rules no longer apply to the acquisition of private companies.
Where a private company is acquired using debt funding, the lender still needs to consider a company's obligation to maintain its capital (as do the directors of the target company). The directors of the company need to reach a view that any guarantee or security to be granted by the company for the acquisition debt will not be enforced, so that no provision needs to be made in the company's accounts. Board minutes should set out clearly the basis on which they have reached this conclusion.
A director of an English company has a statutory duty to act in a way he considers is likely to promote the company's success. If a counterparty to a proposed transaction with a company knows, or ought to know, that the company's directors are breaching that duty in approving the transaction, the counterparty may lose the benefit of any rights, or interests in assets, it received under the transaction documents.
Lenders need to be particularly aware of this when taking guarantees and third party security: what benefit is the surety getting from entering into the transaction? If the borrower is a subsidiary of the surety, the “corporate benefit” for the surety will usually be clear. In other situations, the benefit may be less obvious. Although it is a question of fact whether a transaction is likely to benefit a company, well drafted board minutes setting out the perceived benefits of the transaction (sometimes together with a shareholder resolution approving the transaction) can usually help minimise the risk of a successful challenge.
See also Question 23.
If a breach of environmental law occurs on a company's property, a lender will not automatically be wholly or partly liable for that breach solely as a result of having made a loan to, or taken a guarantee or security from, that company. In some cases, notably the contaminated land regime, lenders benefit from some statutory protection from liability. However, a lender may put itself at risk by the way it enforces or protects its rights under a lending transaction. This risk is most likely to arise in the following situations:
Enforcement of security over real estate. If a lender enforcing a mortgage over real estate becomes a mortgagee in possession, it may incur liability for any environmental breaches occurring while it remains in possession. Lenders proposing to enforce security over real estate should take advice to ensure they do not inadvertently take possession in doing so. This need not materially restrict a lender's enforcement options. A mortgagee can, for example, exercise a power of sale without going into possession.
Control of owner's activities. Environmental liability can arise under a number of different regimes (for example, contaminated land regime, the law of nuisance). The precise basis for determining who is liable for a particular breach of environmental law will depend on the regime under which the breach occurs. Under the contaminated land regime, for example, an individual can become liable for contamination which he “causes” or “knowingly permits”. So if a lender exerts direct control over the management of another company, it may be more at risk of incurring liability for a breach of environmental law relating to that company's assets. In most corporate lending transactions, the degree of control exercised by a lender will be insufficient to create a significant risk. A lender wishing significantly to extend its control over the business of a borrower or other company, typically in a distressed situation, should take advice before doing so.
It is common to subordinate “junior” debt by agreement between the senior creditor and junior creditor. The borrower will also usually be a party to the agreement.
These agreements can be used to subordinate junior debt both before and during the borrower's insolvency. For pre-insolvency subordination, the borrower will simply agree not to make, and the junior creditor will agree not to claim or accept, junior debt payments (other than any permitted payments the parties have agreed).
Different techniques can be used to ensure the subordination remains effective if the borrower enters an insolvency procedure. The simplest is for the junior creditor to agree not to prove in the insolvency until the senior creditor has been paid in full. A better and more commonly used alternative is “turnover subordination”. The junior creditor agrees to “turn over” to the senior creditor any recoveries it makes from its claim until the senior creditor has been paid in full. The senior creditor is taking credit risk on the junior creditor for this obligation. To address this, the senior creditor can also require the junior creditor to hold any turnover amounts on trust for the senior creditor until the junior creditor makes the turnover payment.
Structural subordination is also common. It is achieved by the junior lender lending to a holding company of the senior lender's borrower (the subsidiary), rather than by an agreement between the lenders. This structure subordinates the junior debt as on a subsidiary's insolvency, all the subsidiary's creditors must be paid in full before any distribution is made to the holding company.
Lenders wishing to rely on structural subordination should be aware that it will be ineffective if the subsidiary provides a guarantee of or security for its parent's loan. They should also take note of how proceeds from the parent's loan will be passed on to the subsidiary. If the parent will be on-lending to the subsidiary rather than providing equity funding, that loan must be contractually subordinated.
Trading of debt is common. Many medium and large loans are structured as syndicated loans, for which there is an active secondary market. The most common ways of trading debt are as follows:
Novation. This is a full legal transfer of the relevant rights and obligations. It is the traditional way of transferring syndicated loan commitments. Most syndicated loan agreements contain detailed mechanics for transfers by this method.
In almost all secured syndicated loans, any English law security will be held on trust by a security trustee for the benefit of the lenders from time to time. If that is the case, the buyer should automatically benefit from the security following the transfer.
Assignment. Assignments transfer rights only, not obligations, so they are commonly used to transfer fully drawn loans. However, they are less useful where the borrower can request further advances as the seller can be left with obligations but no rights.
Recently, it has become more common for English law syndicated loan agreements to expressly provide for transfers by “assignment agreement”, as well as by novation. Despite their name, these assignment agreements include a release of the seller's obligations and an assumption of equivalent obligations by the buyer, as well as an assignment of the seller's rights. As a matter of English law, there are no significant differences between transferring in this way and transferring by novation. Both are intended to have the same economic effect. But using an assignment agreement may be preferable where there are foreign borrowers or foreign law security, particularly where civil law jurisdictions are involved. Local law advice should be taken.
The transfer mechanics in most syndicated loan agreements make it technically possible to make an effective transfer by way of novation or assignment agreement without the borrower consenting to it at the time, if that is what the parties have agreed. However, loan agreements sometimes do require lenders to obtain the borrower's consent, or to at least consult with the borrower, before transferring.
Sub-participations. A sub-participation transfers the economic interest in a loan without changing the legal relationship between the seller (who remains the lender of record) and the borrower. It therefore does not affect any security granted, which will remain held by, or for the benefit of, the seller. The seller does not usually need to obtain the consent of the borrower, or even notify it.
Sub-participations can be funded or unfunded. On a funded sub-participation, the buyer (participant) pays to the seller (grantor) an amount equal to the loan funded by the seller or the agreed percentage of it. The seller agrees to pass on to the buyer any interest and principal payments it receives from the borrower for that amount.
In an unfunded (or risk) participation, the buyer agrees to “make whole” the seller if the borrower makes a payment default on the loan (or relevant part of it), much like a guarantee. In return, the seller agrees to pass on to the buyer any “profit” it receives on the loan (or relevant part of it).
The main disadvantage of sub-participations is increased credit risk. In a funded participation, the buyer takes credit risk on the seller as well as the borrower. In an unfunded participation, the seller (who is attempting to sell the economic risks and rewards) retains a credit risk on the buyer.
The concept of agency is recognised in England and Wales.
The concept of the trust is recognised in England and Wales.
The terms of the loan agreement will determine the circumstances in which a lender can demand repayment of the loan. A lender can usually only accelerate a loan (that is, demand repayment before a scheduled maturity date) if one or more of the events of default set out in the loan agreement has occurred.
A security document will state when the lender can enforce the security. This is usually following either:
An event of default under the loan agreement.
The lender's demand for repayment when due.
A lender can usually demand under a guarantee as soon as the borrower fails to pay any guaranteed obligation when due. However, the claim under the guarantee will be limited to the overdue amount. A lender will therefore often need to accelerate the loan before it can make a full claim against a guarantor.
If a lender has a mortgage or charge over a particular asset or group of assets (for example, the company's real estate or its shares), it will often enforce its security by appointing a receiver over the asset. Provided the security document has been properly drafted and executed:
The appointment can be made without court involvement.
Following its appointment, the receiver will have power to collect in any income from the asset and to sell it.
A lender may also exercise its own power of sale if it has a legal mortgage, or other properly drafted and executed mortgage or charge. A receiver or a lender making a sale has an obligation to get the best price reasonably obtainable. However, it is not necessary to delay a sale to obtain a higher price. No public auction is required. Sales are usually by private agreement without court involvement. One advantage of appointing a receiver is that a lender is not usually responsible for the receiver's conduct.
If a lender has security over all or substantially all of the company's assets (including a floating charge), the lender will usually have a “qualifying floating charge” (or QFC). Once its security becomes enforceable, a QFC holder may appoint an administrator over the company quickly and easily without going to court. However, it must give two business days' notice to any holder of a higher ranking QFC before doing so. Once a company is in administration, a secured lender cannot actively enforce its security. However, if an administrator sells assets, it must account to the company's creditors in accordance with the statutory order of priorities (see Question 24). This is a popular enforcement option as it creates a moratorium on other enforcement action against the company and potentially allows a sale of the business as a going concern (thereby maximising value).
Company voluntary arrangements (CVAs) and schemes of arrangement are the two main statutory procedures by which a company can restructure its debts.
A CVA is an agreement between a company and its unsecured creditors (and sometimes other creditors). It usually involves the creditors compromising their claims against the company. No court approval of the agreement is required. The directors, an administrator or a liquidator can propose a CVA. To take effect, the CVA must be approved by a majority of the creditors together holding more than three-quarters by value. These thresholds are calculated by reference to the number and value of the creditors present at the meeting, either in person or by proxy, who vote. The CVA must also be approved by a majority in value of the company's shareholders. Once approved, the CVA binds all creditors who were entitled to vote. It does not bind secured or preferential creditors, unless they have consented.
Technically, a CVA is an insolvency procedure. However, the directors continue to run the company, unlike in an administration or a liquidation. There is no automatic moratorium on enforcement rights against a company during a CVA. However, most “small companies” (defined by turnover, asset value and number of employees) can apply to court for a 28-day moratorium at the start of a CVA. The effect of a CVA moratorium is similar to the statutory moratorium that arises on administration (see Question 22). CVAs can also take place while a company is in administration and therefore benefit from the statutory moratorium.
A company can also make a compromise or other arrangement with its creditors, or any class of creditors, by a scheme of arrangement (scheme). The company, any of its creditors, an administrator or a liquidator can initiate a scheme. A scheme requires the approval of a majority in number of those voting and a three-quarters majority in value. If there are separate classes, each class must pass this test. It must also be sanctioned by the court to take effect. An approved scheme will bind the company and all members of the relevant class(es) of creditors.
A scheme is not an insolvency procedure. There is no moratorium on enforcement rights against a company during a scheme. But like CVAs, schemes can be used while a company is in administration, thereby benefiting from the statutory moratorium.
Aside from CVAs (see Question 21), the two insolvency procedures to which a company can become subject are administration and liquidation.
When a company enters administration, it becomes subject to a statutory moratorium. As a result, during an administration a lender may not, among other things, either:
Start or continue legal proceedings against the company.
Enforce security granted by the company.
However, the moratorium does not apply to the enforcement of security that is a “security financial collateral arrangement” under the Regulations (see Question 4, Registration). This would include most security over shares, other securities or cash deposits, provided the asset is under the possession or control of the security holder. It therefore may not include, for example, a floating charge over a current account, because of the security holder's lack of possession or control over the account.
The moratorium does not prevent a lender exercising any contractual set-off rights it has. However, these will be overridden by the mandatory set-off rules once the administrator announces an intention to make a distribution.
There is no equivalent statutory moratorium during a company's liquidation. A secured creditor may enforce its security. However, there is a stay on starting or continuing legal proceedings against the company without the leave of the court.
When a company has entered administration or liquidation, a transaction it has previously entered into is most likely to be challenged on one or more of the following grounds:
Transaction at an undervalue. A liquidator or administrator can apply to court to have a transaction unwound if:
the company received no consideration or significantly less consideration than it gave;
the company was insolvent when it entered into the transaction or as a result of it; and
the transaction was entered into in the two years immediately before the company's entry into an insolvency procedure.
In a lending transaction, this is most likely to be relevant where the insolvent company has granted a guarantee. However, a court will not set aside a transaction on this basis if it is satisfied it was entered into in good faith and that there were reasonable grounds for believing it would benefit the company.
Preference. Similar rules apply where the company has entered into a transaction that gives a creditor a preference over other creditors, and where the company “was influenced by a desire” to prefer that creditor. Only transactions entered into in the six months before the onset of insolvency (or two years if the parties are connected) are vulnerable to a challenge on this basis.
Void floating charge. Between unconnected parties, a floating charge is invalid other than to secure new money advanced to the chargor if:
the chargor was insolvent at the time of granting the charge, or as a result of giving it; and
the charge was granted within one year of the onset of insolvency.
(Different rules apply between connected parties.) This is most commonly a problem where a floating charge has been granted to support obligations under a guarantee.
Distributions may be made to creditors during an administration or a liquidation, or over the course of both (which may follow one after the other). The order in which creditors are paid on a distribution largely depends on whether any of them has security for its claim and, if so, what type of security.
Any debt secured by a fixed charge or mortgage over an asset will be met from the disposal proceeds of that asset without deduction, other than the costs of realisation. However, as a condition of accepting an appointment, administrators sometimes require the fixed charge holder/mortgagee to agree that they will be able to deduct their fees and costs from these proceeds first, to the extent the value of the other assets of the company proves insufficient to meet them.
A debt secured by a floating charge will be met from the disposal proceeds of the floating charge assets only after the following deductions have been made:
General costs of the insolvency procedure.
Preferential debts: these are amounts owed to employees up to GB£800 per employee, together with any accrued holiday remuneration and sums payable into an employee's occupational pension scheme.
Prescribed part: this is an amount of up to GB£600,000 for distribution among the unsecured creditors. The actual amount of the prescribed part depends on the net value of the floating charge assets.
Distributions will only be made to unsecured creditors following payment in full of:
The general costs of the insolvency procedure.
Subject to the prescribed part, any secured debts from the proceeds of assets subject to security.
The rules governing the priority between two different security interests over the same asset are complicated, and are different for different types of asset. As a basic rule, if two security interests are otherwise equal, the first created will have priority. For later security to take priority over earlier security, one or a combination of the following will usually need to be true:
The later security is a “better” type of security (legal rather than equitable; fixed rather than floating).
The holder of the later security was not aware or deemed to be aware, when it took its security, of the earlier security (or, in some cases, of any negative pledge given to the holder of the first security).
The later security has been better perfected, or was perfected first (the main perfection techniques are giving notice and registering security at title registries).
The type of asset and the types of security involved will determine which of these are relevant to any specific situation. Secured creditors often seek to agree the priority of their respective security interests contractually. This can be an effective way of overriding the default priority rules, but cannot have the effect of prejudicing other creditors.
Registering security at Companies House is sometimes regarded as a form of perfection. However, although registering security at Companies House can help to protect its priority (by giving notice, or deemed notice, of the security to others) that is not the main purpose. If registrable security is not registered at Companies House, it will be void on insolvency and against other creditors.
There are no restrictions on the making of loans by foreign lenders or granting security or guarantees to foreign lenders.
There are no exchange controls.
The following applies in relation to taxes and fees:
A fee of GB£13 is payable to register security granted by a company at Companies House (from 6 April 2013 reduced to GB£10 for security registered electronically).
The maximum fee for registering a mortgage at the Land Registry is GB£250 per property (a sliding scale applies depending on the amount secured or the value of the property).
Nominal fees also apply for registering security at IP registries.
No stamp duty (or similar fee or charge) is payable on the creation of a security interest. On a transfer of shares, stamp duty is generally payable by the purchaser. However, any transfer of shares to a lender or its nominee when taking security, or more commonly as a prelude to enforcing security over shares, will not attract stamp duty liability.
No notaries' fees are payable.
Strategies to minimise the costs of taxes and fees are not common, as fees are nominal (see Question 27).
As at March 2013, the most significant proposed reform is to the security registration regime applicable to UK companies and LLPs. This is expected to come into force on 6 April 2013.
The UK Government has stated the main aims of the new regime are:
To create a single registration scheme for companies and LLPs incorporated in Scotland, Northern Ireland, England and Wales.
To modernise the system and provide for electronic filing of charges.
In contrast to the current regime, where only certain categories of security or charge are registrable at Companies House, under the new rules all mortgages and charges created by UK companies and LLPs will be registrable other than:
Charges by Lloyd’s members to secure their underwriting business.
Charges whose registration is excluded by or under another statute. This would include those charges exempted by the Regulations (see Question 4, Registration).
The new rules will remove the criminal sanction against the company and its officers for non-registration. However, a failure to register when required to do so will, as under the current rules, make the security void on insolvency.
Description. This is a database of all UK legislation. It is managed by the National Archives on behalf of the UK Government. Generally, it is up-to-date, although not all updates are made immediately. Not all amended legislation is consolidated.
Description. This is a database of UK (and some other) legal information, including transcripts of court judgments. Run by a registered charity. Most of the case reports included are from the 21st century, so many older judgments are not included.
Professional qualifications. England and Wales, Solicitor
Areas of practice. General banking; real estate finance; asset based lending; restructuring.
Professional qualifications. England and Wales, Solicitor
Areas of practice. General banking; corporate trusts; real estate finance; restructuring.
Professional qualifications. England and Wales, Barrister
Areas of practice. General banking; asset finance; aircraft finance; receivables finance.