Introduction to Security

In this briefing, Andrew Evans provides an Introduction to Security
 

What is Security

Taking effective security over an asset means that the security holder can, on the insolvency of the borrower, take possession of that asset and use the proceeds to repay the loan. This puts the security holder in a stronger position than the unsecured creditors.

What does the security holder want?

Basically, a security holder has three aims. It wants to ensure that:

1. The security is effective on the insolvency of the borrower.

2. The security will take priority over anyone else who obtains a proprietary interest in the asset concerned.

3. The security can be enforced when required, even if the borrower is in insolvency proceedings.

A creditor may also want to know to what extent security can arise by operation of law and what alternatives there are to taking security.

Categories of Security under English law

There are four primary categories of security under English law as follows:

The term 'mortgage' and 'charge' tend to be used interchangeably but there are some technical differences.

Mortgage

This form of security involves the transfer of title to an asset in order to secure obligations, typically a debt on the condition that it will be re-transferred when the secured obligations are discharged. The assets secured can be tangible or intangible and physical possession of the mortgaged asset is not a requirement.

Depending on whether the necessary formalities have been complied with and whether the borrower has legal title to the asset, a mortgage can be legal or equitable.

Under an equitable mortgage, only a beneficial interest will pass to the mortgagee whereas under a legal mortgage legal title will pass to the mortgagee.

The transfer of title under a legal mortgage operates to prevent the mortgagor from disposing of the asset and assist in the creditor's ability to realise the security if required.

A legal mortgage is the most secure form of security interest and cannot (unlike an equitable mortgage) be taken over future property.

Mortgages over intangible assets such as choses in action (eg. Rights under a contract) are typically taken by an assignment by way of security which can be legal or equitable depending on the formalities complied with. See section 136 Law of Property Act 1925 (LPA) for requirements of a legal assignment.  An assignment by way of security transfers certain rights from the assignor to the assignee as security for the discharge of the obligations of the assignor or a third party. You cannot have multiple assignments running concurrently.

Charge

While under a mortgage title to the asset will pass to the mortgagee, under a charge title does not pass and the chargee instead  obtains an equitable proprietary interest in the security provider's assets e.g. the right to appropriate the charged assets in satisfaction of the debt, the right to restrict the security provider from dealing with the asset freely and a right to the proceeds of sale. There is no right to possession.

Charges can be fixed or floating. A fixed charge will attach immediately to the (definite and identifiable) charged asset while a floating charge hovers over a pool of assets (present and /or future) until conversion or 'crystallisation' (when it fastens onto and becomes a fixed charge over assets). The distinguishing feature of a fixed charge is that the chargor is not free to deal with the charged assets in the ordinary course of its business. The key characteristic of a fixed charge is that the lender has control over the charged asset. Control is crucial to the nature of a fixed charge. A floating charge on the other hand is a charge over a shifting class of assets which the chargor is free to deal and so permits the continuation of the business operations of e.g. a trading company.

Over certain assets e.g. stock-in-trade or inventory, only a floating charge can be created. This is because it would be impractical for a debtor not to be able to deal freely with its stock as this would cause cash-flow problems. The floating charge is normally therefore a catch-all provision for assets not specifically charged and will typically be granted over the whole undertaking.

In the case of present and future receivables, a fixed charge can, in practice, only be effectively taken if the proceeds of the receivables are paid into an account which is strictly operated as a blocked account (National Westminster Bank plc v Spectrum Plus Limited and others [2005] UKHL41).

The distinction between fixed and floating charges is significant upon the insolvency of the entity providing the relevant charges as the holder of a fixed charge is paid out of distributions to creditors prior to all other creditors unlike the holder of a floating charge which is subject to payment to certain preferential creditors  and payment of up to £800K (the prescribed part) to unsecured creditors before they are paid out. More about this below.

Lien

Liens generally arise by operation of law and are more common in commercial transactions e.g. when goods are being supplied, repaired or transported. They are accordingly more of benefit to trade creditors rather than financial creditors e.g. a creditor has a lien over goods until thay have been paid for by the security provider. However, creditors do need to think about doing due diligence in respect of any existing or future liens affecting assets that they might take security over as some will rank ahead of even prior mortgages e.g. a maritime lien.

In addition, it is possible to take a bill of sale over chattels owned by an individual under the Bills of Sale Acts 1878 and 1882, but rarely used because if you get it wrong you not only have invalid security , but the secured debt is also extinguished.

Quasi-security

Quasi-security applies to methods by which a creditor might try to enhance its position on the insolvency of the borrower without taking a full security interest.

Quasi-security includes:

Guarantees and indemnities from third parties

Comfort Letters from third parties e.g. the parent. Are they legally binding or merely expressions of intent?

Set-off and netting arrangements. Netting is a form of contractual set-off. Set-off is mandatory on insolvency for mutual credits, mutual debits and other mutual dealings. Banker's set-off-the general right of the bank to combine two or more accounts held by the same entity.

Bank guarantees and bonds. This is the bank's paper so bank has to pay absent fraud.

Standby Letters of Credit. Operate like a bank guarantee.

Retention of Title (RoT) - Romalpa clauses. Again, a lender needs to do due diligence to see whether its borrower's stock –in-trade actually belongs to the borrower or a third party supplier.

Flawed asset arrangements. This is a mandate arrangement between the bank and the borrower whereby the borrower agrees that the bank does not have to pay what it owes the borrower until the borrower pays what it owes the bank. It was held to be effective on a liquidation in BCCI No 8 [1997] 3 WLR 909.

Negative Pledges. This a covenant by the borrower not to encumber its assets. These should preserve unencumbered assets for the general creditors. It is questionable whether they bind third parties and what effect a negative pledge has on a third party.

Hire purchase and finance lease. Title is with the lender not the borrower so no risk to the lender on the insolvency of the 'borrower'. This is an alternative method to the loan and mortgage for funding.

II. TYPES OF ASSET WHICH MAY BE SUBJECT TO SECURITY

Mortgage - includes securities, chattels and rights under a contract (via an assignment by way of security). Note that a legal mortgage can generally not be taken over most types of intangible property with the exception of: (i) documents that transfer title to the intangible property (e.g. bills of exchange) and (ii) intangibles that can be transferred into the name of the mortgagee and registered in that mortgagee's name (e.g. shares).

Charge - includes land (usually expressed to be a charge by way of legal mortgage, but a charge nonetheless), contracts, book debts, plant and machinery, goodwill, IP rights and licences.

Pledge - includes items of tangible property capable of being delivered (including documents of title to property such as bearer securities).

Lien - any asset.

III. TYPE OF OBLIGATIONS THAT MAY BE SECURED

Under English law, security may secure obligations of any kind (i.e. not just monetary obligations), including future obligations.

IV. LEGAL FORMALITIES REQUIRED

A Legal Mortgage or Charge over land must be created by way of deed (section 52(1) LPA).

A charge by way of legal mortgage over land must be executed as a deed i.e. it must state that it is a deed and be signed, witnessed and delivered as a deed.

Any mortgage or charge of land or other property (whether legal or equitable) must be by deed if the mortgagee or chargee is to have the statutory power of sale and the statutory power to appoint a receiver. Also, a power of attorney must be by deed.

A deed is a written instrument that requires more than a simple signature to be enforceable. A deed is distinguishable from a simple contract for two main reasons: (i) the limitation period for actions brought under simple contract is six years from the date of accrual of action whereas the period is generally twelve years for a deed; and (ii) deeds do not have to be supported by consideration to be enforceable.

For assignments by way of security of debts or other choses in action, the assignment must be in writing.

Pledge - in order for a pledge to be valid, the creditor must be in actual or constructive possession of the asset. A pledge can only be granted over a tangible chattel, excluding real property. No documentation is required but it is obviously preferable that the pledgor and pledgee enter into a letter or memorandum of pledge to record the terms of the pledge including the circumstances when the pledgee might sell the pledged asset.

Lien - no validity requirements as these normally arise by operation of law, although some liens depend on retention of the asset over which the lien is claimed.

Quasi-security - guarantees must be in writing and signed by the guarantor (section 4 Statute of Frauds 1667).

V. PUBLICITY/REGISTRATION REQUIREMENTS

Almost all security (other than pledges) created by English companies and LLPs must be registered at Companies House within the strict 21 day (extended to 31 days during covid, but now back to 21 days) time period. Companies House is a central registry for companies in England and Wales and a public registry.

In addition, charges by way of legal mortgage over land must be registered at the Land Registry regardless of whether it is a corporate or individual granting the charge.

Various other types of asset have their own registration requirements under different regimes e.g. IP rights, ships, aircraft and bills of sale over chattels. Art security can also be registered at the Art Loss Registry.

VI. OTHER PERFECTION REQUIREMENTS

An assignment is perfected when notice of assignment is given to and received by the other contracting party (Dearle v Hall (1823-28) 3 Russ1). In the case of an assignment of the general partner's right to make capital calls on limited partners in funds finance, you cannot register security against an English Limited Partnership so the only way to perfect is by giving notice to the limited partners.

For pledges and liens, these are perfected merely by the creditor holding and continuing to hold the secured asset.

VII. COSTS OF SET UP AND REGISTRATION OF SECURITY

Any security registered at Companies House costs £15 to register online and £23 to register a hard copy.

The fee to register a charge at the Land Registry (assuming it is not registered simultaneously with the transfer of land where no fee is charged) is between £40 to £250 for each title charged depending on the amount secured.

VIII. TIMING FOR PUBLICITY/REGISTRATION

Security has to be registered at Companies House within 21 days (temporarily increased to 31days during covid) of its creation counting from the day after creation. Dire consequences if you fail to do so including the charge being void against the company's other creditors including its liquidator and administrator and the secured debt becoming immediately repayable. If you fail to register, you can apply to the court for registration of the charge out of time (unless in the meantime the company has gone into administration or liquidation) or take a new charge (subject to potential set-aside until the relevant ' hardening periods have expired).

No specific deadline for registering at the Land Registry, but for priority purposes, best to do so within the priority period afforded by the pre-completion searches. Registering security within this period will ensure priority over subsequently registered charges.

Timing for submitting registration and obtaining proof of registration is almost simultaneous with online registration at Companies House and between one and two weeks in the case of a paper registration. In the case of the Land Registry the time period is approximately two weeks depending on how busy they are.

XI. LEX SITUS

Generally speaking, any security must be created under, and be in accordance with, the law of the jurisdiction where the asset is located, notwithstanding that this may be different to the jurisdiction in which the security provider is incorporated.

Mortgages-To create a valid mortgage over real property located in England and/or Wales, the mortgage has to be created under the laws of England and Wales.

To create a valid mortgage or charge over a chattel you normally have to have your security document governed by the law of the jurisdiction where the chattel is located.

X. WHAT TYPES OF RIGHTS DOES A SECURED CREDITOR HAVE?

Before enforcing its security, the holder must generally make a formal demand for payment on the borrower. The effect of a demand is to make the sums due under the loan facility payable. This is particularly important in the context of some of the enforcement rights implied under common law and statute which do not arise until the secured liabilities become payable (expressly granted enforcement rights will normally be exercisable on an event of default occurring under the loan agreement).

In relation to each type of security the following enforcement rights are available:

Legal Mortgage-Foreclosure (a court process whereby the mortgagor's rights in the secured asset are extinguished (i.e. the mortgagor's equity of redemption is extinguished) and that asset becomes vested in the mortgagee). This rarely occurs these days, although under the Financial Collateral Regulations there is a foreclosure equivalent which doesn’t involve any court process; Taking possession; Power of sale (provided the security document contains an express power of sale or is made by deed, in which case the power of sale is implied); and Appointment of a receiver (again available if express power to appoint or is made by deed in which case the power is implied).

Equitable Mortgage-Foreclosure (available provided the security document contains an agreement to create a legal mortgage over the asset in question is capable of being subject to a legal mortgage); Taking possession (available provided the security document contains an obligation to create a legal mortgage and a contractual right to possession); Power of sale (same as for legal mortgage above);

and Appointment of receiver (same as for legal mortgage above). Note that on a sale an equitable mortgagee cannot transfer more than an equitable interest in the mortgaged asset.

For assignments by way of security where the secured property comprises choses in action (e.g. contractual rights), the assignee may exercise its power of sale (provided as above)  and/ or appoint a receiver (provided as above).

Charge-Taking possession (available provided the security document contains an express power to that effect); Power of sale (provided same as for legal mortgage above); Appointment of Administrative Receiver (only available to holder of pre-15 September 2003 floating charge over all or substantially all the chargor's assets); Appointment of Receiver (available provided circumstances relating to legal mortgages exist); Appointment of Administrator (available only to holders of a qualifying floating charges (QFCHs). A qualifying floating charge is a charge created by instrument that states that paragraph 14 of Schedule 18 to the Insolvency Act 1986 applies to it or that it purports to appoint an administrator or administrative receiver. A QFCH is generally a holder of qualifying charge which relates to the whole or substantially the whole of the company's property at the time of appointing the administrator.

Pledge-Power of Sale (available where the power is given either expressly in the security document or impliedly where the pledgor is in default and reasonable notice has been given to him).

Lien-Power of Sale (a lien holder may apply to court for an order of sale where: (i) the lien is equitable or (ii) there is a reason why a quick sale of the assets subject to the lien is preferable (e.g. perishable assets); Appointment of Receiver (available to holders of equitable liens, who may apply to the court for an order to appoint a receiver).

Compulsory Liquidation - a secured creditor can seek to have a company wound up if it has served a statutory demand for a debt in excess of £750 and the debtor fails to pay or if it can show that the debtor is insolvent.

XI. ENFORCEMENT

Foreclosure-This is a lengthy, two-stage court process that is rarely used in practice. First an order for foreclosure nisi must be obtained by the mortgagee and then the mortgagor is given a chance to pay the debt. If payment is not forthcoming, an order for the foreclosure to be made absolute can be sought. Little used because its effect is to deprive the mortgagor of its equity of redemption and it would be a very time-consuming process.

Taking Possession-in most cases a court order is required. Where a secured creditor is entitled to obtain possession of real estate, it can do so by either: i) taking physical possession of the secured property if possession is granted voluntarily; or (more commonly) ii) by bringing an action in the county court for a possession order. This can be a lengthy process e.g. up to two years.

A mortgagee in possession may incur unforeseen liabilities to third parties (e.g. the cost of environmental remediation) and owes certain duties (e.g. to the borrower to account for any income and profit actually received or which should have been received).

Power of Sale-Normally a court order is not required unless the mortgage does not include an express power of sale or is not made by way of deed. Also, a mortgagee may prefer to obtain a court order for sale if there are some issues concerning the consideration for the sale. Otherwise, a mortgagee can sell without a court order, but it does have a duty to get the best price reasonably obtainable and cannot itself buy the mortgaged property without the sanction of a court order.

Appointment of Administrative Receiver and Receiver-These are out of court processes. These can be appointed quickly by notice to and acceptance by, the Administrative Receiver/Receiver.

Appointment of Administrator-Some court involvement is always necessary. Administrators can be appointed in two ways: either simply by filing documents at court (the out of court route); or by making a formal application to the court, and (following a hearing) obtaining a court order (the court route).

Using the court route, the appointing creditor must first issue an application at the court, when a hearing date will be set, the timing of which vary depending  on the court calendar. Notice must then be given to a number of interested parties not less than five business days before the hearing. If appointed, the administrator's appointment may commence at the time of the hearing.

The out of court route is only available to QFCHs and the court route is available to all other creditors.

Using the out of court route, if there are no prior-ranking QFCHs, the appointing creditor can simply file the appointment documents at court and the appointment will commence from the time of filing. If there are prior-ranking QFCHs, the appointing creditor must serve notice of intention to appoint on the prior ranking QFCHs two business days before the appointment. If this period expires or the prior ranking QFCH consents, the appointing creditor can then appoint by filing the necessary documents at court. It is important to use the correct documents otherwise your purported administrator could end up being liable for damages as a trespasser.

Financial Collateral Arrangements (FCAs)-The Financial Collateral Regulations 2003 ( FCRs ) were brought into force to implement Directive 2002/47/EC of the European Parliament and Council and modify existing EU insolvency law in relation to FCAs, to give parties to FCAs certain rights in priority to other parties on the insolvency of the collateral giver, to dispense with registration requirements at Companies House and to permit out of court forfeiture. Briefly, an FCA applies where security over financial collateral (i.e. cash, financial instruments including shares or certain types of monetary claims) is provided by an entity (ie. not an individual) to a financial institution which must have possession or control of such financial collateral. It can also apply to stock-lending and repo arrangements.

Under the FCRs, the collateral taker can enforce an FCA even where an administrator is in place, and without having to account to (ordinarily prioritised) preferential creditors and unsecured creditors. The rights of administrators and liquidators in relation to FCAs are much more limited. For example, they have no right to dispose of the collateral, disclaim the FCA, and avoid the FCA even if it occurred after the commencement of the winding-up or to remove an administrative receiver of the financial collateral. In addition, if the FCA allows, the collateral taker can appropriate the collateral without having to obtain a court order for foreclosure.

Compulsory Liquidation-court sanctioned process. The creditor issues a petition at court to commence the process. A date for hearing is fixed at this point. Notice then must be given to the creditor at least five business days before the hearing. It is possible to obtain a winding up order within about six weeks of issuing the petition.

XII. LEGAL CONCERNS/PROHIBITIONS RELATED TO GRANTING/TAKING SECURITY

Unlawful Financial Assistance-Under Companies Act 1986, unless certain limited exceptions apply, it is unlawful for public companies to give financial assistance directly or indirectly (which includes the giving of a guarantee or provision of security) for the acquisition of shares in  either themselves or their parent companies and for private companies to do so for the acquisition of shares  in their public parent companies.

Corporate Benefit-Where security is given by a company in respect of the obligations of a third party company, the security provider, in its board minutes approving the transaction, must be able to confirm that it is in the company's interests to enter into the transaction. It is common for such third party security to be approved by unanimous ordinary resolution of the shareholders of the company in order to avoid the risk of the shareholders in the company challenging the grant of the security as being ultra vires the directors. In addition, the lender might require the directors to give a certificate of solvency in an effort to avoid the security being attacked as a transaction at an undervalue.

Security for Loans to Directors-Certain restrictions apply to the making of loans, and to related dealings such as the provision of security for loans, by a company, either to its directors, or to directors of its holding company or to persons connected with those directors. Basically a company cannot make a loan to its director or the director of its holding company or give a guarantee or provide security in connection with a loan made to a director unless it is approved by a resolution of the members of the company and (if the director is a director of the company's holding company) a resolution of the members of the holding company as well. There are additional restrictions covering quasi-loans and credit transactions to or for the benefit of directors and their connected persons   and guarantees and security for such loans in the case of a public company or a company associated with a public company where, again, approval by resolution of the members of the company and, if applicable, its holding company is required.

Taking Security over Shares in a Publicly Quoted Company

Another point to watch when taking security over shares in publicly quoted companies from its directors are the disclosure and notification requirements involved. For example, the  Market Abuse Regulations (MAR) (Article 19(1) and (7)) imposes notification obligations on any person discharging managerial responsibilities (PDMR) or their closely associated persons, within a company to which MAR applies. If a PDMR, or a person closely associated with a PDMR, grants security over his or her shares he/she must disclose the transaction to the company. The company then has to notify the market.

MAR (Article 19(11)) imposes 'closed periods' on PDMRs , or their closely associated persons, within a company to which MAR applies on dealing with its shares (including the grant of security). Clearance may only be provided in exceptional circumstances (e.g. severe financial difficulty).

The AIM Rules include certain disclosure obligations and restrictions on dealing in the company's shares for directors and their families. The AIM Rules also contain significant shareholder disclosure obligations and dealing restrictions for directors and applicable employees during closed periods.

The Takeover Code may apply to the company. If it does, there are potential disclosure obligations under Rule 8 if a charge is taken over 1% or more shares in the company. Security taken over 30% or more of the voting rights of the company could trigger a mandatory takeover offer when enforced.

Part 22 of the Companies Act 2006 allows a public company to serve notice on those 'interested' in its shares which could include a security holder. The notice can require the security holder to give information not only about its own interest but any concurrent interest of which the security holder has knowledge. Failure to comply with the notice entitles to company to obtain a court order that the shares be subject to restrictions.

Part 28 of the Companies Act 2006  contains 'squeeze out' and 'sell out' rules applying when an offeror has unconditionally agreed to acquire 90% in value of a target's shares giving the offeror the statutory right to buy out the remaining minority shareholders. This right cannot be excluded.

Under the FCA DTA disclosure regime, the holder of shares (or the voting rights in those shares) in UK companies whose shares are listed on the main market or AIM are required to notify the company (using a TR1-notification of major shareholding) once they reach the 3% threshold and each 1% change thereafter. If a lender therefore forecloses on shares under the FCRs or exercises its voting rights in respect of shares held by it as collateral the DTA disclosure regime can apply.

For any questions please contact Brad Isaac.

XIII. RIGHTS OF CHALLENGE FOR THE SECURITY PROVIDER/THIRD PARTIES

General-The security provider might contest the debt, or contend that the debt was not due and owing (i.e. that the holder of the security had not made a proper demand) or that the security was invalid or not improperly perfected, or that the relevant appointment documents were invalid, or that the relevant notice requirements were not followed.

Limitation-A limitation period of 12 years from the cause of action applies where the document is executed as a deed. This is reduced to six years where the security document is signed under hand.

Conflicting arrangements-Security may not be enforceable if there is an inter-creditor or standstill deed in place governing the enforcement of the security which prohibits or delays enforcement.

Challengeable transactions-A liquidator and an administrator can, in certain circumstances, challenge and have security arrangements set aside, making the security unenforceable. Reviewable transactions include security arrangements that constitute: i) a preference, ii) a transaction at an undervalue; or iii) a (wholly or partly) invalid floating charge.

Briefly, a preference occurs when a debtor has done something or allowed something to be done which has the effect of putting a creditor into a better position in the liquidation, administration or bankruptcy of the debtor than he would have been if the thing had not been done. Such a transaction is challengeable if it was done within 6 months of the insolvency or two years if the relevant parties were connected with debtor (e.g. in the case of  a debtor company, directors, shadow directors, associates of such directors or shadow directors and associates of the company and, in the case of an individual, a relative or life partner of such individual); the debtor was insolvent at the time or as a result of the transaction and the debtor had a desire to put the creditor in a better position than he would have been if the thing had not been done (section 239 Insolvency Act 1986 (IA)). A classic example of this type of transaction is where the directors of a company have given a guarantee to a bank and then the company gives security for the previously unsecured debt within a short time of the company entering into formal insolvency. From a lender's standpoint, the main point to notice is that the transaction creating the preference has to be done voluntarily so if the lender exerts pressure on the debtor it should never be a preference.

Again briefly, a transaction at an undervalue occurs (section 238 IA) when a debtor enters into a transaction (e.g. a gift or guarantee) for a consideration the value of which, in monetary terms, is significantly less than the value of the consideration provided by the debtor. Such a transaction can be set aside if:

• where the debtor is a company, the transaction took place within 2 years before the commencement of its winding-up and the debtor was insolvent or became insolvent as a consequence of entering into the transaction

• where the debtor is an individual, the transaction took place within 5 years of the before the commencement of his bankruptcy and , if the bankruptcy occurs in the third, fourth or fifth years, the debtor was insolvent or became insolvent as a consequence of the bankruptcy (i.e. if the bankruptcy occurs within 2 years of the transaction, there is no need for an insolvency practitioner to prove that the debtor was insolvent or became insolvent as a consequence of entering into the transaction).

Where the debtor is a company, there is a defence if it can be shown that :

• the debtor entered into the transaction in good faith and for the purpose of carrying out its business; and

• when it did so, there were reasonable grounds for believing that the transaction would benefit the company.

• When taking a guarantee from a company, it is therefore common practice to do the following:

• Detail in the board minutes the benefits to the company in entering into the guarantee (to assist demonstrating that the transaction benefitted the company);

• have the entering into the guarantee blessed by a unanimous resolution of the members (to prevent the transaction being ultra vires the directors); and

• have the directors make a declaration of solvency (so that , if correct, the transaction could never be a transaction at an undervalue).

The position from the lender's standpoint is more difficult if the debtor is an individual especially if the bankruptcy occurs within the first two years of the transaction.

Under section 245 of the IA a floating charge created by a debtor company will be invalid in its liquidation or administration if it was created in favour of a connected person within 2 years before the commencement of insolvency proceedings or a non-connected person within I year of its administration or liquidation except to the extent of the value of the consideration of the floating charge which comprises money paid, goods or services supplied or debts discharged at the time of or after the creation of such floating charge. The section does not however apply to FCRs (described above).

Undue Influence-Where the security provider can show that he/she entered into the security document whilst under the influence of another, the security will be unenforceable. Undue influence can be implied where there exists a relationship of trust and confidence between the parties to a contract. Certain types of relationship gve rise to a presumption of undue influence and these include parent and child and husbands and wives. The issue for a lender is that if it can be shown that there was undue influence by the debtor on the guarantor even if the lender was unaware of such undue influence, the transaction involving the lender (e.g. a guarantee) can be set aside. If a lender is taking a guarantee in circumstances where there is no commercial relationship between the debtor and the guarantor, a lender needs to protect itself by:

• requiring the guarantor take independent legal advice on the guarantee;

• providing the guarantor's solicitor with sufficient financial information to be able to advise the guarantor appropriately; and

• obtaining confirmation from the solicitor that he/she has advised the guarantor appropriately before the guarantor entered into the guarantee.

(See the leading cases of Barclays Bank v O'Brien [1994] 1 AC 180 and Royal Bank of Scotland v Etridge (No 2) [2002] 2 AC 773)

Lien - Statute provides that liens over the books, papers and records of a borrower are unenforceable to the extent that enforcement would deny their possession to a  liquidator and administrator.

XIV. SECURED CREDITORS' POSITION IN INSOLVENCY

Rights to and conditions required to continue/initiate security enforcement in insolvency

Perfection (as previously mentioned) is necessary to ensure that the security has the intended priority over the other creditors of the security provider, although perfection does not always guarantee validity and priority in all circumstances (for example, where a transaction is challengeable by an insolvency practitioner).

Further, when a chargor enters into administration or liquidation, unsecured  creditors must lodge formal notice of the debt owed to them, called a proof of debt, to the administrator or liquidator. A secured creditor can rely entirely on its security and not submit a proof or surrender its security and prove for the whole amount of the debt or place a value on its security and prove for the balance of the debt.

Administration-An automatic moratorium is imposed at the start of the administration which prevents creditors from enforcing security without the consent of the administrator or permission of the court, unless the FCRs apply to the security. A secured creditor is however, generally speaking, entitled to be repaid from the proceeds of sale of the secured assets. It may then claim as an unsecured creditor (who will receive a share of the assets proportionate to the size of the company's debt to the unsecured creditors) for any balance. Note that a company cannot enter into administration if an administrative receiver is in office.

Compulsory Liquidation-Compulsory liquidation provides a moratorium preventing creditors from enforcing security without permission of the court. A liquidator acts primarily in the interests of unsecured creditors and shareholders, but must distribute the assets in accordance with the following priority:

First: Fixed charge holders

Second: Administrators and Liquidators (for expenses in administration or winding up) Note that under the moratorium procedure introduced by the Corporate Insolvency and Governance Act 2020 if a company enters into administration or winding-up within 12 weeks of the end of a Part A1 moratorium, any unpaid moratorium debts or pre-moratorium debts (where the company does not have the benefit of a payment holiday for these) will benefit from super-priority (i.e. they will rank before administration or liquidation expenses).

Third: Ordinary Preferential Debts (e.g. employees' wages), Second Preferential Debts (e.g. claims from HMRC such as VAT, PAYE, employee NICs and Construction Industry Scheme deductions) and then the Prescribed Part up to a maximum of £800,000 for floating charges created on or after 6 April 2020).

Fourth: Floating Charge holders

Fifth: Ordinary unsecured creditors including all other taxes e.g. corporation tax (pro rata)

Sixth: Shareholders (receive any surplus).

Secured creditors' rights in influencing decisions in the creditors assembly

Receivership-The receiver only owes duties to the secured creditor who appointed him; there is no meeting of creditors.

Administration-The views of the secured creditor may be taken into consideration by the court when considering the appointment of the administrator. However, an administrator owes a duty to act in the interests of the creditors as a whole.

Compulsory Liquidation-A secured creditor may be able to exert some influence on the choice of liquidator by voting at creditors meetings, or if appointed to the liquidation committee, may take some limited further control over the liquidator's actions.

If you have any questions, please contact Andrew Evans or your usual Banking contact.

Contacts

Andrew Evans