Security

Question 1

What is a security and the reason for it?

Answer 1

Security is temporary ownership, possession or other proprietary interest in an asset to ensure debt owed is repaid (collateral for debt)
* main reason for this is to protect creditor in even borrower enters into a formal insolvency procedure - improves priority of creditor

Question 2

What are the different forms of security?

Answer 2

• Pledge: borrower (security provider) give possession of asset to creditor until debt is paid back.
• Lien: with a lien, creditor retains possession of asset until debt is paid back - operation of law and allows (e.g., mechanic retain possession of repaired vehicle until money paid)
• Mortgage: borrower retains possession of asset but transfers ownership to creditor (lender) - gives creditor right to take possession of asset and sell it and borrower right to get asset back once debt is repaid
• Charge: borrower retains possession of asset but rather than transferring ownership, charge involves creation of an equitable proprietary interest in asset
  
  • charging document will give lender certain contractual right over asset (e.g., right to appoint administrator to take possession and sell), if debts is not paid back when it should be
  • two types: fixed and floating charges

Question 3

What is a fixed charge?

Answer 3

Fixed charge is normally taken over assets such as machinery and vehicles - creditor can control what security provider can do with fixed charge assets (done by borrower giving an undertaking to do or not to do something without creditor’s consent)
* borrower can still use asset over course of business but is restricted from disposing or charging it
* if charge becomes enforceable, creditor will have ability to appoint a receiver/administrator of that asset or exercise power of sale of asset.

better form of security but not all assets are suitable by this way of charging

Question 4

What is a floating charge?

Answer 4

Floating charge floats over whole of a class of circulating assets - whenever assets in that class are owned by security provider at any given time subject to floating charge, security provider is free to dispose asset as it wishes until crystallisation
* crystallisation means floating charge stops floating and fixes to asset in relevant class which are owned by security provider at time of crystallisation - creditor thus acquires control of those asset
* crystallisation may occur by operation of law or triggered by certain events contractually agreed between creditor and security provider (e.g., borrower breaches significant term of loan agreement)

= floating charge may be appropriate where it’s not practical for security provider to undertake not to dispose of its asset (e.g., trading company needs to dispose freely of its stock)

Question 5

What are the disadvantages of a floating charge - creditor’s view

Answer 5

• floating charge covers asset that change constantly (e.g., stock or cash) so until charge crystallises, company can freely sell or use asset in business - poses a problem as by the time charge crystallises (e.g., on insolvency), they may be few or no asset left to secure repayment.
• floating charge has lower priority when company winds up but if charge has a negative pledge clause, it stops another creditor, knowing of clause, to take a fixed charge over asset - so floating charge gets priority over later charge
• charge created on or after 15th Sept 2003 are subject to part of proceeds of asset being set aside (prescribed part fund)
• floating charge are capable of being avoided during insolvency
• administrator is free to deal with floating charge asset in their control without reference to charge holder or court and can pay their remuneration and expenses out of proceeds of asset

Question 6

What are guarantees?

Answer 6

These are not security as they do not give rights in assets but their commercial effect is similar to security, as such security and gurantees tend to be treated together
* gurantee for a loan is an agreement that the guarantor will pay borrower’s debt if borrower fails to do so - guarantees can come from companies or individuals (i.e., directors)

suitable where fixed charge by creditor might not be enough due to asset potentially losing value - creditor could call on guarantee and if they refuse to pay, creditor can sue them for their money.

Question 7

How to register charge?

Answer 7

Most securities created by company needs to be registered in Companies House - includes charges created by an English company over assets located both within UK or abroad
* security should be registered within 21 days beginning with day after day on which charge is created. This should include:
* Form MR01 should be completed detailing:
- company creating charge
- date of creation of charge
- persons entitled to charge
- and short description of any land or intellectual property registered in UK subject to fixed charge
* certified copy of charge
* relevant fee

= Registrar allocates to charge a unique reference code and includes it on register with certified copy of charge - registrar must issue a signed certificate of registration

Question 8

Who registers charge and what happens on failure to register?

Answer 8

Charge may be registered either by company that created charge or any person interested in charge (e.g., lender) = usually lender’s solicitor who completes registration formalities

In event of failure to register charge at all or within 21 day period:
* charge is void against liquidator and any creditor of company
* debt becomes immediately payable

Question 9

What must companies do once charge has been registered?

Answer 9

• Keep available for inspection copy of every charge and every instrument that amends or varies charge
• documents must be kept either at company’s registered office or such location permitted under Companies Regulation
• inform Companies House of place where documents are available for inspection and any changes
• Failure to comply with requirements above will be an offence and company will be liable to a fine

Question 10

What is the order of priority between creditors upon winding up?

Answer 10

1. Creditors with fixed charge
2. Preferential creditors: mainly wages (up to £800 per employee), occupational pensions and certain sums owed to HMRC
3. Creditors with floating charge
4. Unsecured creditors
5. Shareholders

Question 11

What is the priority amongst secured creditors?

Answer 11

Generally, where more than one creditor with a fixed charge over same asset, first fixed charge created has priority (provided charge was properly registered) - same with floating charge
* order can be varied by agreement between creditors through Deed of Priority

Question 12

What is the priority amongst other categories of creditors & shareholders?

Answer 12

• Shareholders, unsecured preferential creditors rank equally between themselves
• does not matter when debt was incurred as **no one unsecured creditor will take priority **within that category upon distribution of proceeds of sale - though does not charge order of prioroty set out