Security
Why Take Security?
Protection for lender against insolvency of the borrower + increases likelihood of
recovering debt
Security => in event of B’s default, L can sell asset to repay amount outstanding under
loan:
o Quicker & cheaper than having to sue through courts
o Ensures L does not rank below other secured creditors in order of priority =
increases likelihood of recovering debt
Quasi-security (guarantee, indemnity, comfort letter) = lender can:
o Pursue contractual right vs guarantor / indemnifier OR exert moral pressure on
comfort letter provider increases likelihood of recovering debt
Why give security?
Cheaper borrowing, due to lower risk for lender
Weak credit status / lack of credit history, meaning unable to borrow w/osecurity
Why may a borrower be unable to give security?
Negative Pledge
Clause in LA preventing borrower from taking further security
Financial Assistance
Unlawful financial assistance under S.677-693 CA (giving security can fall into the ambit)
Types of Security
Charges
Equitable (or statutory) right over asset = to appropriate charged asset & sell it to
discharge secured debt (no transfer of title to asset itself)
Fixed Charge – Machinery
Attaches to an asset
Once created , gives lender claim over proceeds of sale of asset in priority over other
creditors
Where B sells asset subject to fixed charge, buyer takes subject to fixed charge provided
has notice of charge (usually given by registering at CH per S.859A-Q CA)
For valid creation, preventing reclassification as floating charge – substance over form
Spectrum Plus, lender must show sufficient level of control over asset
o Normally charge document specifies B must obtain L’s consent to deal with asset
(sell / create further charge)
Floating Charge – Stock in Trade / Cash
Used for assets which borrower needs to be able to deal with freely (fixed charge
substantially limits borrower’s ability to deal with the assets)
o Under floating charge borrower is able to deal with the assets freely w/o
infringing terms of charge
Re Yorkshire Woolcomber charge is a floating charge if:
o Charge on a class of assets of a company present & future
, o That class is one which, in ordinary course of business of company, would be
changing from time to time
o Charge contemplates that, until some future step is taken by interested parties,
company may carry on its business in ordinary way & may deal with that asset as
usual
Spectrum - substance of charge is more important than label
Essential characteristic of floating charge per Spectrum – asset subject to charge is not
appropriated as security for payment of debt until occurrence of some future event; in
the meantime, B is free to use charged asset & remove it from security (essentially ability
to deal with asset freely, until crystallisation)
Crystallisation
On occurrence of specified event, charge crystallises such that B may no longer deal in the
charged assets without Lender’s consent:
Matter of law:
o Liquidation of Borrower
o Appointment of receiver
o Borrower ceases to carry on business
As otherwise specified under security document (e.g. EoD / event which, in opinion of
Lender, puts assets in jeopardy)
Weaknesses of Floating Charge
Vulnerability to subsequent fixed charges (rank behind subsequent fixed charges)
UNLESS negative pledge against subsequent charges, of which holder of later fixed
charge had notice (generally through registration of security document containing
negative pledge at CH)
Fixed charge holders, preferential creditors + ring-fenced fund all rank ahead
Administrator’s costs + tax liability on CG arising from disposals by administrator paid out
of floating charge assets
More stringent avoidance rules on insolvency
Floating charge may not be recognised in some jurisdictions
Even if floating charge crystallises over stock, stock might be subject to valid retention of
title clauses = prohibiting Lender from being able to sell asset & realise proceeds (under
retention of title clause, relevant asset does not belong to borrower & cannot be
charged to lender)
Advantages of Floating Charge
L obtains security, but B still able to dispose of assets in ordinary course of trading
Grandfathered / Qualifying FC:
Pre-15 September 2003 => grandfathered floating charge, where FC over all /
substantially all of company’s assets
Holder may block appointment of administrator + appoint administrative receiver who
owes primary duty to appointing creditor
Not subject to ring-fenced fund
Post-14 September 2003
Why Take Security?
Protection for lender against insolvency of the borrower + increases likelihood of
recovering debt
Security => in event of B’s default, L can sell asset to repay amount outstanding under
loan:
o Quicker & cheaper than having to sue through courts
o Ensures L does not rank below other secured creditors in order of priority =
increases likelihood of recovering debt
Quasi-security (guarantee, indemnity, comfort letter) = lender can:
o Pursue contractual right vs guarantor / indemnifier OR exert moral pressure on
comfort letter provider increases likelihood of recovering debt
Why give security?
Cheaper borrowing, due to lower risk for lender
Weak credit status / lack of credit history, meaning unable to borrow w/osecurity
Why may a borrower be unable to give security?
Negative Pledge
Clause in LA preventing borrower from taking further security
Financial Assistance
Unlawful financial assistance under S.677-693 CA (giving security can fall into the ambit)
Types of Security
Charges
Equitable (or statutory) right over asset = to appropriate charged asset & sell it to
discharge secured debt (no transfer of title to asset itself)
Fixed Charge – Machinery
Attaches to an asset
Once created , gives lender claim over proceeds of sale of asset in priority over other
creditors
Where B sells asset subject to fixed charge, buyer takes subject to fixed charge provided
has notice of charge (usually given by registering at CH per S.859A-Q CA)
For valid creation, preventing reclassification as floating charge – substance over form
Spectrum Plus, lender must show sufficient level of control over asset
o Normally charge document specifies B must obtain L’s consent to deal with asset
(sell / create further charge)
Floating Charge – Stock in Trade / Cash
Used for assets which borrower needs to be able to deal with freely (fixed charge
substantially limits borrower’s ability to deal with the assets)
o Under floating charge borrower is able to deal with the assets freely w/o
infringing terms of charge
Re Yorkshire Woolcomber charge is a floating charge if:
o Charge on a class of assets of a company present & future
, o That class is one which, in ordinary course of business of company, would be
changing from time to time
o Charge contemplates that, until some future step is taken by interested parties,
company may carry on its business in ordinary way & may deal with that asset as
usual
Spectrum - substance of charge is more important than label
Essential characteristic of floating charge per Spectrum – asset subject to charge is not
appropriated as security for payment of debt until occurrence of some future event; in
the meantime, B is free to use charged asset & remove it from security (essentially ability
to deal with asset freely, until crystallisation)
Crystallisation
On occurrence of specified event, charge crystallises such that B may no longer deal in the
charged assets without Lender’s consent:
Matter of law:
o Liquidation of Borrower
o Appointment of receiver
o Borrower ceases to carry on business
As otherwise specified under security document (e.g. EoD / event which, in opinion of
Lender, puts assets in jeopardy)
Weaknesses of Floating Charge
Vulnerability to subsequent fixed charges (rank behind subsequent fixed charges)
UNLESS negative pledge against subsequent charges, of which holder of later fixed
charge had notice (generally through registration of security document containing
negative pledge at CH)
Fixed charge holders, preferential creditors + ring-fenced fund all rank ahead
Administrator’s costs + tax liability on CG arising from disposals by administrator paid out
of floating charge assets
More stringent avoidance rules on insolvency
Floating charge may not be recognised in some jurisdictions
Even if floating charge crystallises over stock, stock might be subject to valid retention of
title clauses = prohibiting Lender from being able to sell asset & realise proceeds (under
retention of title clause, relevant asset does not belong to borrower & cannot be
charged to lender)
Advantages of Floating Charge
L obtains security, but B still able to dispose of assets in ordinary course of trading
Grandfathered / Qualifying FC:
Pre-15 September 2003 => grandfathered floating charge, where FC over all /
substantially all of company’s assets
Holder may block appointment of administrator + appoint administrative receiver who
owes primary duty to appointing creditor
Not subject to ring-fenced fund
Post-14 September 2003
