Trends and regulatory climate

Trends
What is the current state of the lending market in your jurisdiction and have any new trends emerged over the last 12 months?

Following significant levels of refinancing over the past 12 to 24 months, we are now seeing more event-driven activity. With an excess of liquidity in the market, many banks have had to bring other lenders into what would otherwise have been a bilateral facility or smaller club deals. This in turn has meant that pricing generally remains tight. The new capacity offered by Chinese banks has also created new opportunities for European arrangers when forming new syndicate groups. In terms of macroeconomic and geopolitical influences, the market remains cautious pending possible Brexit and the outcome of the US elections.

Regulatory activity
Is secured lending a regulated activity in your jurisdiction?

Secured lending is a regulated activity in the United Kingdom in relation to mortgage and consumer lending, but is not a regulated activity to the extent that it falls outside either of these regimes, as outlined below. By way of background, there is a general prohibition in Section 19 of the Financial Services and Markets Act 2000 providing that no person may carry on a regulated activity in the United Kingdom, or purport to do so, unless he or she is an authorised person or an exempt person. Accepting deposits in order to lend the funds required is regulated as a banking activity.

To give comfort to those engaged in dealing in securities, expressly excluded from these activities are certain activities in relation to lending. Article 14 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 provides that dealing in investments as principal – which includes buying, selling, subscribing for or underwriting securities or contractually based investments as principal – is a specified kind of activity. Article 17 provides that a person does not carry on an activity of the kind specified by Article 14 by accepting an instrument creating or acknowledging indebtedness in respect of any loan, credit, guarantee or other similar financial accommodation or assurance which he or she has made, granted or provided. The reference to a person accepting an instrument includes a reference to a person becoming a party to an instrument otherwise than as a debtor or a surety.

Finally, although custody business is regulated by Article 40 of the regulated activities order, taking and enforcing security does not amount to custody, provided that title does not transfer unless and until security is enforced. Therefore, where a person provides another person with finance, even if he or she takes security, this will not be a regulated activity, unless it falls within the UK consumer credit or mortgage regimes.

Are there any specific regulatory issues which a prospective borrower should consider when arranging or entering into a secured loan facility?

Borrowers are generally not regulated in respect of their borrowing activities, but prospective borrowers may consider whether the particular activity or transaction that they are undertaking falls within the scope of consumer credit regulated activities or the Financial Conduct Authority (FCA) mortgage regime (as outlined below), and therefore whether the lenders with whom they are dealing need to be authorised by the FCA.

Are there any specific regulatory issues which a prospective lender should consider when arranging or entering into a secured loan facility?

Mortgages
Prospective lenders should consider whether they fall within the recently reformed UK mortgage regime. The EU Mortgage Credit Directive (2014/17/EC) has been implemented into UK law (the final text of which can be found in FCA: Handbook Instrument: Mortgage Credit Directive Instrument 2015 (FCA 2015/18)) and is intended to harmonise mortgage regulation across EU member states, both to prevent irresponsible lending and borrowing practices that became apparent during the financial crisis and to create a more efficient and competitive single market for mortgages. The directive applies to first and second charge mortgages, having transferred second charge lending into the mortgages regime from the consumer credit regime. Before the directive was enacted, the United Kingdom already had a heavily FCA-regulated first charge residential mortgage market; therefore, in practice the new directive provisions were not revolutionary.

If a lender is caught by the mortgages regime, there are very prescriptive affordability rules with which it must comply before any lending, as well as strict rules governing the mortgage during its lifecycle. The FCA mortgage regime applies where:

  • the contract is one under which a person provides credit to an individual or to trustees;
  • the contract provides for the borrower’s obligation to repay to be secured by a mortgage on land in the European Economic Area; and
  • at least 40% of that land is used, or is intended to be used, for residential purposes.

Consumer credit
Consumer credit regulation was brought within the legal framework of the Financial Services and Markets Act in 2014 and is therefore now the responsibility of the FCA. The UK consumer credit regime consists of the Financial Services and Markets Act and its secondary legislation (implementing EU legislation), retained provisions in the Consumer Credit Act 1974 and its secondary legislation, and rules and guidance in the FCA Handbook. The Financial Services and Markets Act (Regulated Activities) Order now encompasses credit-related activities and modifies the application of the Financial Services and Markets Act to the consumer credit sector. ‘Consumer credit regulated activities’ are:

  • credit broking;
  • debt-related consumer credit activities (ie, debt adjusting, debt administration, debt counselling and debt collecting);
  • entering into a regulated consumer hire agreement as owner;
  • entering into a regulated credit agreement as lender;
  • operating an electronic system in relation to lending; and
  • providing credit information services and credit references.

The consumer credit regime applies broadly to arrangements making credit available to individuals or relevant recipients of credit. ‘Relevant recipient of credit’ refers to either:

  • a partnership consisting of two or three persons, not all of whom are bodies corporate; or
  • an unincorporated body of persons that does not consist entirely of bodies corporate and is not a partnership.

Where lending is captured by this regime, there are very prescriptive rules around pre-contract information, affordability, the form and content of the agreement and obligations on lenders during the term of the agreement.

Prospective lenders should also be aware of the debt-related regulated activities that fall under the heavily regulated consumer credit regime, as similarly prescriptive rules apply. Where another entity carries out debt-related activities, without lending, these may require that entity to be separately authorised and regulated.

Are there plans or proposals for reform or significant changes to the regulatory landscape in this area?

The FCA mortgage regime was recently reformed. There are currently no other proposals for significant changes to the regulation of secured lending outside the consumer credit regime. However, the current regulatory position is not set in stone, a point which was highlighted following the Court of Appeal's judgment in Fons Hf v Corporal Ltd ([2014] EWCA Civ 304 (March 20 2014)). The court held in Fons that a loan agreement is an instrument which either creates a debt or acknowledges it and is therefore a debenture. There was concern that this decision could mean that loan agreements would be regulated investments under the Financial Services and Markets Act (Regulated Activities) Order, with the result that borrowers under loan agreements would need to be regulated in respect of borrowing, as they would be carrying on the regulated activity of dealing in investments as principal under Article 14 of the regulated activities order. However, the FCA issued a letter on July 17 2014 to the Loan Market Association confirming that the FCA does not consider that the Court of Appeal's judgment in Fons altered its interpretation or application of the regulatory perimeter prescribed by the Financial Services and Markets Act. This demonstrates the possibility that future case law will have the potential to alter the regulatory position in relation to secured lending.

Structuring a lending transaction

General
Who are the active providers of secured finance in your jurisdiction (eg, international banks, local banks or non-bank financial institutions)?

Traditional banks (both international and local banks) are active providers of secured finance in England and Wales. However, in particular sectors such as the leveraged, real estate and fund financing sectors, institutional investors such as credit funds and insurance companies are also very prominent. 

Is well-established market-standard facility documentation used in your jurisdiction for secured lending transactions?

Most English law syndicated finance transactions use documentation which is largely based on the recommended forms of documentation produced by the Loan Market Association (LMA). The LMA produces various template forms of facility documentation across the investment grade and leveraged financing markets, as well as other specialist product areas, including real estate. Bilateral secured facilities are more likely to be documented on bank standard form documentation.

Syndication
Are syndicated secured loan facilities typical in your jurisdiction?

Yes.

How are syndicated facilities normally structured? Does the law in your jurisdiction allow a facility agent to be appointed to act on behalf of other banking syndicate members?

In typical syndicated facilities (and in line with the recommended forms of LMA documentation as referred to above), a facility agent (usually acting out of the agency division of one of the syndicate lenders) is appointed to administer and service the syndicated loan facility in accordance with the terms of that particular facility document – for example, by coordinating utilisations and payments, as well as generally coordinating communication between the borrowers and the syndicate lenders (eg, administering consent requests and transfers between lenders).

Does the law in your jurisdiction allow security and guarantees to be held on trust by a security trustee for the benefit of the banking syndicate?

Yes. In contrast to other jurisdictions in continental Europe, in England and Wales the concept of the trust is recognised. Security is typically granted in favour of a security trustee, who holds the security on trust for the specified secured parties from time to time.

Special purpose vehicle financing
Is it common in secured finance transactions for special purpose vehicles (SPVs) to be used to hold the assets being financed? Would security generally be given over the shares in the SPV or would lenders require direct asset security?

Yes. In England and Wales SPVs are commonly used to hold the assets being financed, with security then being taken over the shares of that SPV. It is also common for security to be taken over the assets of the SPV in addition to share security. 

Interest
Is interest most commonly calculated by reference to a bank base rate or a market standard variable reference rate (eg, LIBOR, EURIBOR or HIBOR)? If the latter, which is the most commonly used reference rate in your jurisdiction?

LIBOR is the primary benchmark used in the syndicated loan market in the United Kingdom, with EURIBOR and other non-LIBOR benchmarks used as relevant for other particular currencies under the loan facility.

In the event of non-availability of the benchmark, there may be an option to use reference bank rates as a fallback. However, banks are increasingly reluctant to act as reference bank. The most common position in syndicated loan facility documentation currently is for reference bank rate fallback provisions to be included, but with the identity of those institutions to provide such rates being left to be agreed between the borrower and the facility agent at the relevant time. Bank base rates are typically used only in smaller, bilateral transactions.

Are there any regulatory restrictions on the rate of interest that can be charged on bank loans?

In a non-consumer context, restrictions are very light. Grossly exorbitant payments can be set aside if entered into by a company within a certain period of time before insolvency (under the ‘extortionate credit transactions’ provisions of the Insolvency Act 1986). Payments which are triggered on a breach of contract (eg, default interest rates) must not be penal. In broad terms, payments which are out of proportion to any legitimate interest of the non-defaulting party in enforcing the primary obligation will not be enforceable.

Use and creation of guarantees
Are guarantees used in your jurisdiction?

Yes. In England and Wales guarantees are the most commonly used form of credit support in both secured and unsecured syndicated loan financings. 

What is the procedure for their creation?

In order for a guarantee to be enforceable under English law, it must be documented in writing (signed by the guarantor) and must either be executed as a deed or otherwise be provided to the beneficiary of such guarantee for consideration. There are no other formalities.

Do any laws affect or restrict the granting or enforceability of guarantees in your jurisdiction (eg, upstream guarantees)?

The key areas affecting or restricting the granting or enforceability of guarantees in England and Wales are corporate benefit rules and financial assistance rules and the risks of clawback arising on insolvency. These areas are briefly outlined below.

Corporate benefit
Directors of English companies are under a statutory duty to act in a way which they consider is most likely to promote the success of that company. Upstream or cross-stream guarantees (ie, guarantees which secure the indebtedness of a holding or sister company) typically raise doubts over the existence of corporate benefit. Provided that the guarantor is in good financial health, doubts as to corporate benefit can usually be dealt with by a resolution of the shareholders of that company approving the proposed transaction. The essence of this 'solution' is that the duties of the directors are essentially owed to the members (provided that the company is not at risk of insolvency), so the members can sanction what would otherwise be a breach of duty. Corporate benefit duties are governed by the jurisdiction of incorporation/establishment of the guarantor company (rather than by the governing law of the contract).

Financial assistance
Unlike in other jurisdictions where financial assistance is prohibited, the financial assistance regime in England for private companies is arguably very liberal – the prohibition now remains only in respect of English public companies providing financial assistance for the acquisition of their own shares or the shares in a holding company, or where a private company is providing financial assistance in relation to the acquisition of a target public company.

Clawback
Guarantees and security may be at risk of being set aside under English insolvency laws if the guarantee or security was granted by a company within a certain period of time before insolvency (eg, on the grounds that the transaction represents a transaction at an undervalue). A transaction could be challenged on this ground if the relevant company received no consideration or consideration of significantly less value – in money or money's worth – than the consideration given by such company. For a transaction to be vulnerable, the company must have been insolvent at the time that it entered into the transaction (or have become so as a result of entering into it) and the transaction must have been entered into in the two years immediately before the onset of the insolvency.  

A court will not make an order in respect of a transaction at an undervalue if it is satisfied that the company entered into the transaction in good faith and for the purpose of carrying on its business and that, at the time that it did so, there were reasonable grounds for believing that the transaction would benefit the company.

Guarantees and security may also be challenged on the grounds that the transaction represents a preference in favour of a company's creditors or a void floating charge.

Subordination and priority
Describe the most common methods of structuring the priority of debts and security.

The ordering of payments of debts between creditors can be achieved contractually in an intercreditor (or subordination) agreement. Under a typical contractual subordination, the creditors agree with the debtor that the debtor will make no payments (or only limited payments) in respect of the junior debt unless and until the senior debt has been paid in full. Coupled with this, the junior creditor agrees to turn over to the senior creditor all junior recoveries up to the amount of the senior debt and, pending turnover, to hold those receipts on trust for the senior creditor.

In leveraged finance transactions, contractual subordination is used alongside structural subordination. This means that the senior lenders will lend at a lower level in the group structure (closer to the asset-rich operating companies) than the deeply subordinated creditors (eg, high-yield bondholders and equity investors), which will lend to a more remote holding company and therefore will have recourse only to the shares in the holding company's subsidiaries (ie, what is left after the creditors of the subsidiaries have been paid). Certain classes of subordinated creditor (eg, high-yield bondholders) may also get a guarantee from a more structurally senior entity. While that guarantee would typically itself be contractually subordinated, at least this gives the subordinated creditor equal ranking with the unsecured creditors of the company which has given the guarantee.

Priority of claims in respect of security is also typically regulated by the intercreditor agreement, which will set out an order of application of proceeds of security. The intercreditor agreement will also regulate which creditors are entitled to take enforcement action and any applicable enforcement rules, such as ‘standstill periods’ which apply to any junior enforcement action.

Documentary taxes and stamp duty
Are any taxes, stamp duty or other fees payable on the granting of a loan, guarantee or security interest, or on its enforcement?

No stamp duty or documentary taxes are generally payable in England in respect of the execution or delivery of loan and guarantee documentation.

No stamp duty or documentary tax is payable on the creation of a security interest. However, there is currently a nominal fee payable on the registration of security granted by English companies at the Companies Registry. There are also specific nominal fees payable on registration at the Land Registry in relation to security taken over land.

Cross-border lending

Governing law
Is it more common for local law to govern the terms of the facility documentation or is the law of another jurisdiction often elected by the parties (eg, English law or New York law)?

English law is internationally used in facility documents, whether the parties are domiciled in England or elsewhere.

Restrictions
Are there any restrictions on the making of loans by foreign lenders or the granting of security or guarantees to foreign lenders?

There are no such restrictions under English law (apart from in isolated circumstances, such as where economic sanctions apply).

Are there any exchange controls that restrict payments to a foreign lender under a security document, guarantee or loan agreement?

There are no such exchange controls under English law.

Security – general

Security agreements
Is it possible to create a security interest over all assets of an entity? If so, would a single security agreement suffice or is a separate agreement required for each type of asset?

Yes. In England and Wales, security may be granted over individual assets (eg, a piece of land or a bank account) or over the whole of a company's assets and undertaking (present and future) via a single universal security instrument – a debenture.

Release of security
What are the formalities for releasing security over the most common forms of assets?

English law-governed security is typically released by way of a deed of release. From an English company's perspective, it is preferable for such release to be recorded at the Companies Registry by way of filing the relevant release forms; however, this is not required in order for such release to take effect. Where security over registered land is released, the appropriate Land Registry release forms are required to be filed at the Land Registry in order for the release to take effect.

Asset classes used as collateral for security

Real estate
Can security be granted over real estate? If so, what are the most common forms of security granted over real estate and what is the procedure?

Yes. The most common form of security interest granted in respect of land in England and Wales is a charge by way of legal mortgage created in a deed. Such a security must be registered at the Land Registry to take effect in law and, where granted by an English company or a limited liability partnership (LLP), must also be registered at the Companies Registry within 21 days of creation. 

Machinery and equipment
Can security be granted over machinery and equipment? If so, what are the most common forms of security granted over this kind of property and what is the procedure?

Yes. The most common forms of security granted over machinery and equipment are fixed charges (in the case of machinery and equipment over which the security taker will exercise control over the assets) and floating charges (where the security grantor will retain control over the assets), in each case created in a deed and, where granted by an English company or LLP, required to be registered at the Companies Registry within 21 days of creation.

Typically, the security taker will require the security grantor to attach a nameplate to the charged assets in order to notify third parties of its security.

Whether security purported to be taken over particular assets is characterised as a fixed or floating charge will depend on whether sufficient control is granted to the security taker over those assets. Without sufficient control by the security taker, the charge will be deemed to be a floating charge. It may be that the security taker does not want to exercise control over certain types of assets, in which case it will be more appropriate to take a floating charge over those assets.

Whether a secured lender has the benefit of a fixed or floating charge will be relevant in the event of insolvency of the charger company in terms of the secured lenders' rights and priority in recovery.

Receivables
Can security be granted over receivables? If so, what are the most common forms of security granted over this kind of property and what is the procedure?

Yes. The most common forms of security granted over receivables are legal assignments and fixed charges (where the security taker will exercise control) or floating charges (where the security grantor will retain control over the assets) created in a deed. Where granted by an English company or LLP, such security is required to be registered at the Companies Registry within 21 days of creation.

Typically, security over receivables is perfected by providing notice of the security to the third party against which the assigned right is enforceable.

Please see above under "Machinery and equipment" for further detail as to the characterisation of fixed and floating charges.

Financial instruments and cash
Can security be granted over financial instruments? If so, what are the most common forms of security granted over this kind of property and what is the procedure?

Security can be granted over all types of financial instruments – again, typically made by way of deed. Security over certificated registered shares is usually by way of equitable mortgage or fixed charge (these methods avoid the security taker having the administrative burden of ownership, which comes with a legal mortgage). The security taker is therefore not noted on the share register, but protects its interest by taking possession of the share certificates and executed stock transfer forms (blank as to the transferee), which will enable it to transfer the shares on enforcement. Shares in listed companies are typically uncertificated and held through the electronic settlement system, CREST, which maintains the share register. Again, security is usually by way of equitable mortgage or fixed charge. To create this security, the security grantor transfers the shares (or other securities held in CREST) into an escrow account. It cannot transfer them out of that account without the security taker's permission.

Most bearer debt securities are in global form (ie, a single certificate, physically held by a common depository, representing the whole of the issue). Interests in the securities are typically cleared through a system such as Euroclear or Clearstream; however, the noteholder typically holds its interest through one or more intermediaries (typically, banks acting as custodians). The noteholder's interest is therefore recorded in book-entry form with an intermediary and its primary ‘asset’ is a claim against the relevant intermediary. Security is therefore taken via an assignment or charge over the securities account, over the corresponding rights against the relevant intermediary and (to the extent that the securities come out of global form) over the securities themselves. The security taker's interest is noted as a book entry.

Security over financial instruments or cash given by an English company or LLP will normally be registered at the Companies Registry within 21 days of creation, although the security may be exempted from this requirement if it falls within the ambit of the Financial Collateral Regulations (No 2) 2003.

Can security be granted over cash deposits? If so, what are the most common forms of security granted over this kind of property and what is the procedure?

Yes. The most common form of security granted over cash deposits are fixed charges (where the security taker will exercise control over the assets) and floating charges (where the security grantor will retain control over the assets), in each case created in a deed and, where granted by an English company or LLP, required to be registered at the Companies Registry within 21 days of creation.

Typically, security over cash deposits is perfected by providing notice of the security to the third party against which the security right is enforceable (eg, in the case of a bank account, the account bank).

Please see above under "Machinery and equipment" for further detail as to the characterisation of fixed and floating charges.

Intellectual property
Can security be granted over intellectual property? If so, what are the most common forms of security granted over this kind of property and what is the procedure?

Yes. The most common forms of security granted over intellectual property are fixed charges (where the security taker will exercise control over the assets) and floating charges (where the security grantor will retain control over the assets), in each case created in a deed and, where granted by an English company or LLP, required to be registered at the Companies Registry within 21 days of creation.

Please see above under "Machinery and equipment" for further detail as to the characterisation of fixed and floating charges.

Enforcement

Criteria for enforcement
What are the common enforcement triggers for loans, guarantees and security documents?

A lender will typically be entitled (but not obliged) to cancel loan commitments and/or accelerate loan repayments on the occurrence of one or more events of default as set out in the facility document. Typical events of default include non-payment of principal or interest, as well as breach of any representation or undertaking under the facility document. In line with Loan Market Association standard documentation, guarantee obligations are most commonly included in the facility documentation itself (rather than requiring a standalone guarantee) and arise whenever a borrower does not pay any amount when due. Enforcement of security documents will typically be triggered by the occurrence of an event of default or acceleration under the facility document.

Process for enforcement
What are the most common procedures for enforcement? Are there any specific requirements with which lenders must comply?

A secured lender will typically have a range of enforcement options available to it, depending on the nature of its security and the scope of its rights under the relevant security documentation. For example, it may appoint a receiver to take control of or sell secured assets (this is a common method of enforcement of fixed-charge security, such as over real estate or shares) or, if the secured lender has security over all or substantially all of the company's assets (ie, a ‘qualifying floating charge’, such as pursuant to a debenture (ie, a universal security document)), it may appoint an administrator (or, in limited circumstances, an administrative receiver) through an in-court or out-of-court procedure to take control of the company.

A secured lender may also exercise its powers as mortgagee – for example, to take possession of or sell secured assets (although this is not common, due to various risks involved) – and its rights of appropriation in respect of financial collateral (eg, cash and shares, in limited prescribed circumstances). A secured lender may also exercise its contractual or (if applicable) banker's rights of set-off, although it should be noted that, once the company has entered insolvency, certain sums due from the company (in particular, those incurred at a time at which the secured lender had notice that the company was likely to enter insolvency) are not permitted to be taken into account for the purpose of set-off in insolvency.

The procedures and requirements applicable to each enforcement option will be prescribed by statute and/or the terms of the relevant security documentation. In particular, there are specific procedures and requirements for administration set out in insolvency legislation which must be followed carefully.

Ranking in insolvency
In what order do creditors rank in case of the insolvency of a borrower?

The statutory order of priority of creditors on insolvency is broadly as follows:

  • Realisations from the disposal of assets subject to fixed-charge security are applied to discharge the claims of the holders of such security (subject to the deduction of the costs of realisation, provided that this has been agreed with such holders); and
  • Realisations from the disposal of floating-charge assets are applied:
    • first, to discharge general costs of the insolvency procedure (ie, administration or liquidation expenses), including the remuneration of the insolvency officer;
    • second, to discharge any preferential claims under English law (primarily occupational pension scheme contributions and specified employee claims, subject to certain maximum amounts and other limitations as set out in the insolvency legislation);
    • third, towards an amount referred to as the ‘prescribed part’ (being a proportion of the realisations from the disposal of floating-charge assets determined pursuant to a formula set out in the insolvency legislation and currently capped at £600,000 per company), which is required to be set aside and made available to unsecured creditors;
    • fourth, to discharge the claims of the holders of floating-charge security; and
    • fifth, to discharge the claims of secured creditors (to the extent not fully satisfied out of the proceeds of realisation of their fixed and floating security) and unsecured creditors (for the balance of their claims following application of the prescribed part).