Portuguese law sets out an exhaustive list of assets which may be subject to mortgage - namely real estate assets and movable assets which are subject to mandatory registration. The creation of mortgages over assets other than those specified in the law is not permitted.

However, Article 691.2 of the Portuguese Civil Code provides an exception to this rule. Under this article, mortgages over factories can be extended to cover all machinery, equipment and other chattels pertaining to the factory, as long as the relevant assets are listed in the mortgage deed.

Therefore, a special feature of the factory mortgage is its ability to cover both real estate (ie, the land itself and the factory built upon it) and the equipment used by the company in its production activities. This enlarges the object of the mortgage, and consequently the value of the collateral, while at the same time linking the security of the credit facility to assets which are essential for the company to carry out its production activities.

Thanks to a combination of low interest rates and a relatively stable economy, companies have proved increasingly willing to resort to credit by taking out second mortgages over their factories in order to purchase equipment, and this can be an envisaged tool for asset finance deals. However, this involves a substantial element of risk if the mortgaged assets are not sufficient to cover both loans. The main risk involved is borne by the first lender in respect of its second-ranking entitlement.

If the debtor wishes to access further capital locked up in its factory, it is cheaper for it to take out a second mortgage than to extend the terms of the first mortgage agreement. The security, powers and interest of a second mortgagee rank second to those of the first mortgagee - but this is not problematic, since the same lender has issued both mortgages.

However, if the debtor subsequently turns to a new lender in order to pay off the first mortgage - which it is entitled to do without obtaining the prior consent of the original lender - the new lender will obtain a fully secured, first-ranking mortgage over the factory. The original lender will be left with a second-ranking mortgage and, if the debtor defaults, will not be properly covered, as the cross-protection resulting from the first mortgage will no longer apply.

For further information on this topic please contact Pedro Cassiano Santos or Hugo Moredo Santos at Vieira de Almeida & Associados by telephone (+351 21 311 3400) or by fax (+351 21 352 22 39) or by email ([email protected] or [email protected]).