When taking security, it is imperative that the lender ensures its security will be effective in the event of the borrower’s insolvency or default, taking priority over third parties.
- What is Security?
When a lender loans money to a borrower, as well as repayment of the initial loan amount plus interest on it and any other costs and expenses that are provided for, the loan agreement may require that the borrower performs certain obligations. Their undertakings to pay and to perform certain obligations can be secured or unsecured. If secured, the borrower will grant “security” or “a security interest” in favour of the lender over all or certain of its assets. The grant of security to the lender is a grant of an interest in the specified assets of the borrower to allow the lender to satisfy a demand on the borrower. In the event the borrower breaches any of its obligations to the lender, the lender will have a right to exercise a number of rights and remedies over those assets.
The rights and remedies referred to vary according to the type of security interest but, generally, the main purpose of taking security is to allow the lender to take possession of and sell or lease the property to discharge the debt and obligations secured.
Many types of asset can be subject to security including aircraft, cars, computers and office equipment. This article is not specific to any particular asset. It merely aims to provide a general overview of the process by which a lender can recover an asset in the event of default on the part of the borrower. However, whatever the asset, it must be accurately described in the security documents.
- When can a lender exercise his powers? - Reviewing the loan and security documentation
Generally, a lender’s powers of enforcement will be expressly provided for in the security document. Mortgages, standard securities, debentures, deeds of covenant and chattels mortgages are all examples of common types of security documents. These narrate the circumstances in which the lender can exercise his powers to take possession and sell or lease the assets. Other documentation between the parties, such as a facility or loan agreement, will also provide insight as to the extent of the lender’s powers. Ideally, well drafted loan and security documentation should make the position clear.
For example, in the case of security over an aircraft, it will be necessary to review the loan agreement and the aircraft mortgage to check what the events of default are and how they are triggered. It is important that the “events of default” specified in the corresponding loan and security documentation are the same to avoid any dubiety.
In certain circumstances, the lender may also be able to rely on implied enforcement powers arising by operation of law which will be set out in applicable legislation. Generally, these powers are only available once the secured debt becomes payable to the lender.
When deciding to take security, the lender should also be aware of any other issues which could affect its ability to enforce the security at the appropriate time. For example, whether there are any other types of outstanding security that will rank in priority to the lender’s interest or whether there are any particular regulatory or compliance requirements relating to the asset or the security.
- Demanding Payment / Notice of Default
After establishing an “event of default” has occurred which is sufficient to allow the lender to exercise his powers of enforcement, the lender must determine whether the secured liability is payable by the borrower automatically or whether it will be necessary for the lender to demand payment before the amount actually becomes payable. Moreover, the lender will have to clarify whether making a demand itself ensures the security is enforceable or whether the demand has to be unsatisfied for this to occur?
In practice, a lender who wishes to enforce security will want to make a formal demand for payment to ensure the borrower is fully aware of what is happening. Some security documents will not provide for any formal notice whereas others may stipulate a precise period – the documentation should always be checked before taking action and demanding the payment of the termination sum.
Where the lender issues a formal notice of default, it is essential that it sets out the specific events of default that the lender is relying on in order to terminate the loan. This must be properly served on the borrower and often, in a loan agreement, or similar document, the parties will have specified the contact details and method of delivery of any notice of default. The notice must be served in accordance with these.
Generally, the borrower must be given sufficient time to enable him to repay the debt before the lender enforces its security interest over the assets. To determine whether sufficient time has been given depends on the circumstances of the particular transaction. Issues considered in previous cases include:- what the documentation said about the issue; on whom the demand was served; how specific and accurate the demand was; what discussions took place between the parties beforehand; and the financial position of the borrower.
- Repossession and Locating the Asset
When enforcing its security a lender might not require any court approval. For example, if the lender has a “legal mortgage” he can enter into possession of the relevant asset following a demand under the loan agreement simply because he is the legal owner by virtue of the transfer of legal title under the mortgage.
With other types of security, it may be beneficial for the lender to obtain a court order. (i.e. where the borrower opposes repossession or where there is uncertainty as to whether an event of default has occurred) For example, in the event of wrongful taking of possession by the lender, damages may be very high, especially in relation to those third parties who incur loss as a result of such seizure. Without court authority for taking possession, a private sale by the lender may also be challenged on various grounds, such as the authority of the lender to pass good title, the right to sell, the lack of sale at best price and the infringement of the rights of other parties possessing security or other interests in and or claims against either the aircraft or the borrower.
In some circumstances a lender may not wish to take possession himself and under the Law of Property Act 1925 in England, it may appoint a receiver to do so on its behalf. Such an appointment can be made relatively quickly without the involvement of the court. Very often the first hurdle may be locating the asset itself. This can be particularly difficult in the case of a readily moveable asset such as an aircraft, ship or car.
- Sale or Lease
Invariably, the security documentation will contain an express power of sale of the asset. However, if that is not the case, the lender, in England, may be able to rely on the statutory power of sale contained in sections 101 and 103 of the Law of Property Act 1925. These sections give the lender a power of sale over the asset in the case of a mortgage or charge which is made by deed. When the secured liability becomes payable, this power allows the lender to sell the property privately or by auction. There is no requirement to apply to the court. However, the circumstances in which such power can be enforced are restricted by section 103 of the 1925 Act which requires three months notice or five months arrears of notice on breach of the mortgage. However, those provisions are often excluded in the security agreement.
If a lender has entered into a contract to sell the property, the borrower’s right to recover ownership is then extinguished.
Alternatively, the lender may wish to lease the asset instead to repay the debt. A large number of different asset types can be leased including, computers, vehicles, plant and machinery, industrial and commercial property. Very often, the lender may find it much easier to lease the property, particularly in relation to equipment where it is often a more financially viable way for a company to use an asset.
- A Borrower in Administration: particular considerations
It is essential to note that different considerations would apply in circumstances where the borrower is subject to formal insolvency procedures at the time of enforcement and the position in this respect must always be checked.
For example, if the borrower is subject to Administration, no proceedings, including the enforcement of security, can be taken without the consent of the Administrator or the court.