Banking and Finance

There are a number of advantages of a lender taking security from a borrower. However, the main ones are that:

• The lender would obtain rights against specific assets of the borrower if the borrower was unable to meet the claims of all of its creditors; and
• The lender would obtain priority over the other creditors of the borrower in receiving their payment.

Types of security

Under English law four types of securities interests are recognised, namely: mortgages, charges, pledges and liens. Each of these types of security essentially creates a legal or equitable security interest in the assets of the borrower which enable the lender to appropriate them should the borrower default or fail to perform its underlying obligations.

It must be noted that each of the types of security grant different types of rights and they can be distinguished as follows:

• Mortgages – a legal mortgage is created by the transfer or assignment of the legal title to an asset by way of security. This is subject to either an express or implied condition that upon the satisfaction or discharge of the obligation under which it was created that the transfer is transferred back to the borrower;
• Charges – there is no transfer of title to the asset and therefore the charge is an equitable interest (except in relation to charges by way of a legal mortgage over land which were created pursuant to section 85 (1) of the Law of Property Act 1925 (“LPA 1925”). Effectively the charge is an agreement under which the borrower allows the lender to appropriate the asset and to apply the proceeds towards discharging the borrower’s obligations;
• Pledges – this involves the actual or constructive transfer of the possession of an asset to the lender. It can be used for assets whose title transfer passes by delivery. The ownership of the asset remains with the borrower however the lender has the ability to sell the asset should the borrower default on their payment obligations; and
• Liens – these arise from common law rights either by general usage or by agreement. They enable the lender the right to retain possession of an asset until the borrowers obligation has been satisfied and duly discharged. It must be noted that there is no power of sale conferred upon the lender however a power of sale is sometimes granted by virtue of an agreement between the parties or by way of custom.

Fixed and floating charges

Charges can be either fixed of floating. Generally only limited companies create floating charges. For a fixed charge the borrower will ordinarily grant a charge over its more permanent assets. These usually deal with land and fixtures and fittings. A fixed charge attaches immediately to the asset and the lender is given control as to the borrower’s ability to deal with those assets to which the fixed charge applies. Therefore without the consent of the lender the borrower is unable to dispose of the asset.

This position is different from that created under a floating charge. Under a floating charge the attachment is deferred until the position is crystallised. In this instance the lenders rights attach to a shifting class of assets which includes future assets. This leaves the borrower free to manage and dispose of assets in the ordinary course of their business. This is until the position becomes crystallised. Once the position does become crystallised the floating charge then converts into a fixed charge and becomes attached to all of the assets within the charged class which the borrower owns or acquires thereafter. At this point the borrower is unable to deal with the assets. It is important to note that the crystallisation of a floating charge does not need to be registered at Companies House as there is no new security being put into place.

Assignments

An assignment is generally the means under which security is created over choses in action. These are things such as debts or other contractual rights. The assignment can be contained within either a debenture which creates legal security over a number of assets or in a stand alone agreement.

An assignment can be either equitable or legal. To enable the assignment to qualify as a legal assignment it must comply with certain provisions of section 136 of the LPA 1925. These requirements are that:

• The assignment must be in absolute form and not state to be by way of a charge only;
• It must be signed by the assignor; and
• Notice in writing must be given to the debtor.

If these conditions are met then the assignment is effective from the date of such notice to pass and transfer:

• The legal rights to such debts;
• All legal and other remedies; and
• The ability to give good discharge for the debt without the agreement of the assignor.