Businesses need cash to run, grow, sustain, and sometimes to get out of trouble. Loan funding is often sought by businesses to get cash in. Loan documentation tends to be fairly standard, whereby a document is drafted to outline essentially, who the borrower is, who the lender is, how much is being loaned, for how long, and what interest will be paid on the loan. There are other terms included in a loan document but the nuts and bolts tend to be as above.
Lenders do not tend to loan money to borrowers without the borrower putting up some form of asset as collateral. The idea being that the lender can sell the collateral to get the loan repaid if the borrower cannot, or will not pay. This is known as ‘security’ where assets are secured against the loan.
Effective security means that the lender can, on the insolvency of the borrower, take possession of assets, sell it and use the proceeds to repay the loan. This puts the lender in a stronger position than creditors who do not have security. Depending on the circumstances, the lender has the option of taking security over specific assets of the company or over all the assets of the business. If the bank chooses to do the latter a debenture will be used to create fixed and floating charge over all the property and assets of the company.
How a security is categorised has an impact on success for recovery in default. Choosing the wrong security could mean a lender loses out in the event of the borrower’s insolvency or sequestration. It could also mean that a borrower is forced to give up possession of a valuation business asset which would otherwise have generated revenue for the business. These considerations, though not exhaustive, are why knowing which type of security is being granted within loan documentation is vital.
Types of Scottish Security
In Scotland there are five main types of security:
- Floating Charge – a non-possessory security which can be granted by a company of limited liability partnership over its property.
- Standard Security – a fixed charge over heritable property.
- Liens – A right which entitles a party to hold on to assets in his possession pending payment of a debt owed. For example, a mechanic has a right to hold your car that he/she has repaired until you pay the bill.
- Pledges – a pledge is a delivery of an asset in security to a creditor. Ownership of the asset remains with the debtor and the creditor has a right to sell the asset if the debt isn’t paid. The most common type of pledge used in lending situations is a pledge over shares held by a debtor in a company.
- Assignations in Security – used mainly to transfer to a lender the borrower’s rights in incorporeal (intangible) moveable assets such as book debts and intellectual property.
When it comes to companies borrowing money in Scotland, the standard Scottish security package is when lender will include a floating charge and standard security against all debts owed to the lender by the borrower. In addition, a bank may also ask the shareholders or directors to grant a personal guarantee against all sums within the loan. This reality this means that if there are any sums outstanding under the loan which are not paid, or satisfied in full by selling the securitised assets, the lender can come after the granter of the personal guarantee personally. This has the effect of piercing the corporate veil where otherwise the debts of the company would be limited, and shareholders liability is limited to the share capital.
- Floating Charge
In Scotland a floating charge can be granted to a lender by a limited company or LLP.
A Scottish floating charge though is documented separately from any fixed charges; unless otherwise agreed, all assets of a company are subject to a floating charge and therefore secured to the bank, whether or not they are also subject to a fixed charge.
As in England, a Scottish floating charge must be submitted for registration with Companies House in Edinburgh within 21 days of its creation, otherwise it is void against any liquidator, administrator or creditor having a claim.
The borrower will also be free to dispose of and acquire assets until such time as the floating charge has crystallised. If the floating charge attaches to all assets, the assets charged by the floating charge therefore change throughout the duration of the security.
If the floating charge is a “qualifying floating charge” then the bank shall have the right to appoint an administrator of the company. The test of what constitutes a qualifying floating charge is the same as in England ie the floating charge (alone or with other fixed or floating charges held by the bank) relates to the whole, or substantially the whole, of the company’s property and states that paragraph 14 of Schedule B1 of the Insolvency Act 1986 applies, or allows the holder to appoint an administrator or administrative receiver of the company.
- Standard Securities
Heritable (freehold property under English law), and leasehold property with a term of more than 20 years, may be charged using a statutory form of security known as a standard security. The standard security is the only effective form of security that may be taken over land in Scotland.
A standard security is a Scottish law equivalent of an English legal mortgage over interest in land and can be granted by individuals, partnerships and corporates.
The date of creation of a standard security is the date of registration in the relevant Scottish Property Register, and not the date it is executed or delivered; without registration there is no security right.
Once the standard security is registered in the relevant Scottish Property register, if the standard security has been granted by a corporate the bank has 21 days to register it at Companies House in Edinburgh, otherwise it is void against any liquidator, administrator or creditor having a claim.
To enforce an English legal mortgage or charge, the secured bank would have the ability to appoint a fixed charge receiver with the powers set out in the charge and under the Law of Property Act.
There is no power to appoint a fixed charge receiver in Scotland. The mechanisms for enforcing a standard security – known as “Calling Up” – are set out in statute and they must be strictly adhered to in relation to procedure and timing to avoid a charge to enforcement of a standard security being made.
Blog 1 of this series highlights the main business securities that a lender shall consider when lending to a business available. Each though shall need to be appropriate to and suitable for your business and its need. Additionally, the lender will want to consider ranking of other securities in competition with it in the event of insolvency or sequestration.
Blog 2, within this series, will highlight some of the major benefits that obtaining security brings to borrowers and lender.