Security in loan agreements: charges, mortgages and guarantees

Security gives a lender rights over assets, or a claim against someone other than the borrower, if the loan isn't repaid. If you are lending, it improves your chances of recovery if the borrower fails. If you are borrowing or guaranteeing, it is what you stand to lose. The main forms in English law are fixed charges and mortgages, floating charges (usually packaged in a debenture) and guarantees.

Fixed charges and mortgages

A fixed charge attaches to a specific asset, such as a property, an item of plant, shares or intellectual property. The borrower can't sell or deal with the asset without the lender's consent, and if the borrower defaults the lender can enforce against it, typically by appointing a receiver or selling the asset. A legal mortgage or legal charge over land works in a similar way and is the usual form of property security.

Fixed charge holders are paid out of the proceeds of the charged asset (after the costs of realising it) ahead of the general expenses of an insolvency process, preferential creditors and unsecured creditors, which makes fixed security the strongest form. The label in the document doesn't decide the question, though. If the borrower is in practice free to use and dispose of the asset without the lender's control (a common issue with charges over book debts or stock), a charge described as fixed may be treated as floating.

Floating charges

A floating charge covers a changing class of assets, such as stock, receivables or all of a company's undertaking, and lets the company deal with those assets in the ordinary course of business until the charge crystallises, usually on default or insolvency. It suits assets that turn over constantly, which a fixed charge can't easily cover.

The cost of that flexibility is priority. In an insolvency, floating charge holders are paid after the expenses of the insolvency process and after preferential creditors (which include certain employee claims and some taxes owed to HMRC), and a portion of the floating charge realisations (the prescribed part) is set aside for unsecured creditors. A qualifying floating charge over the whole or substantially the whole of a company's property also allows the holder to appoint an administrator out of court.

Timing matters as well. Under section 245 of the Insolvency Act 1986, a floating charge created shortly before the company goes into administration or liquidation can be invalid except to the extent of new money or value provided when or after it was created. The look-back period is longer where the lender is connected with the company, such as a director.

Debentures

“Debenture” strictly means any document that creates or acknowledges a debt, but in UK lending it usually refers to an all-assets security document. A typical debenture contains fixed charges over property, plant, shares, IP and bank accounts, and a floating charge over everything else, along with covenants restricting the borrower from disposing of assets or granting other security (a negative pledge). If a company already has a debenture in place with its bank, a second lender will usually need the first lender's consent and a deed of priority.

Registering company charges

A charge granted by a UK company must be registered at Companies House. Under section 859A of the Companies Act 2006, the statement of particulars and a certified copy of the charge must be delivered within 21 days beginning with the day after the date the charge was created. If this is missed, the charge is void against a liquidator, administrator and creditors of the company, although the debt itself remains payable, and it becomes immediately repayable. The court can extend the period, but only on application and on grounds such as inadvertence, so it is far better not to miss it.

Security over registered land must also be registered at HM Land Registry to protect the lender's priority. Other specialist registers apply to some assets, such as registered trade marks and patents. Security given by an individual or partnership over goods can fall under the bills of sale legislation, which has its own strict formalities.

Personal guarantees

A personal guarantee is a promise by an individual, usually a director or shareholder, to pay the company's debt if the company doesn't. A guarantee must be in writing and signed by the guarantor (or someone authorised by them) to be enforceable, and in practice it is usually executed as a deed.

A guarantee is unsecured unless the guarantor also charges their own assets, such as their home, so it is only worth what the guarantor can pay. For the guarantor, the risk is often underestimated. Look at whether the guarantee is capped, whether it covers only this loan or “all monies” owed now and in future, whether it can be terminated for future borrowing, and whether the guarantor is liable as a primary obligor (which removes some of the protections a guarantor would otherwise have). Where the guarantor's home is involved and a spouse or partner is also signing, lenders usually require them to receive independent legal advice before signing.

Combining security

In practice, lenders to small companies often take several forms of security together: a legal charge over property, a debenture over the company's other assets and a personal guarantee from the directors. Each one should be checked on its own terms and against the others, including what triggers enforcement and whether the guarantee can be called before the company's assets are enforced against.

If you are being asked to give security or a guarantee, and particularly if your home is at stake, get independent legal advice before signing. To check how a loan agreement deals with security, default and enforcement, you can upload it to QuickLegalCheck for a review.