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Detailed Practice Notes written by our Professional Support Lawyers, guiding you through the key issues in each topic.
Quasi security - overview
Quasi security is the common term describing the various ways of enhancing a creditor's protection against a debtor without creating a security interest.
Third party support
A third party may agree to provide financial support to a debtor in favour of the creditor by providing:
A guarantee is an undertaking given by one party (the guarantor) to another in respect of a debtor performing its obligations to ensure that such obligations are performed (whether by the debtor or the guarantor) if the debtor fails to perform them. A guarantee supports a primary obligation between two parties other than the guarantor but is itself a secondary obligation; so if the underlying contract is void, set aside or the debtor is discharged from its obligations then the guarantor's obligations fall away.
An indemnity is similar to a guarantee in that one party undertakes to be responsible for the obligations and liabilities of a third party should such third party fail to perform its obligations. However, it provides a creditor with more protection than a guarantee as it is a primary obligation, which will continue even if the underlying contract is void, set aside or if the debtor is discharged from its obligations
A performance bond
A performance bond is a contractual commitment by a company, bank or other financial institution to pay a sum of money when a specified event occurs. If the performance bond is provided by a bank or other financial institution a counter indemnity will invariably be required from its customer. When a specified event occurs the bank, other financial institution or company giving the performance bond will be liable to pay the specified sum to the beneficiary under the terms of the performance bond. This may be by simple demand, unless it is able to show fraud or that the demand has been made outside the terms specified in the performance bond.
A standby letter of credit
A standby letter of credit (mainly found in US banking transactions) is a contractual arrangement whereby one contracting party obtains payment from the issuer of the standby letter of credit, usually a bank, when the other contracting party fails to perform the contract. Standby letters of credit are similar to bonds creating a primary obligation on the issuer away from the obligations of the parties to the underlying contract.
A creditor and debtor may enter into a commercial arrangement to enhance/increase the creditor's protection, such as:
a factoring agreement with a creditor whereby the creditor purchases the present and future receivables from the debtor at a discounted price - as the debtor no longer owns the debts it is unable to grant security over them in favour of another third party
a finance lease or a sale and lease back arrangement whereby a creditor either purchases an asset from a third party and then leases the same to a debtor or purchases the asset from the debtor itself and then leases it back to the debtor
including a retention of title clause in a contract acts as a type of security interest for a supplier, the creditor, by allowing a supplier to retain legal title to goods that have been supplied to a buyer, the debtor, until the buyer pays for the goods in full - although not suitable for securing a loan, a retention of title clause may undermine a lender's security as a borrower is unable to grant security over an asset if it does not beneficially own the asset, or
including a negative pledge clause in a contract prohibiting a debtor from giving security to a third party
Right of set-off
The right of set-off provides a creditor with the right to set off money owed to a debtor by it against money owed to it by that debtor. There are three possible ways of a creditor having a right of set-off:
an equitable right of set-off whereby a liquidated debt owed to the borrower is set off against a liquidated debt owed by the borrower
a contractual right of set-off, eg a loan agreement, will generally enhance a lender's equitable right of set-off, or
a mandatory right of set-off on liquidation under the Insolvency Rules 1986, SI 1986/2116
A creditor may require a debtor to place an amount of cash representing the debt owed in an account as security. Generally, this mechanism is not used for a simple loan but may be used by a bank or another financial institution when a performance bond or a letter of credit is provided by it.
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