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Security - overview
Money may be lent on a secured or unsecured basis. If a loan is secured, provided the security is created properly and not capable of being set aside, the lender is protected against the borrower's default of the loan or insolvency and may be paid out of the realised security ahead of any other creditors of the borrower.
Creation of security
The main types of security interest are:
a lien - there are three types of lien, depending on the type of lien the lender will have the right to possess and/or sell a borrower's property:
common law
equitable
statutory
a pledge - this creates security by the delivery (actual or constructive) of an asset to a lender, to be held until the performance of an obligation while ownership of the asset remains with the borrower
a mortgage - this creates security by transferring ownership of an asset to the lender including the right to sell on default and an obligation to re-transfer title on satisfaction of the debt; possession is not required to perfect the security and usually remains with the borrower; two types of mortgages exist:
legal
equitable
a charge - there are two types of charge, fixed or floating, both of which are equitable rights; a charge does not transfer legal or beneficial interests in the asset to the lender nor do they confer a right to possession; the lender will have the right to resort to the asset in order to pay off the debt
Perfection of security
The first main concern of a lender when it obtains security is to ensure that the security is effective against the borrower or a liquidator, administrator or receiver. To ensure that this is the case the lender must perfect the security. Perfection may involve:
possession - pledges and common law and statutory liens require the lender to have and retain actual or constructive possession of the secured asset
title - a mortgage requires the legal or beneficial title of the secured asset to be transferred to the lender
notice - in certain cases notice of security is given to the relevant contracting third party to ensure priority over any subsequent security or transfer of a chose in action; however, if the lender fails to give notice and the borrower subsequently assigns the asset to another party who gives notice to the relevant contracting third party before the lender then that party will have priority over the lender, or
registration of company charges - under the Companies Act 2006 (CA 2006), s 874 a charge created by a company registered in England and Wales is, so far as any security on the company's property or undertaking is conferred by the charge, void against the liquidator, administrator or a creditor of the company, unless the prescribed particulars of the charge together with the instrument (if any) by which the charge is created or evidenced, are delivered to the registrar of companies for registration within the period allowed for registration, ie 21 days beginning with the day after the day on which the charge is created
Priorities
The second main concern when a lender obtains security is to ensure that the security is effective against third parties who also obtain an interest in the secured asset. The general priority rule is the first in time prevails. There are a number of exceptions to this principle; five of the most important are:
the bona fide purchaser rule - if an equitable interest is followed by a legal interest, the subsequent legal interest will take priority if the holder acquired such interest for value without notice of the equitable interest
Dearle v Hall [1824-34] All ER Rep 28 - the rule for priorities of dealings in equitable interests is that priority is governed by the time that notice is given to the borrower or to the person in control of the equitable interest ie the first to give notice has priority
registration - security interests created by companies and registered under CA 2006 will have the following priority ranking: (a) fixed charges and mortgages will have priority over a preceding floating charge unless the floating charge has already crystallised; (b) fixed charges and mortgages rank in priority according to the date of their creation; and (c) floating charges rank in priority according to the date of their creation. In the case of registered land, registered charges rank according to the order in which they are entered on the register (subject to any entry to the contrary on the register); in the case of land, the security will normally be in the form of a legal charge (also known as a charge by way of legal mortgage). Ownership of the land remains with the borrower
cases where the 'equities are unequal' - the basic priority principle only applies where 'the equities are equal' and the courts may decide that the basic principle should be overridden because to follow it in the particular circumstances would be inequitable, and
the 'purchase money security interest' - the courts have indicated that where a lender has specifically financed the acquisition by a company of a particular asset on the basis that the asset will be charged to that lender its charge will take priority over an earlier general charge over the assets of the company as a lender is not able to receive better title than the borrower holds
Subordination
A lender may wish to vary priority conferred by law and/or regulate the priority of payments before and after the borrower's insolvency by entering into a contractual arrangement with other creditors of the borrower.
Enforcement of security
The security document will provide when and how the lender may enforce the security. Generally, security will be enforceable once the underlying secured indebtedness is repayable. The security document will also usually give very wide enforcement powers to the lender, ie the right to sell the asset.
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