Last Updated October 08, 2019

Law and Practice

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Winston & Strawn London LLP provides a wide range of legal services through its banking and finance practice, to public and private companies, leading financial institutions, multilateral and development finance institutions, private equity and investment funds, alternative funding sources, investors and emerging companies, on investment grade, leveraged and mezzanine financings. The firm advises on high-profile transactions and matters ranging from cross-border transactions, initial public offerings (IPOs) and project finance matters, to distressed acquisitions and creative “first-of-their-kind” financings. Clients include leading international funding sources which provide senior, subordinated, secured and unsecured debt, and hybrid (equity/debt) products, as well as institutional investors who regularly participate in senior debt markets, equity sponsors, and borrowers in both developed and emerging economies. Additional thanks to partners Ed Denny and Dan Meagher and associate Shaheer Momeni, among others, for their contributions to this chapter.

General

While the law summarised below relates to England and Wales only, the rules of Scots law and the laws of Northern Ireland do not differ materially from this. However, local counsel in the non-English jurisdictions of the UK should always be consulted to determine any differences in matters of detail.

In England, lenders will typically look to take security over all of a corporate obligor’s present and future assets, property and undertaking by means of a debenture (a form of security agreement). The debenture will generally include the following types and forms of security interests: 

  • a legal mortgage over real property; 
  • an assignment by way of security of bank accounts, any insurance policies and any material contracts; 
  • fixed charges over certain assets of the chargor’s (including its shares and investments, intellectual property rights, plant and machinery, cash deposit accounts and book debts/receivables); and 
  • a floating charge to cover the balance of the chargor’s assets. 

Where the English obligor owns assets outside of England and Wales, local law security is generally also taken. Where security is being taken from an English individual, that is granted on an asset-specific basis. Both fixed and floating security can be taken from an English corporate obligor, but an individual cannot grant floating security and charges over chattel are complicated. The composition of a security package will be a matter of negotiation between the borrower and the lender. 

The ranking on insolvency of fixed and floating security in England is different, with fixed security ranking ahead of certain preferential creditors, who rank ahead of floating security. However, to ensure an effective fixed security interest, the security holder must have control over security assets, both contractually and in practice. 

Perfection Requirements

The requirements for the formalisation of security interests are limited, and are confined to registering the security interest at a public register of security interests, delivery of applicable title and transfer documents (eg, share certificates and signed but undated stock transfer forms) and serving a notice of security to any relevant third party (in each case, if required). 

Specifically, pursuant to Section 859A of the Companies Act 2006 any mortgage or charge granted by a company or limited liability partnership registered in England and Wales must be registered at Companies House in the 21-day period beginning the day after the date of creation of the charge, or it will be void against a liquidator, administrator and any creditor of the company. Security interests created over UK registered land, intellectual property, ships or aircraft will also need registering on specialist registers for these asset types. Overseas companies are not required to register at Companies House any charge created by them on or after 1 October 2011.

While there are exceptions, a security interest over freehold and leasehold property located in England and Wales should generally be registered as soon as possible after the transaction at the Land Registry (registered land) or the Land Charges Department (unregistered land). Such registration is binding on a future lender or purchaser of the property. Although the security interest will not be void due to failure to register, if the security is not registered, an acquirer in good faith of the property can acquire title.

Security over UK patents, registered trade marks and registered designs should be registered at the UK Intellectual Property Office (IPO). Where security is taken over intellectual property registered in the European Union Intellectual Property Office (EUIPO), the security must be registered in the EUIPO as well.

Where security is taken over shares, it is usual for the chargee or security trustee to request changes to the constitutional documents of the company whose shares are being charged, to remove the directors’ right to veto a transfer of shares.

Searches for pre-existing security interests can generally be made electronically on the relevant online registry. As long as the secured creditor registers its security at the relevant register within the prescribed time, the security will be effective against other creditors, a liquidator or administrator with effect from the date of creation. 

Financial Collateral Regulations

The Financial Collateral Arrangements (No 2) Regulations 2003 exempt certain security over financial collateral, such as cash, financial instruments and credit claims (claims under loans made by credit institutions) from registration requirements. In practice, however, security documents creating these types of security interests are commonly still registered on the basis that if a purported fixed charge over such collateral is re-characterised as a floating charge, it may be deemed to have required registration and be void if registration was not made.

Costs Involved

In addition to legal and financial and other professional costs relating to due diligence and documentation, all registrations of security at Companies House will incur a fee of GBP23 (or GBP15, if filed electronically) in respect of each security document filed. The fee payable on registrations of security at the Land Registry will be assessed on the amount the mortgage or charge secures (between GBP40 and GBP250 per property, or GBP20 and GBP125 per property, if filed electronically), although special rules apply to the calculation of fees for more than 20 properties. All registrations of security at the IPO will incur a fee of GBP50 in respect of each registered patent, trade mark or design. 

Security over property is not liable to stamp duty land tax and there are no other notarisation or stamp fees payable when security is created.

A floating charge granted over the assets and undertakings of a chargor is one of the most common forms of security taken by lenders in the UK. A floating charge can be created without restricting the chargor's right to deal with the charged assets without the prior consent of the lender until crystallisation (usually, upon the occurrence of an event of default), at which point the charge attaches specifically to each individual asset. Only a company or an LLP, but not individuals, can create a floating charge.

An important distinction between a fixed and a floating charge is that a floating charge is subject to various preferred claims and the prescribed part, as discussed below, while a priority fixed charge has priority over all other creditors and survives the insolvency of the borrower. Following crystallisation, a floating charge will have the characteristics of a fixed charge, but it will not have the priority enjoyed by a fixed charge. In effect, crystallisation does not itself affect priorities.

Under English law, the board of directors of an English company must act in the best interests of the company of which they are directors, rather than in the interests of its associated companies or the group as a whole.

Issues of corporate benefit often arise in the context of upstream and cross-stream guarantees. 

In essence, an upstream guarantee will be acceptable if the guarantor company’s board of directors reaches the conclusion that the giving of the guarantee will bring real benefit to the company or their actions are ratified by a resolution of all the shareholders of the company. Such benefit could consist of the group as a whole receiving financing that would otherwise not be available to it on favourable terms and the parent or other group member agreeing to share the benefit of that financing to the guarantor company in consideration of the guarantee given by it. Transfer pricing rules may lead to guarantee fees being payable between members of the group. In all circumstances, the question of whether there is sufficient corporate benefit will depend on the specific facts of the transaction which the directors must carefully consider.

The position is more complicated if there is a risk that the proposed guarantor is insolvent and a shareholder resolution will be insufficient to protect against creditors seeking to set the guarantee aside on the insolvency of the guarantor.

The Companies Act 2006 includes prohibitions on the giving of "unlawful" financial assistance by a public company or its subsidiaries in connection with the acquisition of shares in that public company or acquisition of its English holding company's shares by another person, while there is no whitewash procedure to follow which would enable the provision of financial assistance, and only limited exceptions are available.

Financial assistance includes giving guarantees or security for any acquisition funding. On a debt-financed acquisition of a public company, the target will therefore often be re-registered as a private company and give guarantees or security once it has re-registered. However, to be re-registered it is necessary to acquire a sufficient percentage to de-list and resolve on registration.

Breach of the restriction against unlawful financial assistance can result in criminal sanctions, including fines and possibly imprisonment of directors and officers of the offending company. Security taken from a company in contravention of the financial assistance restrictions will be void. 

The statutory financial assistance rules do not apply to the acquisition of private companies.

Restrictions on assignment are common in a range of contracts, such as intellectual property licences, leases and ordinary book debts. Where these apply, third-party consents will be required to create some types of security over certain assets, which may be challenging to obtain. As in other jurisdictions, there are proposals to introduce legislation to override restrictions on assignment of debts to allow for factoring and receivables financing, but the complexity of these proposals has stalled proceedings in the UK for the moment. 

The grant of a guarantee or security by an English obligor should be approved by the obligor’s board of directors. A shareholders’ resolution is usually required as well, in particular in connection with the grant of upstream or cross-stream guarantees or where the provision of the guarantee or security could otherwise breach the prohibition on financial assistance.

Security is usually released by a deed of release upon discharge of the secured liabilities, or on permitted disposal of a charged asset. 

When security granted by an English-registered company or limited liability partnership is released, the security provider will usually require the release to be recorded at Companies House. However, a failure to do so does not affect the effectiveness of the release. When a legal mortgage over registered real estate is released, the lender must also execute and file the appropriate Land Registry or Land Charges Department form. 

When an asset subject to a floating charge is sold, a release of the charge is usually not necessary. However, the buyer may request a letter of non-crystallisation from the charge holder. This is to ensure the buyer takes the asset free from any fixed charges. 

Any security arrangements which have been notified to other parties will require notice of the release and re-assignment.

Priority of security is governed by English common law rules, not by order of registration. Consequently, a lender which advances money to a company in reliance on a clear search of the register of security interests should not assume that it is protected; there may be an earlier charge granted within the preceding 21 days that has not yet been registered.

Competing Security Interests

With respect to competing fixed security or mortgages, priority is generally determined based on which security was created first (as long as such security was registered within the 21-day grace period). The same applies with respect to competing floating charges. A fixed charge or mortgage will rank ahead of a floating charge, except when the fixed charge (or mortgage) is obtained after the floating charge came into existence and the holder of the fixed charge (or mortgage) obtained it knowing that it violated the terms of the existing floating charge. 

The priority of successive assignments of an account receivable is not governed by the general common law rule of first in time but rather by the first to give notice. Consequently, an assignee that is the first to give notice of assignment to a debtor will obtain priority over an earlier assignee that has not yet given notice.

There are, however, a number of exceptions to these rules, including that, where security is granted over an asset requiring registration in a specialist register (eg, real estate or intellectual property), the priority of such security will be determined by the order of registration in the specialist register. With respect to the priority of mortgages and fixed charges over real estate, the rules differ for registered and unregistered land. The basic priority rules for registered land are that legal mortgages rank in priority in the order shown in the relevant Land Registry register and equitable mortgages and charges rank in order of date of creation. The basic priority rules for unregistered land are, firstly, that a lender holding the title deeds to a property subject to a legal or equitable mortgage or charge can rely on the possession for priority. If the title deeds are not held by the lender, the lender can protect its security by registering a Class C land charge with the Land Charges Department where the security is over a legal estate. Registered Class C land charges rank in order of their registration.

Subordination

Depending on the nature of the particular transaction, contractual subordination is recognised by UK courts. It is often used in conjunction with other structuring techniques, such as turnover trust, structural subordination, assignment of junior debt and taking security.

Contractual subordination may be achieved by agreement between creditors, eg, by them entering into a deed of priority or an inter-creditor agreement. In its simplest form, contractual subordination not only prevents the junior creditor from being paid until the senior creditor has been paid in full, but also subordinates the junior creditor in an insolvency situation to all other creditors ranking equally with the senior creditor. It is, however, also possible to create arrangements whereby the junior creditor is subordinated to the senior creditor only.

Contractual subordination remains effective on the insolvency of a borrower incorporated in England, subject only to the mandatory statutory pari passu principle that the priority of creditors on insolvency is determined by whether they are preferential, general or deferred creditors.

Winston & Strawn London LLP

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Authors



Winston & Strawn London LLP provides a wide range of legal services through its banking and finance practice, to public and private companies, leading financial institutions, multilateral and development finance institutions, private equity and investment funds, alternative funding sources, investors and emerging companies, on investment grade, leveraged and mezzanine financings. The firm advises on high-profile transactions and matters ranging from cross-border transactions, initial public offerings (IPOs) and project finance matters, to distressed acquisitions and creative “first-of-their-kind” financings. Clients include leading international funding sources which provide senior, subordinated, secured and unsecured debt, and hybrid (equity/debt) products, as well as institutional investors who regularly participate in senior debt markets, equity sponsors, and borrowers in both developed and emerging economies. Additional thanks to partners Ed Denny and Dan Meagher and associate Shaheer Momeni, among others, for their contributions to this chapter.

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