Bank loans have decreased since the credit crunch, which has meant that it has been an increasingly common practice for directors and shareholders to loan their companies money. In return, security is offered over certain assets of the company, providing comfort until the loan is repaid.
However, what is also unfortunately a common practice, is that the security is either not properly executed, authorised or registered; potentially rendering it unenforceable. If this is the case, the director or shareholder has no enhanced protection, should the company become insolvent, and the lender will rank alongside all other creditors of the company.
Below we have outlined our top ten tips for directors and shareholders who are currently looking to lend their company money (or who have already loaned money and wish to check the enforceability of their security). Most of these points will also apply to non-director and non-shareholder lenders as well.
The first step to take is to review whether the company has any restrictions on borrowing or granting of security. Such restrictions would be detailed in the company’s articles of association or any shareholders’ agreement which may be in place. Any loan to the company or security granted must be in line with any such restrictions to ensure that the loan is valid and enforceable. Should restrictions be in place in the articles, they can be amended by a shareholder resolution.
Any security granted in breach of the company’s articles of association could still be upheld against the company if the lender is deemed to be acting in “good faith” (i.e. the lender didn’t know about the restrictions within the articles of association). However, for directors lending to a company, and even shareholders, this could be difficult to prove. It is therefore important to check, prior to making the loan.
2. A question of priority
The lender will want to ensure that their name is at the top of the list of the company’s creditors, should the company go into insolvency, to hopefully ensure full repayment of the loan.
A search at Companies House should be undertaken to ascertain the company’s current list of security holders. Should there already be existing security granted by the company, a deed of priority can be entered confirming that your security shall rank ahead of the existing security holders, if the company becomes insolvency. This deed will often have different priorities over different assets of the company.
3. What and how to charge?
An important part of the security process will be to decide what assets of the company to take security over and what form of security to use.
Identify the valuable assets of the company and plan your security accordingly. For example, if the most valuable asset is the company’s property, the security could be a debenture plus a charge over the freehold. Similarly, if the company’s main asset is its intellectual property, security could be taken over the relevant trademarks, patents etc.
4. Consider a debenture
To understand a debenture, it is important to understand the distinction between fixed and floating charges.
A fixed charge is generally a charge or mortgage secured on particular tangible property, such as land/buildings, a ship, machinery, shares or intellectual property.
Floating charge assets are those that the company can deal with, such as stock. A company’s assets can be charged by a floating charge but also traded and replaced, without needing fresh consent from the lender. This continues until the loan becomes repayable and the floating charge “crystallizes” into a fixed charge.
Under a debenture, the lender can take fixed and floating charges over the company’s assets to seek as much protection as possible for the loan. An advantage to obtaining a debenture, and why this should always be sought by the lender, is that it carries the right to appoint their own administrator to act in the interest of the bank and all of the company’s creditors.
5. Timing is everything
The timing, as to when the security is taken by the lender, is crucial.
Should the loan have already been advanced and then the security subsequently taken, this leaves such security potentially open to attack by any subsequent liquidator under the Insolvency Act 1985. The basis of attack is that the granting of security may be considered to be a preference. It is therefore vital to ensure that the security is taken before or at the same time as the loan is provided to the company.
6. Commercial risk
Don’t just focus on the security, if the company will struggle to service any interest or capital repayments, seriously consider whether you should be advancing (further) monies.
7. Properly documented
Prior to the loan being made, the company should produce board minutes which show, amongst other things, that the terms of the loan were approved, that any conflicts of interest of any board member were approved and that the loan itself was providing a corporate benefit to the company. Shareholder approval is also recommended so that any challenge by shareholders to the granting of the security is avoided. In addition, it should be noted that certain loans to directors must have shareholder approval and any shareholders’ agreement should also be reviewed in relation to approval requirements for the borrowing and granting of security.
If possible, a declaration of solvency should also be sought from the company.
8. Financial collateral arrangements (No.2) Regulations
If it is the intention of the lender to take outright ownership of the secured asset in the event of default (instead of appointing an administrator or receiver) then the Financial Collateral Arrangements (No.2) Regulations 2003 should be complied with. Briefly, these regulations require a valuation of the secured asset to be taken by the lender. Where the value of the asset exceeds the amount of the loan outstanding, the lender must account for the excess balance. If the value of the asset is less than the outstanding amount, the company could remain liable for any balance due.
Any security granted over the assets of the company must be registered with Companies House within 21 days from the day after the security is created. If the necessary forms and documentation, together with payment of the applicable fee, are not received by Companies House in time, the security will be void against a liquidator, administrator or any creditor of the company.
In respect of intellectual property, further registrations should be made with the relevant trade mark and patent offices. Similarly, security over land should also be registered at the Land Registry.
10. Take legal advice
As you can tell from the top tips above, there are a lot of considerations and steps required to ensure that your security is adequate and enforceable. It is therefore strongly advisable to seek legal advice. Although there is a cost to obtaining legal advice, the size of this cost should be relatively small compared to the consequences of having invalid security!
For more information as to how we can help you (including arranging a free consultation), please contact your usual Fox Williams contact.