When financing the acquisition or development of real estate, lenders typically require borrowers or investors to provide some form of security to protect their interests. These security arrangements not only give the lender legal rights over the property but also influence the structure and enforceability of the loan agreement. Understanding the various types of legal charges and their implications is essential for both borrowers and lenders involved in real estate finance. This article explores the common forms of security used in such transactions, their differences, and the practical and legal considerations associated with each.
We are often asked what sort of security is typically created or entered into by a borrower/investor who is borrowing money to acquire, finance or develop real estate.
The most usual form of security in return for borrowings which are secured against a property until such time as the borrowing is repaid over real estate assets are set out below:
- Legal mortgage
- Equitable mortgage
- Floating charge
Legal mortgage
A legal mortgage and an equitable mortgage are fixed charges, and both create a similar type of security. Both entitle the lender to take possession of the asset(s) and dispose of it with priority over unsecured creditors.
So, what is the difference between a legal and an equitable mortgage?
Most borrowing is secured by a legal mortgage. The difference between a legal mortgage and an equitable mortgage lies largely in the extent to which the mortgage is perfected by registration at the Land Registry, and legal and equitable mortgages are treated differently in terms of the rules of priority as against other creditors.
It is also common for security to be granted over the rental income from a property. This usually takes the form of an assignment whereby the borrower’s tenants are directed to pay the rental income to the lender (usually via a managing agent) so that the rental income does not pass through the hands of the borrower. This assignment can be created by a separate security document, but it is more commonly contained within the mortgage (or a debenture if one is granted in the security package).
Can a corporate borrower create a floating charge?
The answer is, yes it can. A floating charge is a charge over a class of assets which during the borrower's business changes from time to time and which may be disposed of without consent of the lender. A floating charge is sometimes taken with very large and complex property portfolios where the borrower requires maximum flexibility, and the lender is not too concerned over control. However, in such circumstances, a lender tends to take both a floating charge and a legal or equitable mortgage.
Equitable Mortgage
If there are circumstances where a legal charge cannot be granted, then an equitable charge can be considered as an option. An equitable charge does not take effect in law and does not give a lender a legal interest in the property but a beneficial interest instead.
Set out below are scenarios where an equitable charge may take place:
- Second Charges: A lender might be looking to charge a property that already has an existing charge in place. If consent from the existing first charge holder cannot be obtained to a second legal charge, then an equitable charge might be the only other option for that lender.
- Leasehold properties: Where the property is leasehold, and the lease contains a prohibition on creating a legal mortgage over the lease, then an equitable charge may be an option.
- Failure to comply with formalities: A legal charge might have failed for some reason – for example if it was not executed correctly or registered correctly and therefore an equitable charge might arise instead.
What are the risks associated with an Equitable Charge?
- Whilst with a legal charge, the lender has a power of sale, which enables a forced sale of a property to repay the borrowings in the event of a loan default, an equitable charge can only take effect in equity and not law, there is no power of sale.
- If a lender needs to recover sums owed, they will require the registered proprietor’s consent to sell the property. If consent is not forthcoming, either:
- the charge remains in place until the borrower pays or until a sale is agreed; or
- the lender applies to court for a court order to sell the property.
- When relying on a court to grant an order or decide whether a charge is enforceable and what remedies are available, you are at the mercy of the judge. The decision is at their discretion, and you cannot predict the outcome. In addition to the unknown, the process can be long and expensive.
- An equitable charge cannot be registered at H M Land Registry as a charge against the property’s title. This means prospective purchasers, tenants and lenders will not immediately be aware of its existence and a property could be sold without the lender’s knowledge. We would advise that a notice is entered onto the property’s title confirming that an equitable charge is in place. However, depending how the notice is registered, the borrower could apply to remove this.
- The lender will be an unsecured creditor, should the borrower become bankrupt, or the borrowing entity go insolvent. Those lenders with legal charges or secured creditors will take priority on repayment.
What are the alternative options to an Equitable Charge?
If a legal charge cannot be granted by the borrower over that property, and an equitable charge is too risky, then options might be:
- Legal Charge over a different property – alternatively, the borrower offers a different unencumbered property for security and the parties proceed with a standard form legal charge between the lender and borrower.
- Third Party Legal Charge – the borrower offers a different property to be secured that is jointly owned with another party (i.e., a spouse) or owned by a connected company. Each third party will need to take separate independent legal advice ahead of entering into the charge. The third party is effectively guaranteeing repayment of the loan by the borrower, and if the borrower fails to do so, the third party may lose the property.
Conclusion
Choosing the right form of security is critical for ensuring that a lender’s interests are adequately protected in real estate finance transactions. While legal mortgages remain the preferred and most robust option, there are circumstances where equitable mortgages or floating charges may be necessary or advantageous. However, these alternatives carry greater risk and limitations that both parties must carefully evaluate. Understanding the legal implications and potential pitfalls of each option allows borrowers and lenders to structure more secure, enforceable, and commercially viable financing arrangements.
The information provided in this article is provided for general information purposes only, and does not provide definitive advice. It does not amount to legal or other professional advice and so you should not rely on any information contained here as if it were such advice.
Wright Hassall does not accept any responsibility for any loss which may arise from reliance on any information published here. Definitive advice can only be given with full knowledge of all relevant facts. If you need such advice please contact a member of our professional staff.
The information published across our Knowledge Base is correct at the time of going to press.
