A lender which has taken security from a company has a number of options available when it comes to enforcing its security, depending on the nature of the security and the type of asset secured.
In this note we consider the following:
- preliminary steps which should be taken before enforcing security;
- appointment of an Administrator;
- appointment of a Receiver;
- the power to sell assets; and
- the power to take possession of assets.
Security Review and Reservation of Rights
Following an event of default, a lender which has taken security from a company will have a number of options available to it under the terms of the facility agreement and its security. However, before enforcing its security a lender will need to be certain that it has the right to do so. A lender will also need to know what rights it has and when they may be exercised.
A review of the facility agreement should be conducted by the lender’s solicitors to establish and advise the lender on matters such as the validity of the security, whether an event of default has occurred, what it is entitled to do after an event of default, when the security can be enforced and the options available to them.
On occasion a lender will require time to consider which action it would like to take against a borrower. In order to protect its position and avoid a claim that by delaying enforcement action the lender has waived default, it is often advisable that a reservation of rights letter is sent to the borrower immediately after an event of default has occurred. Such a letter explains to the borrower the nature of the default and that the lender is reserving any right they have now or in the future arising from the event of default.
Once a review of the security has been completed and the lender is satisfied on the enforceability of its security and that it would like to take enforcement action, then consideration will need to be taken of which enforcement option it will proceed with.
Appointment of a Receiver
One of the options which may be available to the holder of a fixed charge is to appoint a receiver.
The receiver will take charge of the assets over which they are appointed and the principle duty of the receiver is to preserve and realise the assets over which (s)he is appointed in order to repay money owed to the charge holder under its security. A receiver’s primary duty is owed to the appointing charge holder but (s)he also owes a duty to the borrower to act in good faith in the course of the appointment.
Often a charge-holder will appoint a receiver under the contractual terms of the security documents, but the holder of a mortgage or charge created by deed also has a statutory right under the Law of Property Act 1925 to appoint a receiver to the charged assets. However, because the power to appoint a receiver under the LPA 1925 is generally more restricted, it is common for a charge-holder to appoint a receiver under the contractual terms of the security document and the appointment will grant the receiver all of the powers contained under the LPA 1925 as well as the powers under the security itself.
The grounds for making an appointment must exist before a receiver is appointed and any demand for payment will need to comply with the terms of the security document.
The appointment of a receiver involves the execution of a document appointing a receiver to the assets secured by the charge, the delivery of the appointment document to the proposed receiver and the acceptance by the receiver of the appointment. A receiver has a statutory indemnity under the LPA 1925 in respect of liabilities arising from asset realisation and it is common for a charge-holder to provide a contractual indemnity in respect of any liabilities as additional protection.
Appointment of an Administrator
An option available to the holder of a qualifying floating charge (“QFC”) is to appoint an Administrator by filing prescribed documents at court (known as an out of court route). A QFC is a charge which relates to the whole or substantially the whole of the company’s property and empowers the holder to appoint an administrator or expressly states that paragraph 14(2) of the Insolvency Act 1986 applies to the floating charge.
The out of court route is available to holders of QFCs if the QFC is enforceable, the company is not in liquidation, provisional liquidation or administrative receivership and the holders of all prior QFCs have consented to the appointment or received two clear business days’ notice of the intention to appoint administrators and have not raised any objections.
A company may also place itself into administration using an out of court route or enter administration following a court application and hearing, which is referred to as the court route.
Once appointed, the Administrator will take control of the company’s affairs and realise assets for the benefit of the creditors. An Administrator must perform his/her functions with the objective of:
- Rescuing the company as a going concern; or
- if rescuing the company is not possible, achieving a better result for the company’s creditors as a whole than would be likely if the company were wound up (without first being in administration); or
- if the Administrator cannot achieve a better result for creditors as a whole, then realising property in order to make a distribution to one or more secured or preferential creditors.
An Administrator is an agent of the company and an officer of the Court and (s)he is required to carry out their functions in the interests of the creditors as a whole.
A statutory moratorium comes into play when a company goes into Administration which prevents creditors from enforcing their claims against the company.
The power to sell assets
Whether a lender has the power to sell secured assets will depend on whether it has a power of sale under the security document, under statute or common law. Otherwise, a court order is required to sell the secured assets.
A statutory power of sale under section 101(1)(i) of the LPA 1925 applies to all mortgages made by deed. There is no requirement to apply to Court and it arises when the secured liabilities become due. However, there are a number of restrictions under section 103 LPA 1925 which dictate when the statutory power of sale can be exercised, including a stipulation that a power of sale cannot be exercised unless a formal demand has been made and money is still outstanding after three months. A review of the security documents is therefore necessary to establish whether and to what extent those restrictions have been disapplied so that lender can act more quickly in exercising its power of sale.
A lender has a number of duties on the sale of a secured assets, which include acting in good faith, taking reasonable steps to obtain a proper price for the assets, obtaining the best price reasonably obtainable, acting with reasonable skill and care and acting fairly to the borrower.
How the proceeds of sale are to be applied will depend on whether a lender has exercised the statutory power of sale or a power of sale granted under the security document, but typically prior ranking encumbrances are paid first, followed by the expenses of sale and then secured liabilities are discharged, with any surplus being paid to any subsequent security holder or, if there is none, to the borrower.
The power to take possession
*Please note that this guidance should read in conjunction with the latest Covid-19 legislation concerning proceedings for possession brought under CPR 55 and proceedings seeking to enforce an order for possession*
A legal mortgagee has a right to possession of mortgaged property and the right is different to the power of sale. It arises without the need for the secured debt to be payable but until the power of sale is exercisable the right of possession can only be exercised to protect the security, not to enforce it.
A lender will become mortgagee in possession by taking physical possession of the mortgaged property or bringing an action for possession. However, it is important to bear in mind, especially when the borrower is a company, the duties, obligations and risks which a lender will face when taking possession such as accounting to the borrower for any income and profit received and becoming liable for damages. As such, quite often a lender will take the approach of appointing a receiver or an administrator rather than taking possession of the secured asset.
Upon default by a borrower, a creditor with the benefit of security over a company’s assets has a number of enforcement options available to it. However careful thought should be given to the most appropriate and commercially sensible option available and a review of the facility agreement and security documents should be undertaken by legal professionals at an early stage and before any enforcement steps are taken to ensure that the security and proposed method of enforcement are valid.
If you should have any queries arising from the content of this guidance note or would like to seek further advice on the enforcement of security, then please speak to one the specialist lawyers in our Insolvency and Restructuring Team, Caroline Benfield or Elizabeth Taylor.