What Security Is For

1.1Security in one paragraph

A lender takes security when it wants more than a promise to repay. If the loan is not repaid, it can have particular assets of the borrower sold and pay itself first from the price. A company usually gives all its security to a bank in one document, a debenture. You are a trainee in the banking team at Harlow Vance LLP in Birmingham, and you act for the bank.

1.2Why a bank will not lend on a promise alone

A promise to repay is worth only what the borrower can pay. When a company fails, it owes its bank, its suppliers, its staff and the tax authority all at once. Its assets are not enough for everyone.

A bank that lends without security is one of the unsecured creditors. What is left of the company is sold and shared out among them. Each gets the same small part of its debt, and gets it late. Security takes the bank out of that queue for the assets it covers:

• The bank is paid from those assets before the general creditors.
• It can act on its own when the loan goes wrong.
• While the loan runs, it controls what the borrower does with its most valuable assets.

A bank lends mostly its depositors' money, not its own. So its credit committee often approves a large loan only on condition of security.

1.3The loan in this workbook

Coldharbour Bank plc lends to Marlow Precision Engineering Limited, a family company that owns its factory in Kettering and makes precision parts for aircraft and medical devices. Two members of the family own all its shares. The company itself owns a small subsidiary, Marlow Tooling Limited, which makes the clamps and holders that keep parts steady while they are machined, in a rented unit nearby.

Under the loan agreement, called the Facility Agreement, the bank lends two sums:

• A term loan of £12,000,000, lent once and repaid over five years.
• A revolving facility of £3,000,000, which can be drawn, repaid and drawn again, like an overdraft.

The money pays for a new machining hall, six new machines to fill it and the repayment of an earlier lender. That lender finances the company's unpaid invoices and holds security over them. The bank will not lend while that security is still in place. Marlow Tooling signs the loan agreement as guarantor, so it must pay if the borrower does not.

These are the parties and your own team:

1.4What the Bank asked for, and what the family refused

The Bank's credit committee approved the loan on one condition: security over everything the Company owns. Its first request had four parts:

• A debenture from the Company.
• A debenture from Tooling.
• A charge over the Company's own shares, given by the family who own them.
• A personal guarantee from each of them, a promise to pay from their own money.

The family refused the last two. Both would have reached past the Company to their own homes and savings. As they put it, the Bank was “lending to a business, not taking our house.” It accepted the refusal and charged a higher margin (its interest above its own costs) for the extra risk.

Tooling's debenture fell away too, for three reasons the Bank accepted. Tooling's lease allows a charge only with the landlord's consent, which would have cost a fee and taken months. Its suppliers were nervous of a charge over everything it owned. And its assets were small.

Instead, Tooling guarantees the loan, and the Company charges its 100 shares in Tooling to the Bank. So the Bank reaches Tooling's value by selling the shares, not the assets. A buyer takes Tooling whole, lease and all, and the landlord is never asked.

The Company also pushed back on security in general. Security costs a borrower money: a valuer, searches, registrations and two sets of lawyers. It also ties the borrower's hands, because a charged asset cannot be sold or borrowed against elsewhere without the lender's consent.

The Debenture is the compromise. The Bank takes a claim on everything, and the Company stays free to trade with most of it.

1.5Four kinds of security in one document

Clause 3 of the Debenture uses four kinds of security:

A floating charge crystallises (becomes fixed) when the Bank gives notice, or when an event listed in clause 4 happens. From then on, the Company needs the Bank's consent to deal with the asset.

The Bank wanted fixed security over everything, because a fixed charge is stronger in two ways. First, the lender controls the asset while the loan runs. Second, when a company fails, some claims are paid ahead of a floating charge but never ahead of a fixed one. Part of the wages owed to staff is one example.

The Company could not work like that. It sells parts every day and buys materials every week, and no banker wants a call about every pallet that leaves the factory. The floating charge is the answer both sides could sign:

The clause does two jobs. It charges every asset that the fixed charges do not name. Its closing words also catch any asset whose fixed charge or assignment fails for any reason. That asset stays secured, under the weaker floating charge.

This matters most for the book debts, the money customers owe the Company. The Debenture calls the charge over them fixed. But customers pay into the Collection Account, an account in the Company's name at the Bank, and a court will look at how that account is actually run, not at the label. If the Company can use the money freely, the charge is floating, whatever the label says.

1.6What each asset gives the Bank

This table lists what the Company owns and how each asset is secured:

Other clauses keep the Bank in control of the most valuable assets:

• The six machines. Each stays at the factory with a plate saying it is charged to the Bank (clause 8.5).
• The book debts. Customers pay into the Collection Account, and nothing leaves it without the Bank's permission (clause 8.3).
• The Tooling shares. The Bank holds the certificate and a signed transfer form with the buyer left blank (clause 5.2).
• The insurance. The insurer pays the Bank, which decides whether the money rebuilds or repays (clause 8.2).

1.7How the Debenture is laid out

The Debenture has 16 clauses and five schedules, in four groups. Clauses 1 to 4 create the security, and clauses 5 to 8 keep it good. Clauses 9 to 13 turn it into money if the loan goes wrong, and clauses 14 to 16 end it and set the general terms.

Clause 5 deals with perfection, the steps after signing that make the security good against everyone else. The main step is filing the charge at Companies House within 21 days. A charge filed late is void against a liquidator or an administrator (experts who run a failed company), so the lender would lose it just when it needs it.

Clause 6 stops the Company giving security to anyone else. Clause 7 records what it says it owns, and clause 8 lists what it must do.

Clause 2 comes before all of these, because security secures a debt. Clause 2.1 repeats the Company's promise to pay:

This is the covenant to pay. Clause 1.1 defines the debt as the Secured Liabilities: all money the Company owes the Bank under the loan agreement or the Debenture. The Company asked why it must promise twice. The answer is that a charge secures only what its own document says it secures.

The Company signed the Debenture as a deed (a formally signed document), by two directors. That matters because the law gives a lender the power to sell and to appoint a receiver only when the mortgage is made by deed.

1.8Your job

Your job is to keep the security file in order. That is the deal's machinery. One day the file must prove what the Bank holds, long after everyone has forgotten how each paper arrived.

• Keep the conditions precedent list: the documents the Bank must hold before it lends.
• Note where each piece of security sits: Tooling's guarantee in the loan agreement, the share charge in the Debenture.
• In any security document, read the covenant to pay first and match its debt to the loan agreement.
• Check that the Debenture is signed as a deed by two directors.
• List every document that comes back with it, with the date and where it is kept.
• Record each asset figure with its source and its date.