SECURITY ON LOAN AGREEMENTS
Lending money to a person or company, whether as a close family member, friend or business associate without securing the loan increases the risk that you may never get the loan funds back.
So, in this blog, you will learn about the various levels of security available, when loaning money. If you would prefer to watch a video we have prepared on this subject instead, then click here and head over to our video library under the “Loan” section.
No Security at all
Let’s start off, with no security at all. This if often the with family or friends where there are existing relationships of trust. Often when the parties have an existing relationship of trust, the thought of never getting paid back simply doesn’t occur.
Where there is no security, if the loan isn’t paid back for whatever reason, and the borrower doesn’t have sufficient assets to repay some or all of the loan there may be little chance of you getting your money back.
So, if you are lending large sums of money or an amount that you cannot afford to lose, you really need to be looking at arranging security on the loan just in case there is a default
This leads onto the different levels of security available to you when lending money, starting with the lowest and moving up the ladder.
THE 3 DIFFERENT LEVELS OF SECURITY
No.1 – Personal Guarantee (PG)
First let just be clear about what a personal guarantee is. It’s where a third party guarantees the obligations a borrower. So, if the borrower fails to repay the loan amount, the guarantor will become responsible for settling the debt.
Some people often misunderstand a personal guarantee, as they think it “guarantees” repayment of the loan. That’s far from the truth because the guarantor might not have sufficient personal assets or the Personal Guarantee might have been drafted to limit the liability of the guarantor.
One drawback about a personal guarantee, is that there is no central register to check against. As such you will never know what their exposure is no matter how nicely you ask! As a result, you could lend £50,000 to a third party using a personal guarantee, without knowing that they have already signed several hundred PG’s? The likelihood of that borrower having sufficient personal assets to satisfy all of that debt obligation is remote.
So, with a personal guarantee, you’re afforded the least protection in recovering the loan in the event of a default
Personal Guarantees do have their place. They are very useful when lending to a company, in which case the Directors of the company, will often be asked by the lender to provide a Personal Guarantee in case the company defaults on its loan obligations. This allows you to pursue the Director/s personally for repayment of the loan. But make sure you carry out your due diligence on the guarantor to ensure they have sufficient assets to satisfy the loan.
Do not be enticed into lending money to an individual on the basis that you will get additional protection if they also sign a PG. In fact, the PG makes no difference because the borrower is already personally liable as an individual.
No.2 – A Charge
Next, we have a charge. This is an agreement between the lender of the funds and the borrower whereby a specific property can be used as security, typically owned by the borrower.
When done properly, the charge should be registered at the land registry, and companies house if lending to a company. The lender will then have an interest in that charged asset, allowing them to obtain a court order for the sale of the asset, in the event of a default. The lender will be able to recover the principal sum loaned, interest and costs. This is often called as a fixed charge because it’s fixed on a particular asset.
So, If you want your loan to be more secure, obtaining a charge over an asset will give you more security than a Personal guarantee
When considering a charge you need to be aware that there is a pecking order to consider in terms of seniority, with the holder of a first charge having priority over subsequent charges. So, if you are a second charge holder, you will get whatever equity is leftover after the first charge and associated cost are deducted from the sale proceeds.
It is worthwhile mentioning here that HMRC trump everything. So, if the borrower enters into bankruptcy, HMRC recover tax owed first. Thereafter, the liquidator will get their fees paid and only then do you move onto the first charge (and costs of enforcement), second charge etc.
Difficulties can arise if you are not a first charge holder but maybe have a second or even third charge. The further on down the line you are, the greater the chance of there being insufficient equity in the charged asset to satisfy your debt. This is why due diligence on the asset is so important, which is the subject of another blog.
No.3 – Debenture
These are used when loaning to companies and cannot be created by individuals. A debenture is a document whereby the borrower or security provider, will grant security over all or substantially all of its assets for the loan. It is often referred to as a floating charge.
If there is a default by the company in repaying the loan, the lender can enforce the debenture. This is often done by appointing an administrator, selling the company assets without permission of the court or take possession of the charged assets. The debenture document will set out the terms of enforcement.
Hopefully, this blog gives you some insight into security considerations, when considering loan transactions. For more information about our loan drafting legal services, including our fixed costs for drafting loan agreement, carrying out due diligence and drafting security documents, head over to our loan agreement page HERE
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