Finance & Property departments at Francis Wilks & Jones LLP
Land as security in the new economy
In recent times the status of land as a security asset has altered dramatically. Once one of the most desirable security assets – providing ongoing capital appreciation and a clear realisation value if default occurred – the position is now very different. Property values have fallen significantly and opportunities to obtain finance against, or dispose of, properties are much reduced.
As a result of the above it is more important than ever that property security is properly obtained and understood, whether it is given by the financier’s client or taken to support a personal guarantee.
Some areas to consider
A wide range of issues arise when taking property security but it is only possible to focus on a small number here. Some areas to consider include:
- What level of due diligence is needed in relation to the property being offered as security? Is it considered prime or ancillary security? What is its value? Are there any concerns around ownership or competing security interests?
- Is the security value so significant that a properly considered report on title addressed to the financier is needed or, if registered land, would an online search at HM Land Registry (HMLR) suffice?
- Do you want a charge over jointly owned residential property with the ability to use the sale proceeds from each owner’s interest in it to pay amounts owed to you? If so, a properly drafted personal guarantee from each owner should be obtained. Each owner should sign the legal charge which might overcome the lack of a guarantee but this is not an ideal argument to rely upon.
- Are step-in rights needed for the financier to correct defaults which might otherwise prejudice the security e.g. a right to pay off rent arrears or develop out an incomplete development site?
- Are there any environmental issues?
- Are any collateral arrangements needed e.g. that rent from sub-tenants be paid to the financier direct to service the facility?
Obtaining the required priority
With a company the property may be charged by a general debenture or a separate specific legal charge. With registered land the security should be registered at HMLR to ensure that the correct priority position is obtained – HMLR’s position being that charges over land take priority by the date of registration at HMLR.
On occasion financiers take a first ranking debenture over a client without focusing on specific security assets and register it at Companies House but not at HMLR. It is later discovered that the client owns valuable property over which it has given a subsequent specific legal charge which has been registered at HMLR. As far as HMLR is concerned, the debenture will rank behind the subsequent specific legal charge.
The debenture holder may be able to raise other arguments which may effectively give it priority. For example that the legal charge holder was aware of a negative pledge in the debenture preventing further security being given without the debenture holder’s consent and so should account to the debenture holder for monies received as a result of that pledge being broken. However this is by no means ideal.
Enforcement rights What enforcement rights are needed?
Is a right to appoint an administrator over a corporate client required because being able to trade the client’s business may enable the property to be sold for more? A properly drafted debenture will provide this. A standard legal charge will not but might do so by including a “lightweight” floating charge. This simply enables the financier to appoint an administrator if needed. So the financier will not regard the assets caught by the floating charge as its prime security and will concede priority over them if required.
Future value
One recurring current issue is how, if at all, potential future increases in value can be realised. A financier (or IP) may wish to realise the property but to retain some interest in any future increase in its value. Assuming that someone can be found who is willing to buy on that basis how can this be achieved? Several issues would arise. What would be the cut-off point for increases in value? What would occur when it was reached? Would the property be sold to fund a payment to the seller?
A maximum uplift could be agreed and security taken to cover this. An option to repurchase for an agreed amount or a sale on some type of shared ownership arrangement might also be possible. However practical issues would arise from each possibility.
The furture
Careful thought is needed in taking and enforcing property security to ensure that it provides the greatest upside possible for a financier and that unforeseen difficulties do not arise. The dramatic alteration in the property market has left financiers and IPs with much to consider.
