REALWorld Law

Does the law lay down any rules which must be complied with before a corporate entity can give valid security over its real estate assets, for example 'financial assistance' rules and 'corporate benefit' rules?

The UK’s decision to leave the European Union is likely to cause some uncertainty. Fiscal consequences may include changes in Stamp Duty Land Tax (England), Land and Building Transaction Tax (Scotland) and Land Transaction Tax (Wales). There may well be some other changes. If you have a contact in DLA Piper, please do check the latest position with him or her.

The most common forms of security over real estate are:

• legal mortgage;
• equitable mortgage; and
• floating charge.

A legal mortgage and an equitable mortgage are fixed charges and both create a similar type of security. Both entitle the mortgagee to take possession of the asset and dispose of it with priority over unsecured creditors.

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 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 usually contained within the mortgage (or a debenture if one is granted).

A corporate borrower can also create a floating charge. This is a charge over a class of assets which in the course of the borrower's business changes from time to time and which may be disposed of without consent of the lender. This type of charge is sometimes taken with very large and complicated property portfolios where the borrower requires maximum flexibility and the lender is not too concerned over control. However, it is more normal for a lender to take both a floating charge and a legal or equitable mortgage.

A fixed charge over property can be granted by anyone, including companies, limited liability partnerships, English limited partnerships acting through their General Partners, traditional partnerships and individuals. A floating charge cannot be granted by an individual or a limited partnership.

The Loan Market Association (LMA), a trade body for the European syndicated loan market, produces two suggested forms of English law security agreements to sit alongside, respectively, the LMA's Real Estate Finance Investment Facility Agreement and the LMA's Real Estate Finance Development Finance Facility Those suggested forms of security agreement contain fixed and floating charges of the types described above and are frequently used to form the basis of transaction security in UK Real Estate Finance Transactions.

Last modified 22 Mar 2024

Does the law lay down any rules which must be complied with before a corporate entity can give valid security over its real estate assets, for example 'financial assistance' rules and 'corporate benefit' rules?

Real estate includes the land, buildings erected on it and fixtures which form part of those buildings.

It is also possible to take security over fittings, furniture and moveable objects.

Title to land can be either freehold, leasehold or commonhold (although the last is rarely encountered) although not all leases are considered good security. For instance, short leases at market rent have little value and most leases contain some form of forfeiture clause which allows the landlord to take back the property in certain circumstances. This is not satisfactory if one of those circumstances is the tenant's insolvency.

Last modified 22 Mar 2024

Does the law lay down any rules which must be complied with before a corporate entity can give valid security over its real estate assets, for example 'financial assistance' rules and 'corporate benefit' rules?

The key characteristic of a trust is that it allows legal ownership and beneficial interest to be separated. The trustees become the owners of the trust property as far as third parties are concerned, and the beneficiaries can expect the trustees to manage the trust property for their benefit. This is well recognized under English law.

Last modified 22 Mar 2024

Does the law lay down any rules which must be complied with before a corporate entity can give valid security over its real estate assets, for example 'financial assistance' rules and 'corporate benefit' rules?

Debt is commonly traded between lenders. Syndicated lending documentation has, to a large extent, become standardized on the terms incorporated in facility agreements produced by a trade body known as the European Loan Market Association (LMA). These are then negotiated between the parties. In particular, there are two specific English law governed LMA Real Estate Finance standard facility agreement template documents:  an investment loan facility agreement and a development loan facility agreement. Each of these is in general use in syndicated transactions in the real estate market in the UK and allows for free transferability of debt between lenders with the security being held on their behalf by a security agent (acting as trustee for the changing pool of lenders from time to time) and the debt being administered by a facility agent.  Bilateral loan facility agreements and non-LMA documents usually contain equivalent transfer provisions to those in the LMA documents. However, the ability of lenders to transfer debt to other lenders is a matter for negotiation on a transaction by transaction basis.

In addition, there are several ways of transferring debt being:

• novation: the whole of the loan and the lender's obligations are transferred to the transferee;
• assignment: the loan is assigned to the transferee, but this cannot be used to transfer an undrawn commitment (which would have to be dealt with by way of novation);
• sub-participation: the economic benefit of the loan is transferred to the transferee but this does not affect the original loan contract between the original lender and the borrower. The original lender remains the lender of record and the buyer of the debt takes the credit risk not only on the borrower but the original lender; and
• synthetic arrangements: the economic risks of debt can also be traded using derivatives and insurance policies.

Last modified 22 Mar 2024

Does the law lay down any rules which must be complied with before a corporate entity can give valid security over its real estate assets, for example 'financial assistance' rules and 'corporate benefit' rules?

If a choice of law is a sensible choice made in good faith, the English courts will generally give effect to it. It would generally not be advisable to choose a law other than English law to govern a security document under which an English (or Welsh) company creates security over land situated in England or Wales.

If a foreign law applies to a security document which is then sued on before the English courts, those courts will expect the parties to bring evidence as to what the foreign law is on the relevant point and if no such evidence is led will generally assume that the foreign law is the same as English law.

Last modified 22 Mar 2024

Does the law lay down any rules which must be complied with before a corporate entity can give valid security over its real estate assets, for example 'financial assistance' rules and 'corporate benefit' rules?

Generally, a security interest created by an English or Welsh corporate entity must be registered at Companies House within 21 days. If it is not so registered, it is void against a liquidator or administrator of that entity and against any other third party creditors of it.

Other than a failure to comply with the registration requirement at Companies House, which cannot be remedied later if registration has not been made within the necessary 21 day period, if the security was not perfected because it was not registered at the Land Registry or notice was not served on third parties, this can still be perfected even though the borrower has become insolvent.

Last modified 22 Mar 2024

Does the law lay down any rules which must be complied with before a corporate entity can give valid security over its real estate assets, for example 'financial assistance' rules and 'corporate benefit' rules?

A holder of security over land is not liable for environmental damage provided it does not take possession of the land and does not itself cause, or knowingly permit, damage to the environment.

Great care must be taken if the security is enforced because owners of land can be liable for environmental damage on that land or coming from it, even if it did not cause such damage. A mortgagee should not go into possession of land without careful consideration of the implications of potential environmental liability. More often a mortgagee will, under the relevant security documentation, have the power to appoint a receiver under the provisions of the Law of Property Act 1925 (an LPA receiver) to enter into possession of and realize the real property assets on behalf of the mortgagee. As the LPA Receiver is an agent of the grantor of the security and not of the mortgagee the mortgagee avoids becoming a "mortgagee in possession" and subject to the legal risks that would involve.

Last modified 22 Mar 2024

Does the law lay down any rules which must be complied with before a corporate entity can give valid security over its real estate assets, for example 'financial assistance' rules and 'corporate benefit' rules?

If the facility is on demand, all the lender need do is demand repayment and proceed to enforce the security if that demand is not met.

More commonly, a term loan agreement will describe events of default which must have occurred before the lender can enforce its security. Typical events of default include non-payment of interest or principal, breach of representation, breach of covenant, material adverse change and insolvency.

Once the security has become enforceable, the lender can generally enforce its security immediately.  Depending on the nature of the security, enforcement could be by way of appointment of a receiver under the provisions of the Law of Property Act 1925 (an LPA receiver), an administrator or by taking possession.

The security assets can be disposed of by way of private agreement and there is no requirement for public auction, although the lender does have certain duties to obtain a proper price for the assets.

Last modified 22 Mar 2024

Does the law lay down any rules which must be complied with before a corporate entity can give valid security over its real estate assets, for example 'financial assistance' rules and 'corporate benefit' rules?

The principal rescue procedure is for the administration of the company. The administrator takes control over the whole of the company's assets with a view to producing a better result for creditors than if the company went into liquidation. Administration creates a moratorium which prevents creditors from enforcing their security without the consent of the administrator or an order of the court.

A corporate voluntary arrangement is an agreement between the creditors of a company which typically involves arrangements for reduced payments to creditors. This has to be approved by a majority of creditors together holding more than three quarters by value, although this is not binding on secured creditors.

Last modified 22 Mar 2024

Does the law lay down any rules which must be complied with before a corporate entity can give valid security over its real estate assets, for example 'financial assistance' rules and 'corporate benefit' rules?

Generally, the onset of a borrower's insolvency does not affect security interests although administration creates a moratorium which prevents creditors from enforcing their security without the consent of the administrator or an order of the court in the case of a company going into administration.  Other moratoria have recently been introduced by the UK Corporate Governance and Insolvency Act 2020 as part of the UK's response to the Covid-19 pandemic.

Security can be set aside in certain circumstances, including where it constitutes a preference or a transaction at an undervalue. Generally, for this to happen, a court order is required and the security must have been created within a certain time period (which can be up to two years (or five years for individuals) depending on the circumstances) before the commencement of the insolvency process.

A floating charge granted by a company within 12 months of commencement of insolvency is invalid save where new money is advanced although, in most circumstances, this provision does not apply unless the company is insolvent when it granted the security or became insolvent as a result.

Last modified 22 Mar 2024

Does the law lay down any rules which must be complied with before a corporate entity can give valid security over its real estate assets, for example 'financial assistance' rules and 'corporate benefit' rules?

The priority of security interests is determined by a complex set of rules that provide that the order of priorities is largely based upon the date of creation of the security. A summary of the priority order in respect of the key real estate security instruments is as follows:

• A fixed charge will have priority over a floating charge even if created after the floating charge.
• Fixed charges rank in priority according to the date of their creation (although where the charge is over land, the Land Registry rules take precedence and provide that priority is determined by the order of registration at the Land Registry. Also, where a charge relates to a 'chose in action' (basically a contractual right or debt) priority is governed by the date of giving notice to the other contracting party).
• Floating charges rank in priority according to the date of their creation.

The holder of a fixed charge is entitled to the whole of the proceeds of sale of that asset without deductions other than the cost of realization.

There are certain prior claims which apply to proceeds of realization of a floating charge. These include:

• the costs of the insolvency process which are met from the sales proceeds;
• preferential debts: subject to certain limits, employees have a claim for unpaid wages and, from 1 December 2020, the UK Government will be reintroducing as a preferential debt Crown Preference which relates to certain unpaid taxes being collected on behalf of the Government by the relevant insolvent company such as VAT & PAYE (pay as you earn) and there will be no cap on those Crown Preference claims ; and
• the prescribed part; 50% of the first £10,000 realized and 20% of the proceeds after that up to a maximum of £800,000 is set aside for unsecured creditors.

Unsecured creditors (which will include the UK Government for debts other than those falling within the Crown Preference categories) rank behind secured creditors and rank equally between themselves (the pari passu principle).

Last modified 22 Mar 2024