Taking security for commercial debt
When entering into commercial arrangements with a third party, the third party may end up owing you money as a result. For example, you might supply goods or services to a third party and they do not pay you. Such a debt could, of course, have an adverse effect on your own cash flow, through no fault of your own – and it is not always a given that the third party will be able to pay you.
To protect your business from unpaid debts, you should consider asking the third party for security if the debt is likely to be significant. The type of security available to you depends on whether the third party is an individual (including a sole trader or a simple partnership) or a corporate entity. In this article, we discuss the various options available if the third party is a corporate entity – a limited company or an LLP (limited liability partnership). Having security means that you have assets to fall back on if the third party is unable to pay you.
A debenture provides the best protection. It creates security over all the entity’s assets and includes:
- a legal mortgage over any real property owned by the entity;
- fixed charges over all the assets of the entity, for example equipment, kit, goodwill, book debts, shares in other companies – essentially any benefit or right that the entity has; and
- a floating charge over the ‘moveable’ assets of the entity (for example stock, which will change as it comes in and goes out).
Floating charge (standalone)
A floating charge, which is essentially just the third bullet point above, may be more palatable if an entity is unwilling to give a full debenture.
You might hear a floating charge being referred to as a “qualifying floating charge”. This means that the floating charge qualifies, under insolvency legislation, to allow the holder of the charge to appoint an administrator over the assets of the third party entity.
Benefits of a floating charge
The benefit of having a qualifying floating charge (whether as part of a debenture or as a stand-alone document) is that it not only creates security over assets, but also allows the holder to appoint an administrator. This means that control of the entity passes to the administrator, who is an insolvency practitioner, whose aim is to obtain as much as possible for the entity’s assets in order to repay that entity’s creditors.
Being a secured creditor also gives you a higher ranking in an insolvency than unsecured creditors in the waterfall of which creditor is entitled to what.
Specific charge over real property
It may be possible to take out a separate legal mortgage over real property. If an entity has a valuable property asset, they might be willing to grant security over it.
Any security given by a corporate entity must be registered at Companies House within 21 days. Any security over real property must also be registered at the Land Registry.
Competing secured creditors
We also need to be aware of competing secured creditors where the entity has given security to a third party, for example their own bank. If this is the case, then it may be that this pre-existing security prohibits the creation of further security in your favour. In order to obtain that security, you would need to get the consent of the third party benefiting from the pre-existing security and in some circumstances may need to enter into an intercreditor with that third party to regulate the sharing of assets on enforcement and the conduct of enforcement action.
Please note that the contents of this article refer only to the laws of England and Wales. Debts and assets in other jurisdictions are subject to other considerations.