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8 December 2020

Lending focus – December 2020 – 7 of 8 Insights

Taking security over a domain name

  • In-depth analysis

The intellectual property portfolio of many companies forms an important and valuable part of their assets. Within the last few decades, there has been recognition of this by lenders and a shift in their acceptance of using IP to form the basis of security, or as part of a package of security.

Although IP assets are valuable, they are intangible assets. Particular challenges are therefore presented regarding the security package. So, in transactions where the IP is of significant value, careful consideration is required as to what, where, when and how security interests over that IP can be created. This is particularly so when security is being taken over domain names because of the uncertainty surrounding its nature and the lack of a system for registering that security.

Domain names often have material commercial significance. The owner of a business will expect to be able to deal with them – buy, sell, offer them as security to a lender. But the law has not fully caught up with commercial practice. The analysis of the legal nature of these rights, and the extent of dealing with them, is still a developing area. The heart of the problem is a lack of a register of domain names which operates to give notice to third parties of rights in relation to those domain names.

What is a domain name?

A domain name is the web address or part of the URL that appears in the search bar of a web browser. It is a string of characters that directs a user to a particular area of space sitting on a server which may or may not contain further information. A domain name is not an intellectual property right (IPR) of itself. The uncertainty surrounding the legal nature of domain names in the UK will be explored further in this article.

Despite not being an IPR, a domain name (and often the large domain name portfolios that a business may own) has substantial value to the business. Owning a domain name allows a business to use that domain name for its business activities and host a website from that domain to the exclusion of all others. Once you own a particular domain name, nobody else can host a website from it for the duration of its registration. Domains are categorised broadly as follows:

  • Generic Top-Level Domains (gTLDs)  – gTLDs include .com, .net, .inc and the new Brand TLDs (for example, .redbull, .apple, and .ferrari).
  • Country-code Top-Level Domains (ccTLDs) – ccTLDs are, for example, .co.uk, .es, .fr, .de etc. for each country.

Domains are registered on a "first come, first served" basis. Once you "reserve" the domain, you are the "owner" of that domain indefinitely provided you continue to pay the renewal fee.

If the particular domain incorporates a business's brand (a registered or unregistered trade mark) then that domain will be of considerable value to the brand owner. This value can lead to problems for a brand owner, for example, cybersquatting, where cyber squatters purchase and "squat" on domain names similar or identical to brands owned by businesses with a view to selling them at a profit or disrupting the business in question.

However, some valuable domain names are not trade marks. Generic domain names (such as hotels.com and insurance.com) have become increasingly popular and valuable in recent years.

Domain terminology – the 3 Rs

A registry is the authority which manages the registration of all domain names in a specific top level domain (TLD). It keeps an authoritative master database of all such registration data and maintains a zone file that describes the domain name space for which that particular registry is responsible. Nominet UK is the official registry for .uk domain names.

Registrars are organisations accredited by The Internet Corporation for Assigned Names and Numbers (ICANN) and certified by the registries to sell domain names. They are bound by the Registrar Accreditation Agreement (RAA) with ICANN, and by their agreements with the registries.

The RAA sets out responsibilities for a registrar, which include the following:

  • maintaining WHOIS data; WHOIS (pronounced as "who is") is an internet record listing that identifies who owns a domain and provides relevant contact information
  • submitting data to registries
  • facilitating public WHOIS queries
  • ensuring domain name registrants' details are escrowed
  • complying with RAA conditions relating to the conclusion of the domain name registration period.

To reserve a domain name in a gTLD, a domain name registrant must register it with an ICANN-accredited registrar. The registrar will check if the domain name is available and create a WHOIS record with the domain name registrant's information. It is also possible to register domain names through a registrar's resellers.

A domain name registrant is the person or organisation who has registered the domain name. To do so, the domain name registrant will usually apply online to a domain registrar or one of their resellers.

The domain name registrant is bound by the terms and conditions of a licence, entered into with the registrar with which it registers its domain name. The licence will impose requirements on the registrant to, for example:

  • adhere to a certain code of conduct
  • indemnify the registrar and registry against any legal or civil action taken as a result of use of the domain name
  • pay registration fees promptly
  • submit accurate data and update this promptly as and when circumstances change.

Initial considerations when taking security over a domain name

At an early stage, a lender should conduct the necessary due diligence in relation to the domain name and evaluate its marketability and value, independent from the registrant company and in conjunction with the goodwill and other IPRs of the company.

During the due diligence process, the lender should require the registrant to furnish a detailed schedule of all its related IP assets. This will enable the lender to decide whether it wishes to take security over those assets as well as the domain name.

If the IP will form a significant part of the lender's security package, it should commission an independent IP audit from a specialist. The audit should corroborate the details of the schedule of related IP assets received from the registrant and confirm whether there are any assets that are merely licensed, rather than owned, by the registrant. If any IP assets are licensed to the registrant, rather than owned, this would significantly impact the resale value of the security package, should the lender need to realise the security.

The due diligence exercise should also focus on uncovering any issues relating to the ownership, validity, use, infringement and renewal of the domain name and any other associated IPRs over which the lender may wish to take security.

Difficulties of taking security over a domain name

There are two fundamental problems with taking security over a domain name:

  • no system for registering security over a domain name
  • uncertainty over the nature of a domain name.

It is worth noting that in practice, these issues may be avoided. First, due to the nature of domain names, it is unlikely that there will be numerous competing interests surrounding a particular domain name registration.

Secondly, there are tried and tested practical workarounds and alternatives to taking security, that produce, in effect, the same results as a mortgage or charge. These should give a lender some peace of mind when taking security over a domain name.

No system for registering security over a domain name

There is no system for registering a security interest over a domain name. Nominet (the .uk Registry), for example, states that it will not record or be bound by mortgage-like security.

The absence of a security register to allow for perfection of a security interest over a domain name poses questions, particularly regarding the priorities situation surrounding a domain name. Crucially, a lender who holds an equitable charge over a domain name as a form of security risks having its claim defeated by the interest of a bona fide third party purchaser for value who subsequently acquires the domain name from the registrant in ignorance of the charge.

Uncertainty over nature of a domain name

It is uncertain whether domain names are properly characterised as property rights or pure contractual rights. The current legal position in the UK is unclear. There is no express UK authority on whether registration of a domain name gives rise to property rights and no statute regulating this matter.

In practice, however, the relationship between registries in the UK (and many other countries) and a domain name holder is entirely contractual. The terms and conditions of Nominet UK specifically state that it does not consider domain names to be property. This adds an additional complication in terms of the rights of the lender where an equitable charge is granted.

Alternatives to taking a mortgage or charge over a domain name

In light of the questions over priority and the nature of domain names, a lender should be cautious about relying solely on an equitable charge over a domain name. Instead, a lender should consider the following alternatives to taking a charge or mortgage over a domain name:

Legal assignment by way of security

A lender could take a legal assignment by way of security of the domain name from the registrant. An assignment will be effective as a legal assignment if it complies with the requirements of s136 of the Law of Property Act 1925 (LPA 1925).

The assignment should allow the registrant to nominate the IP address to which the domain name points and should also contain a provision for transfer back of the domain name to the registrant when the registrant discharges its debt. Notice of the assignment should be served on the relevant registry in the same way that the registry would be notified of an absolute assignment on the sale of a domain name.

The lender will also need to grant a licence for the use of the domain name to the registrant/borrower. This should allow the borrower to continue to use the domain name/IP address during the term of the loan within clearly defined parameters that do not damage or diminish the value of the domain name.

Equitable assignment by way of security

Alternatively, the lender and registrant could enter into an equitable assignment by way of security. If an assignment does not comply with the requirements of section 136 of the LPA 1925 then it will take effect as an equitable assignment.

One of the requirements of s136 is that the assignment must be notified in writing to the third party against whom the assignor could enforce the assigned rights, in the case of a domain name, the registry. A common way of taking an equitable assignment of a domain name is to comply with all the requirements of s136 except for the notice requirement.

However, a lender will want to be able to "upgrade" the assignment to a legal assignment if it needs to enforce its security. Therefore, a lender may require the registrant to sign a notice of assignment and deliver it to the lender as a condition precedent to drawdown.

Alternatively, a lender may take a power of attorney from the registrant to enable the lender to complete the notice of assignment and serve it on the registry. Either way, the lender should ensure that the loan agreement provides that on an event of default under the loan agreement such as non-payment or an insolvency event, the lender will be entitled to enforce its security by serving notice on the relevant registry.

As noted above, a lender holding the benefit of an equitable assignment by way of security is vulnerable. It may have its claim defeated by a bona fide purchaser for value without notice of the lender's interest

Note that before considering taking a legal or equitable assignment by way of security of a domain name, a lender should carefully check the terms upon which the relevant domain name is granted for any anti-assignment provisions. This is because a registry is unlikely to be bound by any purported assignment if the terms of its agreement with the registrant include an anti-assignment provision.

Possession of the keys to a domain name

In addition to putting in place a legal or equitable assignment between the lender and registrant, it is vital that the lender takes possession of the "keys" to the domain name. The "keys" are the authorisation codes to unlock and transfer the domain name. It is crucial that constructive control of the keys is given to the lender before or at the time the assignment by way of security is given.

Practical steps a lender can take to take constructive control of the keys to a domain name include the following:

  • Requiring the registrant to give the online domain name account details and passwords to the lender.
  • If permitted under the existing terms and conditions between the registry and the registrant, ensuring that the registrant details, including any associated administrative, billing and technical details, have been changed to the lender's account. These details should be changed at the time a legal assignment by way of security is taken or, if an equitable assignment has been taken, effected by notice to the registrar after an event of default and on enforcement of the equitable assignment.
  • Requiring the registrant to give evidence to the lender that proves that the registrant has notified the registry of the registration of the lender as the registered holder. This could be achieved by requiring a written acknowledgment of the notice from the registry. The acknowledgement should be obtained as a condition precedent to drawdown of the loan, in the case of a legal assignment. Alternatively, in the case of an equitable assignment, the notice and acknowledgment process would be effected on enforcement.

Taking security over a bundle of rights associated with a domain name

A domain name, by itself, may be of limited value without other intrinsically associated IP rights and assets. Likewise, if a lender takes security over a domain name without taking security over those other rights and assets, that security may be of limited value.

Therefore, a lender should also consider, in addition to taking security over the domain name, taking security over those associated rights. This should ensure that on enforcement, the lender can realise the true value of the domain name.

Key examples of associated rights that might comprise part of the bundle over which a lender takes security are the following:

  • The trade mark contained in the domain name.
  • Any goodwill of the business relating to the domain name.

A lender should be aware of the practicalities of taking security over these additional IPRs. For example, when taking security over copyright (which, in the UK, is not registerable and arises automatically when certain criteria are met), it would be prudent for a lender to carry out a search at Companies House to determine whether there is any pre-existing security over that copyright. Patents and trade marks, however, are registered IPRs so when taking security over them, a lender should carry out a search at the IPO, as well as at Companies House, to uncover any existing security interests.

To protect the value of its security, a lender should also require a borrower to give representations concerning its ownership and the absence of any infringements, or likely infringements, of the relevant IP rights. Again, this will be particularly important in the context of copyright, since determination of copyright ownership and the existence of any other interests in copyright (for example, licences) are not readily accessible due to the lack of a centralised register.

A lender should also require a borrower to give undertakings in relation to the relevant IP rights. IP-related undertakings a lender may want to consider would relate to the maintenance of rights in the IP by paying renewal fees, licence fees and outgoings so that IP rights do not lapse and a waiver of moral rights by the authors of any materials subject to copyright.

If the registrant operates a multi-jurisdiction IP portfolio, a lender should take care to ensure that corresponding security over the relevant IP rights is obtained in other relevant overseas jurisdictions. This is particularly important given the cross-border nature of domain names.

Documentary considerations for an assignment by way of security of a domain name

Any purported assignment by way of security of a domain name should be by way of written contract. This security document should also, if necessary, create security over the IP rights and assets associated with that domain name. The terms of the security document should clearly set out the obligations of the registrant and the rights of the lender, particularly in the event of the registrant's default under the terms of the loan agreement.

Key terms of a security document creating an assignment by way of security over a domain name and security, its associated IP rights and assets include the following:

  • The description of the assets over which security is taken should include the domain name and all associated IP rights and all assets.
  • A clear contractual right for the lender to access and control the domain name so that it may effectively enforce its security.
  • Specific representations and warranties from the registrant such as the following: that the registrant is the current registered owner of the domain name and has the right and authority to assign the domain name; that there are no third party rights over the domain name, and no disputed or claimed third party rights; and that the registrant has complied fully with the terms of the original registration agreement in respect of the domain name and with any subsequent formalities (for example, any renewals of registration that might be required).
  • Specific undertakings from the registrant such as the following: that, following the assignment by way of security, the registrant will cease any use of the domain name that falls outside the scope of use set out in the licence between the registrant and the registrar; to safeguard and maintain present and future rights in the domain name; not to transfer the domain name to a third party, not to create security over the domain name without the prior written consent of the lender (a negative pledge to prevent third parties from subsequently seeking to obtain security over the same domain name without the lender's prior consent).
  • The rights of the lender to effectively exercise remedies upon default by the registrant.

Looking abroad, and potentially forward?

It may be of interest to consider the legal position on domain names in other jurisdictions.

US perspective

Similar to the UK, there is disagreement over the precise legal nature of domain names in the US. However, in the US, there have been several, albeit conflicting, court judgements and official opinions on this issue.

In Network Solutions, Inc. v. Umbro Int’l, Inc. (2000), the Supreme Court of Virginia held that a domain name is not property. The registrant of a domain name receives merely a conditional contractual right to use the registered domain name for the duration of the registrations and consequently, has no rights against the wider world.

However, this decision does not square neatly with the decision in Kremen v. Cohen , 337 F. 3d 1024 (9th Cir. 2003), where it was decided that domain names are indeed property, subject to conversion. This view is supported in the Anti-cybersquatting Consumer Protection Act (ACPA) which authorises in rem civil action against a domain name. This therefore suggests that a domain name is a form of intangible property.

The official view of the American Bankruptcy Institute straddles a middle ground between the two earlier judicial decisions, stating that domain names can be characterised as either general intangibles or conditional contractual rights. However, regardless of their characterisation, domain names ultimately embody property rights that have value, and security interests can be perfected in them under Article 9 of the Uniform Commercial Code (UCC).

In practice, the position taken in the US is that domain names fall under the definition of "general intangibles" under Article 9 of the UCC, since they are not specifically excluded from that definition.

It is essential to perfect a holder's security interest in a general intangible. To do so, the lender must file the proper financing statement in the relevant state's UCC filing office, typically where the registrant is organised.

However, this security interest is of limited use if there is the presence of an anti-assignment provision. In such a case, the lender, despite having security over the domain name, will not be able to enforce his interest pursuant to Section 9-408(d)(6) of the UCC, effectively leaving him empty-handed.

A potential workaround to this situation is achieved by putting the debtor in bankruptcy. The Bankruptcy Code allows a bankruptcy trustee to assume and sell a debtor's contract, despite the presence of any anti-assignment clauses. It therefore follows that the lender can sell the domain name contract and claim the proceeds from the sale, due to its position of bankruptcy trustee ( Straffi v. State of New Jersey ( In re Chris Don, Inc. ).

Canadian perspective

In Canada, legally, domain names are seen as intangible personal property ( Tucows.com Co. v. Lojas Renner S.A ). The only route to perfection of the security is by registering it via the Ontario's Personal Property Security Registration System (PPSA).

Maintaining practical control in the form of constructive possession, however, does not provide legal protection under the PPSA. Pursuant to the PPSA, only investment property, not intangible personal property such as domain names can be constructively controlled.

It has been queried why a secured creditor of a domain name, having done everything necessary and reasonably practicable to put itself in a position where it is able to dispose of the domain name without needing further consent of the original owner, should not be construed as having constructive control and why this should not be a valid method of perfection.

Find out more

To discuss the issues raised in this article in more detail, please reach out to a member of our Banking & Finance team.

A version of this article originally appeared on the Practical Law website in September 2020.

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Equitable Assignment: Everything You Need to Know

An equitable assignment is one that does not fulfill the statutory criteria for a legal assignment, but is binding and upheld by the courts in the interest of equability, justice, and fairness. 3 min read updated on February 01, 2023

An equitable assignment is one that does not fulfill the statutory criteria for a legal assignment, but is binding and upheld by the courts in the interest of equability, justice, and fairness.

Equitable Assignment

An equitable assignment may not appear to be self-evident by the law's standard, but it presents the assignee with a title that is protected and recognized in equity. It's based on the essence of a declaration of trust; specifically, essential fairness and natural justice. As long as there is valuable consideration involved, it does not matter if a formal agreement is signed. There needs to be some sort of intent displayed from one party to assign and the other party to receive.

The evaluation of a righteous equitable assignment is completed by determining if a debtor would rationally pay the debt to another party alleging to be the assignee. Equitable assignments can be created by:

  • The assignor informing the assignee that they transferred a right to them
  • The assignor instructing the other party to release their obligation from the assignee and place it instead on the assignor

The only part of an agreement that can be assigned is the benefit. Generally speaking, there is no prerequisite for the written notice to be received or given. The significant characteristic that separates an equitable assignment from a legal assignment is that most of the time, an equitable assignee may not take action against a third party. Instead, it must rely on the guidelines governing equitable assignments. In other words, the equitable assignee must team up with the assignor to take action.

The Doctrine of Equitable Assignment in Wisconsin

In Dow Family LLC v. PHH Mortgage Corp ., the Wisconsin Supreme Court issued in favor of the doctrine of equitable assignment. The case was similar to many other foreclosure cases, except this one came with a twist. Essentially, Dow Family LLC purchased a property and the property owner insisted the mortgage on the property had been paid off. However, in actuality, it wasn't. 

Prior to the sale, the mortgage on the property was with PHH Mortgage Corp. When PHH went to foreclose on the mortgage, Dow Family LLC contested it. There was one specific rebuttal that caught the attention of the Wisconsin Supreme Court. The official mortgage on record was with MERS, an appointee for the original lender, U.S. Bank.

Dow argued that PHH couldn't foreclose on the property because the true owner was MERS. Essentially, Dow was stating that the mortgage was never assigned to PHH. Based on this argument, PHH utilized the doctrine of equitable assignment.

Based on a case from 1859, Croft v. Bunster, the court determined that the security for a note is equitably assigned when the note is assigned without a need for an independent, written assignment. Additionally, Dow contended that the statute of frauds prohibits the utilization of the doctrine, mainly because it claimed every assignment on a property must be formally recorded.

During the case, Dow argued that the MERS system, which stored the data regarding the mortgage, was fundamentally flawed. According to the court, the statute of frauds was satisfied because the equitable assignment was in accordance with the operation of law. Most importantly, the court avoided all consideration regarding the MERS system, concluding it was not significant in their decision. 

The outcome was a major win for lenders, as they were relying on the doctrine specifically for these types of circumstances.

Most experts agree that this outcome makes sense in the current mortgage-lending environment. This is due to the fact that it is still quite common for mortgages to be bundled up into mortgage-backed securities and sold on the secondary market.

Many economists claim that by not requiring mortgages to be recorded each time a transfer is completed, the loans are more easily marketed to investors. Additionally, debtors know who their current mortgage company is because the new lender must always notify the current borrower in order to receive payment. It was determined that recording and documenting the mortgage merely provides a signal to the rest of the world that the property owner secures a debt.

If you need help with an equitable assignment, you can  post your job  on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.

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Introduction to Security

equitable assignment by way of security

United Kingdom

What is Security

Taking effective security over an asset means that the security holder can, on the insolvency of the borrower, take possession of that asset and use the proceeds to repay the loan. This puts the security holder in a stronger position than the unsecured creditors.

What does the security holder want?

Basically, a security holder has three aims. It wants to ensure that:

The security is effective on the insolvency of the borrower.

The security will take priority over anyone else who obtains a proprietary interest in the asset concerned.

The security can be enforced when required, even if the borrower is in insolvency proceedings.

A creditor may also want to know to what extent security can arise by operation of law and what alternatives there are to taking security.

Categories of Security under English law

There are four primary categories of security under English law as follows:

The term 'mortgage' and 'charge' tend to be used interchangeably but there are some technical differences.

This form of security involves the transfer of title to an asset in order to secure obligations, typically a debt on the condition that it will be re-transferred when the secured obligations are discharged. The assets secured can be tangible or intangible and physical possession of the mortgaged asset is not a requirement.

Depending on whether the necessary formalities have been complied with and whether the borrower has legal title to the asset, a mortgage can be legal or equitable.

Under an equitable mortgage, only a beneficial interest will pass to the mortgagee whereas under a legal mortgage legal title will pass to the mortgagee.

The transfer of title under a legal mortgage operates to prevent the mortgagor from disposing of the asset and assist in the creditor's ability to realise the security if required.

A legal mortgage is the most secure form of security interest and cannot (unlike an equitable mortgage) be taken over future property.

Mortgages over intangible assets such as choses in action (eg. Rights under a contract) are typically taken by an assignment by way of security which can be legal or equitable depending on the formalities complied with. See section 136 Law of Property Act 1925 ( LPA ) for requirements of a legal assignment.  An assignment by way of security transfers certain rights from the assignor to the assignee as security for the discharge of the obligations of the assignor or a third party. You cannot have multiple assignments running concurrently.

While under a mortgage title to the asset will pass to the mortgagee, under a charge title does not pass and the chargee instead  obtains an equitable proprietary interest in the security provider's assets e.g. the right to appropriate the charged assets in satisfaction of the debt, the right to restrict the security provider from dealing with the asset freely and a right to the proceeds of sale. There is no right to possession.

Charges can be fixed or floating. A fixed charge will attach immediately to the (definite and identifiable) charged asset while a floating charge hovers over a pool of assets (present and /or future) until conversion or 'crystallisation' (when it fastens onto and becomes a fixed charge over assets). The distinguishing feature of a fixed charge is that the chargor is not free to deal with the charged assets in the ordinary course of its business. The key characteristic of a fixed charge is that the lender has control over the charged asset. Control is crucial to the nature of a fixed charge. A floating charge on the other hand is a charge over a shifting class of assets which the chargor is free to deal and so permits the continuation of the business operations of e.g. a trading company.

Over certain assets e.g. stock-in-trade or inventory, only a floating charge can be created. This is because it would be impractical for a debtor not to be able to deal freely with its stock as this would cause cash-flow problems. The floating charge is normally therefore a catch-all provision for assets not specifically charged and will typically be granted over the whole undertaking.

In the case of present and future receivables, a fixed charge can, in practice, only be effectively taken if the proceeds of the receivables are paid into an account which is strictly operated as a blocked account (National Westminster Bank plc v Spectrum Plus Limited and others [2005] UKHL41) .

Liens generally arise by operation of law and are more common in commercial transactions e.g. when goods are being supplied, repaired or transported. They are accordingly more of benefit to trade creditors rather than financial creditors e.g. a creditor has a lien over goods until thay have been paid for by the security provider. However, creditors do need to think about doing due diligence in respect of any existing or future liens affecting assets that they might take security over as some will rank ahead of even prior mortgages e.g. a maritime lien.

In addition, it is possible to take a bill of sale over chattels owned by an individual under the Bills of Sale Acts 1878 and 1882, but rarely used because if you get it wrong you not only have invalid security , but the secured debt is also extinguished.

Quasi-security

Quasi-security applies to methods by which a creditor might try to enhance its position on the insolvency of the borrower without taking a full security interest.

Quasi-security includes:

Guarantees and indemnities from third parties

Comfort Letters from third parties e.g. the parent. Are they legally binding or merely expressions of intent?

Set-off and netting arrangements . Netting is a form of contractual set-off. Set-off is mandatory on insolvency for mutual credits, mutual debits and other mutual dealings. Banker's set-off-the general right of the bank to combine two or more accounts held by the same entity.

Bank guarantees and bonds. This is the bank's paper so bank has to pay absent fraud.

Standby Letters of Credit. Operate like a bank guarantee.

Retention of Title (RoT) - Romalpa clauses. Again, a lender needs to do due diligence to see whether its borrower's stock –in-trade actually belongs to the borrower or a third party supplier.

Flawed asset arrangements. This is a mandate arrangement between the bank and the borrower whereby the borrower agrees that the bank does not have to pay what it owes the borrower until the borrower pays what it owes the bank. It was held to be effective on a liquidation in BCCI No 8 [1997] 3 WLR 909 .

Negative Pledges. This a covenant by the borrower not to encumber its assets. These should preserve unencumbered assets for the general creditors. It is questionable whether they bind third parties and what effect a negative pledge has on a third party.

Hire purchase and finance lease. Title is with the lender not the borrower so no risk to the lender on the insolvency of the 'borrower'. This is an alternative method to the loan and mortgage for funding.

II. TYPES OF ASSET WHICH MAY BE SUBJECT TO SECURITY

Mortgage - includes securities, chattels and rights under a contract (via an assignment by way of security). Note that a legal mortgage can generally not be taken over most types of intangible property with the exception of: (i) documents that transfer title to the intangible property (e.g. bills of exchange) and (ii) intangibles that can be transferred into the name of the mortgagee and registered in that mortgagee's name (e.g. shares).

Charge - includes land (usually expressed to be a charge by way of legal mortgage, but a charge nonetheless), contracts, book debts, plant and machinery, goodwill, IP rights and licences.

Pledge - includes items of tangible property capable of being delivered (including documents of title to property such as bearer securities).

Lien - any asset.

III. TYPE OF OBLIGATIONS THAT MAY BE SECURED

Under English law, security may secure obligations of any kind (i.e. not just monetary obligations), including future obligations.

IV. LEGAL FORMALITIES REQUIRED

A Legal Mortgage or Charge over land must be created by way of deed (section 52(1) LPA).

A charge by way of legal mortgage over land must be executed as a deed i.e. it must state that it is a deed and be signed, witnessed and delivered as a deed.

Any mortgage or charge of land or other property (whether legal or equitable) must be by deed if the mortgagee or chargee is to have the statutory power of sale and the statutory power to appoint a receiver. Also, a power of attorney must be by deed.

A deed is a written instrument that requires more than a simple signature to be enforceable. A deed is distinguishable from a simple contract for two main reasons: (i) the limitation period for actions brought under simple contract is six years from the date of accrual of action whereas the period is generally twelve years for a deed; and (ii) deeds do not have to be supported by consideration to be enforceable.

For assignments by way of security of debts or other choses in action, the assignment must be in writing.

Pledge - in order for a pledge to be valid, the creditor must be in actual or constructive possession of the asset. A pledge can only be granted over a tangible chattel, excluding real property. No documentation is required but it is obviously preferable that the pledgor and pledgee enter into a letter or memorandum of pledge to record the terms of the pledge including the circumstances when the pledgee might sell the pledged asset.

Lien - no validity requirements as these normally arise by operation of law, although some liens depend on retention of the asset over which the lien is claimed.

Quasi-security - guarantees must be in writing and signed by the guarantor (section 4 Statute of Frauds 1667).

V. PUBLICITY/REGISTRATION REQUIREMENTS

Almost all security (other than pledges) created by English companies and LLPs must be registered at Companies House within the strict 21 day (extended to 31 days during covid, but now back to 21 days) time period. Companies House is a central registry for companies in England and Wales and a public registry.

In addition, charges by way of legal mortgage over land must be registered at the Land Registry regardless of whether it is a corporate or individual granting the charge.

Various other types of asset have their own registration requirements under different regimes e.g. IP rights, ships, aircraft and bills of sale over chattels. Art security can also be registered at the Art Loss Registry.

VI. OTHER PERFECTION REQUIREMENTS

An assignment is perfected when notice of assignment is given to and received by the other contracting party ( Dearle v Hall ( 1823-28) 3 Russ1). In the case of an assignment of the general partner's right to make capital calls on limited partners in funds finance, you cannot register security against an English Limited Partnership so the only way to perfect is by giving notice to the limited partners.

For pledges and liens, these are perfected merely by the creditor holding and continuing to hold the secured asset.

VII. COSTS OF SET UP AND REGISTRATION OF SECURITY

Any security registered at Companies House costs £15 to register online and £23 to register a hard copy.

The fee to register a charge at the Land Registry (assuming it is not registered simultaneously with the transfer of land where no fee is charged) is between £40 to £250 for each title charged depending on the amount secured.

VIII. TIMING FOR PUBLICITY/REGISTRATION

Security has to be registered at Companies House within 21 days (temporarily increased to 31days during covid) of its creation counting from the day after creation. Dire consequences if you fail to do so including the charge being void against the company's other creditors including its liquidator and administrator and the secured debt becoming immediately repayable. If you fail to register, you can apply to the court for registration of the charge out of time (unless in the meantime the company has gone into administration or liquidation) or take a new charge (subject to potential set-aside until the relevant ' hardening periods have expired).

No specific deadline for registering at the Land Registry, but for priority purposes, best to do so within the priority period afforded by the pre-completion searches. Registering security within this period will ensure priority over subsequently registered charges.

Timing for submitting registration and obtaining proof of registration is almost simultaneous with online registration at Companies House and between one and two weeks in the case of a paper registration. In the case of the Land Registry the time period is approximately two weeks depending on how busy they are.

XI. LEX SITUS

Generally speaking, any security must be created under, and be in accordance with, the law of the jurisdiction where the asset is located, notwithstanding that this may be different to the jurisdiction in which the security provider is incorporated.

Mortgages -To create a valid mortgage over real property located in England and/or Wales, the mortgage has to be created under the laws of England and Wales.

To create a valid mortgage or charge over a chattel you normally have to have your security document governed by the law of the jurisdiction where the chattel is located.

X. WHAT TYPES OF RIGHTS DOES A SECURED CREDITOR HAVE?

Before enforcing its security, the holder must generally make a formal demand for payment on the borrower. The effect of a demand is to make the sums due under the loan facility payable. This is particularly important in the context of some of the enforcement rights implied under common law and statute which do not arise until the secured liabilities become payable (expressly granted enforcement rights will normally be exercisable on an event of default occurring under the loan agreement).

In relation to each type of security the following enforcement rights are available:

Legal Mortgage- Foreclosure (a court process whereby the mortgagor's rights in the secured asset are extinguished (i.e. the mortgagor's equity of redemption is extinguished) and that asset becomes vested in the mortgagee). This rarely occurs these days, although under the Financial Collateral Regulations there is a foreclosure equivalent which doesn’t involve any court process; Taking possession; Power of sale (provided the security document contains an express power of sale or is made by deed, in which case the power of sale is implied); and Appointment of a receiver (again available if express power to appoint or is made by deed in which case the power is implied).

and Appointment of receiver (same as for legal mortgage above). Note that on a sale an equitable mortgagee cannot transfer more than an equitable interest in the mortgaged asset.

For assignments by way of security where the secured property comprises choses in action (e.g. contractual rights), the assignee may exercise its power of sale (provided as above)  and/ or appoint a receiver (provided as above).

Charge -Taking possession (available provided the security document contains an express power to that effect); Power of sale (provided same as for legal mortgage above); Appointment of Administrative Receiver (only available to holder of pre-15 September 2003 floating charge over all or substantially all the chargor's assets); Appointment of Receiver (available provided circumstances relating to legal mortgages exist); Appointment of Administrator (available only to holders of a qualifying floating charges (QFCHs). A qualifying floating charge is a charge created by instrument that states that paragraph 14 of Schedule 18 to the Insolvency Act 1986 applies to it or that it purports to appoint an administrator or administrative receiver. A QFCH is generally a holder of qualifying charge which relates to the whole or substantially the whole of the company's property at the time of appointing the administrator.

Pledge -Power of Sale (available where the power is given either expressly in the security document or impliedly where the pledgor is in default and reasonable notice has been given to him).

Lien -Power of Sale (a lien holder may apply to court for an order of sale where: (i) the lien is equitable or (ii) there is a reason why a quick sale of the assets subject to the lien is preferable (e.g. perishable assets); Appointment of Receiver (available to holders of equitable liens, who may apply to the court for an order to appoint a receiver).

Compulsory Liquidation - a secured creditor can seek to have a company wound up if it has served a statutory demand for a debt in excess of £750 and the debtor fails to pay or if it can show that the debtor is insolvent.

XI. ENFORCEMENT

Foreclosure -This is a lengthy, two-stage court process that is rarely used in practice. First an order for foreclosure nisi must be obtained by the mortgagee and then the mortgagor is given a chance to pay the debt. If payment is not forthcoming, an order for the foreclosure to be made absolute can be sought. Little used because its effect is to deprive the mortgagor of its equity of redemption and it would be a very time-consuming process.

Taking Possession- in most cases a court order is required. Where a secured creditor is entitled to obtain possession of real estate, it can do so by either: i) taking physical possession of the secured property if possession is granted voluntarily; or (more commonly) ii) by bringing an action in the county court for a possession order. This can be a lengthy process e.g. up to two years.

A mortgagee in possession may incur unforeseen liabilities to third parties (e.g. the cost of environmental remediation) and owes certain duties (e.g. to the borrower to account for any income and profit actually received or which should have been received).

Power of Sale -Normally a court order is not required unless the mortgage does not include an express power of sale or is not made by way of deed. Also, a mortgagee may prefer to obtain a court order for sale if there are some issues concerning the consideration for the sale. Otherwise, a mortgagee can sell without a court order, but it does have a duty to get the best price reasonably obtainable and cannot itself buy the mortgaged property without the sanction of a court order.

Appointment of Administrative Receiver and Receiver -These are out of court processes. These can be appointed quickly by notice to and acceptance by, the Administrative Receiver/Receiver.

Appointment of Administrator -Some court involvement is always necessary. Administrators can be appointed in two ways: either simply by filing documents at court (the out of court route); or by making a formal application to the court, and (following a hearing) obtaining a court order (the court route).

Using the court route, the appointing creditor must first issue an application at the court, when a hearing date will be set, the timing of which vary depending  on the court calendar. Notice must then be given to a number of interested parties not less than five business days before the hearing. If appointed, the administrator's appointment may commence at the time of the hearing.

The out of court route is only available to QFCHs and the court route is available to all other creditors.

Using the out of court route, if there are no prior-ranking QFCHs, the appointing creditor can simply file the appointment documents at court and the appointment will commence from the time of filing. If there are prior-ranking QFCHs, the appointing creditor must serve notice of intention to appoint on the prior ranking QFCHs two business days before the appointment. If this period expires or the prior ranking QFCH consents, the appointing creditor can then appoint by filing the necessary documents at court. It is important to use the correct documents otherwise your purported administrator could end up being liable for damages as a trespasser.

Financial Collateral Arrangements (FCAs)- The Financial Collateral Regulations 2003 ( FCRs ) were brought into force to implement Directive 2002/47/EC of the European Parliament and Council and modify existing EU insolvency law in relation to FCAs, to give parties to FCAs certain rights in priority to other parties on the insolvency of the collateral giver, to dispense with registration requirements at Companies House and to permit out of court forfeiture. Briefly, an FCA applies where security over financial collateral (i.e. cash, financial instruments including shares or certain types of monetary claims) is provided by an entity (ie. not an individual) to a financial institution which must have possession or control of such financial collateral. It can also apply to stock-lending and repo arrangements.

Under the FCRs, the collateral taker can enforce an FCA even where an administrator is in place, and without having to account to (ordinarily prioritised) preferential creditors and unsecured creditors. The rights of administrators and liquidators in relation to FCAs are much more limited. For example, they have no right to dispose of the collateral, disclaim the FCA, and avoid the FCA even if it occurred after the commencement of the winding-up or to remove an administrative receiver of the financial collateral. In addition, if the FCA allows, the collateral taker can appropriate the collateral without having to obtain a court order for foreclosure.

Compulsory Liquidation -court sanctioned process. The creditor issues a petition at court to commence the process. A date for hearing is fixed at this point. Notice then must be given to the creditor at least five business days before the hearing. It is possible to obtain a winding up order within about six weeks of issuing the petition.

XII. LEGAL CONCERNS/PROHIBITIONS RELATED TO GRANTING/TAKING SECURITY

Corporate Benefit -Where security is given by a company in respect of the obligations of a third party company, the security provider, in its board minutes approving the transaction, must be able to confirm that it is in the company's interests to enter into the transaction. It is common for such third party security to be approved by unanimous ordinary resolution of the shareholders of the company in order to avoid the risk of the shareholders in the company challenging the grant of the security as being ultra vires the directors. In addition, the lender might require the directors to give a certificate of solvency in an effort to avoid the security being attacked as a transaction at an undervalue.

Security for Loans to Directors -Certain restrictions apply to the making of loans, and to related dealings such as the provision of security for loans, by a company, either to its directors, or to directors of its holding company or to persons connected with those directors. Basically a company cannot make a loan to its director or the director of its holding company or give a guarantee or provide security in connection with a loan made to a director unless it is approved by a resolution of the members of the company and (if the director is a director of the company's holding company) a resolution of the members of the holding company as well. There are additional restrictions covering quasi-loans and credit transactions to or for the benefit of directors and their connected persons   and guarantees and security for such loans in the case of a public company or a company associated with a public company where, again, approval by resolution of the members of the company and, if applicable, its holding company is required.

Taking Security over Shares in a Publicly Quoted Company

Another point to watch when taking security over shares in publicly quoted companies from its directors are the disclosure and notification requirements involved. For example, the  Market Abuse Regulations ( MAR ) (Article 19(1) and (7)) imposes notification obligations on any person discharging managerial responsibilities ( PDMR ) or their closely associated persons, within a company to which MAR applies. If a PDMR, or a person closely associated with a PDMR, grants security over his or her shares he/she must disclose the transaction to the company. The company then has to notify the market.

MAR (Article 19(11)) imposes 'closed periods' on PDMRs , or their closely associated persons, within a company to which MAR applies on dealing with its shares (including the grant of security). Clearance may only be provided in exceptional circumstances (e.g. severe financial difficulty).

The AIM Rules include certain disclosure obligations and restrictions on dealing in the company's shares for directors and their families. The AIM Rules also contain significant shareholder disclosure obligations and dealing restrictions for directors and applicable employees during closed periods.

The Takeover Code may apply to the company. If it does, there are potential disclosure obligations under Rule 8 if a charge is taken over 1% or more shares in the company. Security taken over 30% or more of the voting rights of the company could trigger a mandatory takeover offer when enforced.

Part 22 of the Companies Act 2006 allows a public company to serve notice on those 'interested' in its shares which could include a security holder. The notice can require the security holder to give information not only about its own interest but any concurrent interest of which the security holder has knowledge. Failure to comply with the notice entitles to company to obtain a court order that the shares be subject to restrictions.

Part 28 of the Companies Act 2006  contains 'squeeze out' and 'sell out' rules applying when an offeror has unconditionally agreed to acquire 90% in value of a target's shares giving the offeror the statutory right to buy out the remaining minority shareholders. This right cannot be excluded.

Under the FCA DTA disclosure regime, the holder of shares (or the voting rights in those shares) in UK companies whose shares are listed on the main market or AIM are required to notify the company (using a TR1-notification of major shareholding) once they reach the 3% threshold and each 1% change thereafter. If a lender therefore forecloses on shares under the FCRs or exercises its voting rights in respect of shares held by it as collateral the DTA disclosure regime can apply. For any questions please contact Brad Isaac .

XIII. RIGHTS OF CHALLENGE FOR THE SECURITY PROVIDER/THIRD PARTIES

General- The security provider might contest the debt, or contend that the debt was not due and owing (i.e. that the holder of the security had not made a proper demand) or that the security was invalid or not improperly perfected, or that the relevant appointment documents were invalid, or that the relevant notice requirements were not followed.

Limitation- A limitation period of 12 years from the cause of action applies where the document is executed as a deed. This is reduced to six years where the security document is signed under hand.

Conflicting arrangements- Security may not be enforceable if there is an inter-creditor or standstill deed in place governing the enforcement of the security which prohibits or delays enforcement.

Challengeable transactions- A liquidator and an administrator can, in certain circumstances, challenge and have security arrangements set aside, making the security unenforceable. Reviewable transactions include security arrangements that constitute: i) a preference, ii) a transaction at an undervalue; or iii) a (wholly or partly) invalid floating charge.

Briefly, a preference occurs when a debtor has done something or allowed something to be done which has the effect of putting a creditor into a better position in the liquidation, administration or bankruptcy of the debtor than he would have been if the thing had not been done. Such a transaction is challengeable if it was done within 6 months of the insolvency or two years if the relevant parties were connected with debtor (e.g. in the case of  a debtor company, directors, shadow directors, associates of such directors or shadow directors and associates of the company and, in the case of an individual, a relative or life partner of such individual); the debtor was insolvent at the time or as a result of the transaction and the debtor had a desire to put the creditor in a better position than he would have been if the thing had not been done (section 239 Insolvency Act 1986 ( IA )). A classic example of this type of transaction is where the directors of a company have given a guarantee to a bank and then the company gives security for the previously unsecured debt within a short time of the company entering into formal insolvency. From a lender's standpoint, the main point to notice is that the transaction creating the preference has to be done voluntarily so if the lender exerts pressure on the debtor it should never be a preference.

Again briefly, a transaction at an undervalue occurs (section 238 IA) when a debtor enters into a transaction (e.g. a gift or guarantee) for a consideration the value of which, in monetary terms, is significantly less than the value of the consideration provided by the debtor. Such a transaction can be set aside if:

where the debtor is a company, the transaction took place within 2 years before the commencement of its winding-up and the debtor was insolvent or became insolvent as a consequence of entering into the transaction

where the debtor is an individual, the transaction took place within 5 years of the before the commencement of his bankruptcy and , if the bankruptcy occurs in the third, fourth or fifth years, the debtor was insolvent or became insolvent as a consequence of the bankruptcy (i.e. if the bankruptcy occurs within 2 years of the transaction, there is no need for an insolvency practitioner to prove that the debtor was insolvent or became insolvent as a consequence of entering into the transaction).

Where the debtor is a company, there is a defence if it can be shown that :

the debtor entered into the transaction in good faith and for the purpose of carrying out its business; and

when it did so, there were reasonable grounds for believing that the transaction would benefit the company.

When taking a guarantee from a company, it is therefore common practice to do the following:

Detail in the board minutes the benefits to the company in entering into the guarantee (to assist demonstrating that the transaction benefitted the company);

have the entering into the guarantee blessed by a unanimous resolution of the members (to prevent the transaction being ultra vires the directors); and

have the directors make a declaration of solvency (so that , if correct, the transaction could never be a transaction at an undervalue).

The position from the lender's standpoint is more difficult if the debtor is an individual especially if the bankruptcy occurs within the first two years of the transaction.

Under section 245 of the IA a floating charge created by a debtor company will be invalid in its liquidation or administration if it was created in favour of a connected person within 2 years before the commencement of insolvency proceedings or a non-connected person within I year of its administration or liquidation except to the extent of the value of the consideration of the floating charge which comprises money paid, goods or services supplied or debts discharged at the time of or after the creation of such floating charge. The section does not however apply to FCRs (described above).

Undue Influence- Where the security provider can show that he/she entered into the security document whilst under the influence of another, the security will be unenforceable. Undue influence can be implied where there exists a relationship of trust and confidence between the parties to a contract. Certain types of relationship gve rise to a presumption of undue influence and these include parent and child and husbands and wives. The issue for a lender is that if it can be shown that there was undue influence by the debtor on the guarantor even if the lender was unaware of such undue influence, the transaction involving the lender (e.g. a guarantee) can be set aside. If a lender is taking a guarantee in circumstances where there is no commercial relationship between the debtor and the guarantor, a lender needs to protect itself by:

requiring the guarantor take independent legal advice on the guarantee;

providing the guarantor's solicitor with sufficient financial information to be able to advise the guarantor appropriately; and

obtaining confirmation from the solicitor that he/she has advised the guarantor appropriately before the guarantor entered into the guarantee.

(See the leading cases of Barclays Bank v O'Brien [1994] 1 AC 180 and Royal Bank of Scotland v Etridge (No 2) [2002] 2 AC 773)

Lien - Statute provides that liens over the books, papers and records of a borrower are unenforceable to the extent that enforcement would deny their possession to a  liquidator and administrator.

XIV. SECURED CREDITORS' POSITION IN INSOLVENCY

Rights to and conditions required to continue/initiate security enforcement in insolvency

Perfection (as previously mentioned) is necessary to ensure that the security has the intended priority over the other creditors of the security provider, although perfection does not always guarantee validity and priority in all circumstances (for example, where a transaction is challengeable by an insolvency practitioner).

Further, when a chargor enters into administration or liquidation, unsecured  creditors must lodge formal notice of the debt owed to them, called a proof of debt, to the administrator or liquidator. A secured creditor can rely entirely on its security and not submit a proof or surrender its security and prove for the whole amount of the debt or place a value on its security and prove for the balance of the debt.

Administration- An automatic moratorium is imposed at the start of the administration which prevents creditors from enforcing security without the consent of the administrator or permission of the court, unless the FCRs apply to the security. A secured creditor is however, generally speaking, entitled to be repaid from the proceeds of sale of the secured assets. It may then claim as an unsecured creditor (who will receive a share of the assets proportionate to the size of the company's debt to the unsecured creditors) for any balance. Note that a company cannot enter into administration if an administrative receiver is in office.

Compulsory Liquidation- Compulsory liquidation provides a moratorium preventing creditors from enforcing security without permission of the court. A liquidator acts primarily in the interests of unsecured creditors and shareholders, but must distribute the assets in accordance with the following priority:

First: Fixed charge holders

Second: Administrators and Liquidators (for expenses in administration or winding up) Note that under the moratorium procedure introduced by the Corporate Insolvency and Governance Act 2020 if a company enters into administration or winding-up within 12 weeks of the end of a Part A1 moratorium, any unpaid moratorium debts or pre-moratorium debts (where the company does not have the benefit of a payment holiday for these) will benefit from super-priority (i.e. they will rank before administration or liquidation expenses).

Third: Ordinary Preferential Debts (e.g. employees' wages), Second Preferential Debts (e.g. claims from HMRC such as VAT, PAYE, employee NICs and Construction Industry Scheme deductions) and then the Prescribed Part up to a maximum of £800,000 for floating charges created on or after 6 April 2020).

Fourth: Floating Charge holders

Fifth: Ordinary unsecured creditors including all other taxes e.g. corporation tax (pro rata)

Sixth: Shareholders (receive any surplus).

Secured creditors' rights in influencing decisions in the creditors assembly

Receivership- The receiver only owes duties to the secured creditor who appointed him; there is no meeting of creditors.

Administration- The views of the secured creditor may be taken into consideration by the court when considering the appointment of the administrator. However, an administrator owes a duty to act in the interests of the creditors as a whole.

Compulsory Liquidation- A secured creditor may be able to exert some influence on the choice of liquidator by voting at creditors meetings, or if appointed to the liquidation committee, may take some limited further control over the liquidator's actions. If you have any questions, please contact Andrew Evans or your usual Banking contact.

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