Traps for the unwary – priority of security
Despite what many would assume, a first legal mortgage, or a charge protected by registration at the Land Registry, does not always guarantee priority of security for the lender in all circumstances. It is important for any lender to instruct lawyers who are alive to the priority interests of other creditors of the borrower that may exist prior to the loan and creation of its mortgage or charge.
The aim of any lender taking security for a debt will be to ensure that if the borrower defaults, or becomes insolvent, the lender is first in the queue to recover the payment of its debt ahead of any other creditors i.e., they have priority of security. To achieve this, part of the lawyer’s job will be to ensure that there are no other prior security interests that could usurp the lender’s priority.
Legal and equitable mortgages or charges
Legal mortgages or charges usually rank in priority in the order that they appear in the charges register of the property’s registered title. This helps to establish some priority of security. However, the respective lenders could have agreed to rank their security interests in a different order. Such agreements are known as deeds of priority, deeds of postponement or intercreditor deeds.
Equitable mortgages or charges will between themselves also rank in order of the date of creation, whether or not they are noted on the property’s title register.
While an un-noted equitable charge will be overridden in the event of a new legal mortgage or charge being granted, an equitable mortgage or charge that has been protected by a notice on the title register would take priority of security over a subsequent legal mortgage or charge. Consequently, a lender must not assume that by taking a first legal mortgage or charge it will take precedence over any other noted equitable mortgage or charge – it will not. It will be important for that equitable charge to be removed from the registered title, or for the respective lenders to enter into a deed of priority.
A lender with a first legal mortgage or charge may make a further advance to the borrower with that advance taking priority over a subsequent legal mortgage or charge where:
- the additional amount is made under an obligation to make advances which has been noted on the registered title of the property at the time the second legal mortgage was created; or
- the first lender has not received notice of the second legal mortgage; or
- the first lender and borrower agreed a maximum loan amount at the outset and this was noted on the title at the time the second legal mortgage was created; or
- the respective lenders enter into a form of deed of priority.
Consequently, if a first lender has notice of a subsequent charge and then goes on to make a further advance without the protection of the appropriate entries and/or deed as set out above, any further advance will rank behind the subsequent charge.
Further complicating priority of security, lenders will also need to be wary when dealing with a corporate borrower that has already given a debenture to another creditor.
A fixed charge contained within its legal mortgage or charge will not necessarily have priority over an earlier floating or equitable charge contained within the debenture.
The majority of debentures include what is known as a negative pledge. A negative pledge is where the borrower promises and undertakes to a creditor not to create or permit to subsist any security over its assets without the prior written consent of the creditor.
The purpose of a negative pledge is to prevent a borrower from granting security over its assets to another creditor which would improve the position of the other creditor at the expense of the debenture holder. It is particularly important in preserving priority of security for debenture holders.
If a new lender has actual notice of a negative pledge protecting an earlier debenture and proceeds to take its security in breach of that negative pledge, the security created by its legal mortgage or charge is at risk of being postponed behind that of the debenture holder. This is because equity will regard it as unconscionable for the new lender to obtain priority. Furthermore, the new lender could find itself subject to an injunction by the debenture holder or a claim in tort for inducement to breach contract.
Another issue of priority of security for lenders is seller’s liens.
It is not uncommon for sellers and buyers to agree that part of the sale price is deferred on completion with the result that the unpaid seller’s lien that arises on the exchange of contracts will continue post-completion. The lien creates a proprietary interest in the commercial property in favour of the seller and is by way of security for payment of the deferred consideration. It is similar to an equitable charge, save for the fact that it arises by operation of law. If a buyer fails to pay the deferred consideration, then the unpaid seller’s lien can provide the seller with the remedy to enforce payment by applying to the court for a declaration that the lien exists and an order for sale. Furthermore, the lien will have priority of security over the lender’s first legal mortgage or charge with the result that the unpaid seller can exercise its security in priority to the lender.
In the event that the seller obtains a second legal charge over the commercial property then this would result in the lien falling away and the lender and seller are likely to enter into a form of deed of priority.
A lender however needs to be cautious when a seller does not seek to secure the deferred consideration as the unpaid seller’s lien will remain. Nevertheless, an unpaid seller’s lien must be protected by registration of an agreed or unilateral notice at the Land Registry before the transfer of the property is made to the buyer. If not, the buyer will take the commercial property free from the lien and the buyer’s lender will have priority. It will therefore be important that the lender and their solicitors ensure that the seller does not submit an application to register the lien prior to the completion of the transfer to the buyer/borrower.
GA’s property finance team is made up of experienced property finance lawyers who understand all of the above issues and can advise lenders appropriately to overcome such issues and ensure the successful completion and registration of the lender’s first legal mortgage or charge.