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Securities over Assets

What is a security?

A security is a pledge of an asset to a particular creditor to support a debt. A creditor that holds a security is know as a secured creditor. The asset is known as being 'charged' and securities are also known as charges. Charges are over assets, not over companies or people.

The most commonly know form of security is a mortgage over a house granted to a bank to support the loan to buy the house. Mortgages over company assets have slightly different rules than real property mortgages, particularly with regard to registration, but they have the same effect.

What assets may be secured?

Almost any asset capable of being identified may be charged. The type of asset will generally determine the type of charge required and other factors like registration requirements. The assets charged do not need to be owned by the debtor - they may be provided by a third party - but do need to be owned by the entity providing the charge over them.

Who may take a security?

Any creditor may take a charge over assets if offered by the debtor. Usually trade creditors or creditors with small debts will not go to the time and expense of creating charges. But if creditors have substantial or long term debts it may be beneficial and commercial for them to do so.

What are Fixed and Floating charges?

Charges can be Fixed or Floating. Charges can contain both fixed and floating elements are are known as fixed and floating charges.

A fixed charge (or portion of a charge) is a charge over a particular identifiable asset, usually land or physical plant and equipment. These assets generally do not change in identity during the period of the charge. The charge is fixed on that particular asset.

A floating charge (or portion of a charge) covers a class of assets like debtors, cash at bank, stock, etc. These assets do not maintain the same identity over time (e.g. stock is continually purchased and sold). A floating charge 'floats' over that class of assets and captures the particular asset that is held at the time that the charge is exercised.

How does a charge affect an asset?

This will depend on whether the charge is fixed or floating. The debtor will generally not be able to deal with assets under fixed charges without the consent of the holder of the charge. The asset will have to be released from the charge to be sold.

Assets under floating charges move in and out from under the charge and the debtor will be able to deal with the asset without the consent of the holder of the charge. In our stock example above, once stock is purchased it is covered by the charge. As soon as it is sold, it leaves that cover and cannot be claimed under the charge. The charge 'floats' over this class of asset and, when enforced, fixes (falls) on the particular assets that are there at that time.

When does a charge have to be registered?

Charges over most assets owned by a company must be registered with ASIC to be enforceable against external administrators. Without registration, the charge will be unenforceable. Even without an external administrator being appointed, unregistered charges fall behind other registered charges. Charges over real property do not need to be registered with ASIC, but should be registered on the appropriate land register or they will fall behind other registered charges in priority.

Some charges (usually Bills of Sale) over personally owned assets need to be registered to be enforceable against bankruptcy trustees and some other people. Those requirements are found in the relevant Acts.

Proper legal advice should be sought by creditors when taking a charge to ensure that all requirements are fulfilled.

What should be considered before taking a security?

Certain matters must be considered and some investigation should be done before taking a security. The process is not as simply making the decision to get security if offered by the debtor. A range of procedures should be followed to make the security valid. Some question to ask are:

(a) Does the asset being offered as security actually exist?.
(b) Who owns the asset? Is it the entity that is offering the charge?
(c) Does the owner have the right to charge the asset?
(d) Is the charge one that requires registration and who is to register it?
(e) Is there another charge over that asset that will have priority over your charge?
(f) Is the asset worth more than the debt secured over the asset?
(g) Is the charge properly documented and executed by the right people?
(h) Is the charge Fixed or Floating?
(i) What are your rights for enforcement and are these clearly set out in the documentation?

A valid security may have no value!

A security is only as good as the underlying asset. If the asset is worthless, the security will be of no commercial value. If the security is subordinate to another higher ranking security, it will be worthless unless the value of the asset is sufficient to cover the both secured debts. If the proper procedures have not been followed to register and exercise the security, it may be void once a liquidator or trustee is appointed.

Creditors should get a proper valuation of the asset, make sure that the security is property registered, make sure that the security is in writing and executed by all of the relevant parties. The main piece of advice that can be given is Seek Legal Advice and have everything documented.

Registration under the Corporations Act

If a security requires registration but is not registered at the time that a liquidator or administrator is appointed, that security is likely to be void. Securities registered outside the relevant period may also be void if they are registered within 6 months before the appointment. Attempting to replace a security that would be void with a security that would comply with the registration requirements may also be void. Creditors obtaining securities should ensure that registration is completed as soon as possible after the granting of the security.

Registration under the Bills of Sales Acts

Some securities cannot be enforced against certain persons if not registered. The most common type of security over personally owned assets is a Bill of Sale. These must be registered under the relevant Acts in each state to be able to be enforced against certain persons.

How is a charge exercised?

The charge documentation should have provisions detailing the rights of the creditor. It should also contain provisions dealing with what constitutes a breach of the agreement and how the creditor can make demands before obtaining the right to take possession of assets. It should provide the mechanism for the appointment of a controller over the assets, or for the creditor to take possession of the assets for the purpose of a sale. The charge should be checked before taking any action.

What are the powers of a controller?

These will be set out in the charge documents as the controller assumes control of the assets covered by the charge. Depending on the security, they may be able to carry on the business, manage that property, terminate or dispose of all or any part of the business and dispose of any of that property as they think fit. Any asset that is not covered under the charge does not fall into the control of the controller and they may not exercise any rights that are not given to them under the security documentation.

Can a security be overturned by an external administrator?

Yes. In some circumstances a security may be invalid. These are, in general terms:

(a) if the granting of the charge was a preference;
(b) if there was no current or future consideration for the granting of the charge;
(c) if a related party attempted to exercise a charge in a specific period after its creation (Corporations Act only);
(d) if the granting of the charge is an attempt to defraud or delay payments to creditors;
(e) if the charge is not properly registered;
(f) if the charge was created to replace a charge that would have been void.

Can a charge be a preference?

Yes. Granting a security can be preferential and may be overturned by a trustee in bankruptcy or a liquidator. The usual rules of preferences apply, the creation must have occurred within 6 months prior to the appointment, the debtor must have been insolvent at the time of or because of the creation of the security and it must have granted some form of preferential treatment on the security holder.

Charges that secure advances at the time of the charge are not preferential, but a security obtained just before a liquidation or bankruptcy, where that security covers old debts, may be void as a preference.

Are secured creditors restricted by the other appointments?

In most cases there are no restrictions on secured creditors exercising their securities. The major exception is under the voluntary administration provisions of the Corporations Act. In that case, a secured creditor has 13 business days to exercise his charge. If they do not, they then are bound by a moratorium for the duration of the administration period. Once the second meeting is held, the secured creditor regains the right to exercise their security.

For more detailed information:

Insolvency Resource Page: Registered Securities and the Corporations Act

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

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Last Updated: 4.3.2008