Tue 11 Nov 2014

Securing non monetary obligations

Most people are familiar, whether from purchasing their own home or obtaining commercial funding for their business, with lenders securing repayment of a loan (mortgage) by way of a standard security. The security is registered in the Land Register and if the borrower defaults on the loan, then the lender has powers under the security to sell the property and use the proceeds to pay off the loan.    However the standard security can also be used for other purposes.

Other situations where a security can be useful

 Standard securities can also be used to secure:

  • payment of other debts e.g part of a purchase price which is postponed to a future date or overage payments (which can include extra money to be paid to a seller on a certain event occurring, such as planning being granted for a use which leads to an uplift in the value of the property) or

  • a right of first refusal on the sale of a property (known in Scotland as a pre-emption right) or

  • another obligation to do something specific (know as securing an obligation ad factum praestandum) e.g. to implement obligations by a landowner in an option contract (more detail on this in Steven Thomson's article last month).

    Whilst the form of the of security used for such other purposes is usually slightly different to that of a mortgage type security, it does the same thing. It is registered in the Land Register against the title to the property and will show up in searches of the register carried out by anyone who might want to buy or take a lease of the property or take (another) security over it, so that: 

  • anyone buying would be aware that they could only get a clear title if the security is discharged (in exchange for repayment of the mortgage);

  • any prospective tenant would know that the consent of the security holder would be needed to the grant of the lease; and

  • any other lender would know that its security would rank behind the existing registered security - indeed the existing security will often prohibit the borrower from granting any further securities without its consent.

     The security allows the security holder to restrict what the owner can do with the property e.g it can prohibit certain uses or activities.  It can also impose positive obligations e.g. requiring the owner to maintain the property to a certain standard.

     One point to bear in mind is that if there is a fixed date at which all obligations under the relevant contract cease to be enforceable, it might be necessary to ensure that those which are to be secured are excluded from this cut off provision.


    Owner wants to sell or transfer title to a third party?

     If the owner wants to transfer title to someone else the security holder might either:

  • discharge the security without requiring a replacement - if the secured obligations are due for implementation and the owner has fully implemented them or

  • if the secured obligations are not yet due to be implemented, require a replacement security from the buyer or transferee in exchange for discharge of the existing one and the transferee taking on in full the original obligations.


    Detail of the secured obligations confidential

    Although the security does appear on the public register, so that it can be viewed by anyone, this does not mean that the detail of the secured obligations has to be disclosed. The security will refer to the obligations under the relevant contract e.g. the sale or purchase option contract, but the contract itself does not appear on the public register.


    Security not a panacea

    A standard security provides extra protections for, and gives extra powers to, its holder - beyond those available under the relevant contract - but is rarely a panacea.

    If the security supports the obligations of a seller under an option contract, if the seller becomes insolvent, the security holder would have an automatic right to call up the security and take possession and control of the property - but this would not make the security holder the owner. There is no automatic route which allows the security holder to take title to the land if that is the desired result.

    There are different varieties of enforcement depending upon the result that the security holder is intending to achieve, however it is certainly a useful tool and much better than relying simply on the underlying contract. 

    The main remedies available are:  

  • sale of the property - which is useful if a sum is due and ascertainable, but not a great help if the obligation is not yet due e.g the holder of an option is not yet ready to exercise it or the trigger event for payment of an overage price has not yet occurred;

  • seeking specific implement of an obligation ie requiring the granter of the security to do what the contract obliges him to do;

  • damages ie monetary compensation for loss; or

  • foreclosure, which is taking title to the land - but is something that is rarely achievable or achieved.

    There can also be issues with quantification of loss and what happens on administration or liquidation of the "debtor" and (if the security is not first ranking) the first ranking security holder will control enforcement procedures.

    All of that said, if you are negotiating a contract where you wish to have the best chance of being able to enforce non monetary obligations, it is worth considering insisting on such a security to secure these obligations.


     If you would like to discuss these issues further, please contact us.


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