Recommendations for security on a loan to a company by a director or a shareholder

Increasingly, companies borrow from shareholders and directors, who are likely to offer better terms than a bank. Just as with a commercial loan, the lender may require security. However, often the loan agreement is not correctly formalised, and the security not correctly registered. The lender may not have the preferential rights to proceeds in an insolvency that he or she believes that he or she should have.

It is worth noting here that if the reason for a shareholder or director lending to the company is that a bank refuses to do so on grounds of high risk of insolvency, that commercial risk is likely to be present for any lender. It may be wise not to lend at all.

Restrictions in the articles of association and in any shareholders’ agreement

The constitutional documents of the company, the articles of association and any shareholders’ agreement, may restrict the terms on which a loan can be taken out by the company, or the security that can be used. If there are restrictions that are not followed, the terms of the loan may not be enforceable, except if the lender could prove that he or she acted in good faith.

Since the articles are a public document, it is easy to check them. If there are restrictions in place, the shareholders may wish to amend them by calling a meeting and passing a resolution.

The shareholders’ agreement is private between the members of the company, and therefore more difficult to check. If a copy cannot be obtained, the lender may wish the directors to warrant that there are no restrictions (if one or more are shareholders).

Choice of security

You may want to read in detail about what form of security to take. To summarise, the best assets to use as collateral are those that are more valuable than the amount lent, and that can be liquidated easily.

The charge may be fixed or floating.

A fixed charge is one on a particular asset, such as a property, a vehicle, or a piece of plant or machinery. In order to sell or change the asset, permission from the lender is required, which if given, usually would be conditional on replacing the security with another asset.

A floating charge is one on an asset that may be traded and replaced without consent from the lender. Floating charges are usually placed on assets that are traded, such as stock. When the loan becomes repayable, the floating charge crystallises into a fixed charge.

Priority

If assets have been pledged as security against other loans, a new lender may find himself or herself at the bottom of the list for repayment if the company becomes insolvent. If the assets are not sufficient to repay the debts, the lender may not recover the full amount lent.

Security holders must be registered at Companies House. A search can be undertaken to check priority order, which may differ depending on the different types of assets secured. A deed of priority signed by the directors – confirmation of priority – can be written to make clear the order who has rights over particular assets.

Timing

The security (the right) should be taken at the same time as the loan is agreed. The reason being is that unless it is clear that the loan is conditional on the security, the grant of the security may be seen by a liquidator as only preferential (the consequence of which is that the lender would have least priority).

Board and shareholder meeting minutes

Certain types of loans to directors must be approved by shareholders in a general meeting.

Further, loans secured on certain assets, or for amounts over a certain value, may have to be approved by members under the terms of the shareholders’ agreement. Even if not required under the constitutional documents of the company, passing a resolution removes the risk that shareholders may challenge the terms later.

Any secured loan should be approved by the directors in a board meeting, with minutes documenting that the terms were made clear and approved, and that conflicts of interest were considered.

Intention to take ownership in case of default

On insolvency, the lender may either appoint an administrator, or take ownership of the security. If the latter, then the Financial Collateral Arrangements Regulations require that the asset is valued before possession is taken. If the value exceeds the amount due, then the lender must pay the company. If the value is less, then the company remains liable for the remainder.

Registration at Companies House

All securities must be registered with Companies House within 21 days of the creation of the security. Registration allows other potential lenders to assess the financial position of the company. If the security is not registered within the timeframe, then the lender cannot claim against it.

Additionally, there may be further registration requirements. Security taken on intellectual property may need to be registered if it is a trademark or if there is a patent on it. A security over land should be registered at the Land Registry.

Further information and documents

More general information about the terms of a loan agreement can be found in this article.

Net Lawman offers a number of loan agreements, including ones specifcally for secured lending to a company.

Please note that the information provided on this page:

  • Does not provide a complete or authoritative statement of the law;
  • Does not constitute legal advice by Net Lawman;
  • Does not create a contractual relationship;
  • Does not form part of any other advice, whether paid or free.
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