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When a business is owed money, whether it is due now or at some point in the future, it is generally in the commercial interest of the creditor, the entity which is owed the money, to have some form of protection or assurance that it will be able to recoup the money if the debtor does not fulfil its obligations to pay the sum outstanding by the due date. This protection or ‘security’ can take many forms and the appropriate security will ultimately depend on the commercial context in which the debt arises. In each case a written agreement should be made between the creditor and debtor.
The main types of security are discussed below:
A lien can arise in a number of ways, and not all liens are discussed here, but a text book situation is a common law lien which allows a creditor the right to retain possession of a debtor’s property until the debt has been repaid. This is merely a passive right to retain the property and does not give the creditor the right to sell the asset to pay the outstanding debt. A contractual lien (incorporated into a contract) can extend the common law right, so that the creditor may have the right to sell the property.
A charge gives the creditor the right to sell the charged asset towards payment of the debt in the event of the debtor’s default. A charge does not involve the transfer of ownership of the asset to the creditor nor does it give the creditor the right to take possession of the asset. A charge can be fixed on a particular asset or floating over a class of assets. This distinction is important if the debtor enters into insolvency as fixed charges take priority over preferential creditors and floating charges.
A mortgage involves the transfer of ownership of an asset by way of security on condition that it will be re-transferred when the secured obligations are discharged, usually the repayment of the debt. This transfer of ownership enhances the creditor’s ability to sell the security and prevents the debtor from disposing of the asset.
Other types of security include retention of title whereby ownership of goods supplied remain with the supplier until it has been paid in full, even though the buyer has possession of the goods. A personal guarantee is a promise by an individual to perform the obligations of the debtor if the debtor fails to perform them.
Most debtors or potential debtors are unlikely to offer security for their payments. However, if it is negotiated and agreed as part of the transaction then a creditor will have additional protection if the debtor fails to pay.
Please contact me if you would like help in taking security whether in a commercial or personal context.
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