Security Review

A security review is a crucial part of any lender's strategy to recover money from a defaulting borrower. It allows the lender to uncover any issues with the finance documents early on and determine how it will consequently deal with the borrower and other stakeholders in the loan and security property.

It will involve the examination of the various finance documents and registrations of the security at Companies House and the Land Registry to assess the enforceability of security and guarantees.

These include the loan agreement and any related amendments or reservations of rights, as well as security documents, guarantees, and associated documents. The borrower entity's corporate authorisations and company constitutions may also be reviewed.

Additionally, intercreditor deeds, subordination deeds, deeds of priority, and similar documents are assessed. In the case of development lending, quasi-security documents, such as collateral warranties, are included in the review as well.

After the review, a report is produced summarising any issues found, and commenting on the enforceability of the security and guarantees. The report should also provide advice on potential process-related issues during enforcement.

Assumptions and exclusions would usually be listed either in the engagement terms or as a schedule to the security review itself. It is critical for the lender to understand these presumptions and exclusions to appreciate the scope of the review. It is frequently believed, for instance, that a corporate borrower has completed all formalities required by the Companies Act and its Articles. As a result, it's possible that some details won't be covered in the report; like the examination of articles, due execution, or board minutes.

The UK economy is currently facing numerous challenges, including high interest rates, the cost of living squeeze and continued geopolitical crises. As a result, borrowers and lenders alike are under more pressure than ever before. Taking proactive measures, like a security review, can be part of key preparation when identifying at-risk loans and borrowers, so that when a defaults occur lenders can act swiftly and knowledgeably.

However, there are costs involved in producing the review, and whilst (depending on the drafting in the finance documents) these can often be passed on to the borrower, many lenders are reluctant to incur these costs unless the borrower is in default.

Unfortunately, this delay in conducting the review can result in missed opportunities to address any problems with the security package while the borrower is still cooperative. It's important for lenders to prioritise early security reviews to identify and address any issues promptly.

Additionally, there are various circumstances where a security review is necessary, such as when receivers or administrators need to validate their appointment or when they plan to distribute assets to secured creditors, or when an unsecured creditor is considering a winding-up petition. It is also relevant for potential buyers of a secured debt portfolio who want to make sure that when they acquire the loan(s) they have the necessary security in place as well.

There are various ways a borrower might default on its loan and each lender has its own specific list of events of default. During a security review, the main focus is on identifying potential risks that could render the security invalid or open to challenge. It is also important to identify any assets that the lender does not have valid and effective security over when it expected to do so. The review will suggest actions the lender can take to rectify any such defects and discuss the various enforcement options available, while considering any restrictions on those options.

There are several common issues encountered within the security review process;

Loan Agreement

Loan agreements often vary in format, with some lenders using a short letter-style format that relies on the security documents for the default terms, while others use a comprehensive loan agreement including all provisions needed to outline the borrower covenants and events of default . The range of standard forms that lenders use requires a suitably experienced legal advice that is familiar the a variety of finance documents and can navigate the lender’s precedents to pick-up the key points .

Both the loan agreement and the security documents will typically specify the default triggers for enforcement. However, it is not always immediately clear if a breach of the terms of the loan agreement actually feeds through into the enforcement rights under the security documents.

For example, poorly written security documents may only consider a payment default as giving rise to the lender’s powers under the security and not take into account the facility agreement's more comprehensive list of events of default.

Secured Liabilities

Another potential complication is how the term ‘secured liabilities’is interpreted within the finance documents as this determines what the security captures in terms of monies due to the lender. Even if the term refers to “all monies” it may be limited by reference to a specific the loan agreement and not necessarily include any further advances or other cross-secured facilities that might be applicable.

A potential solution to this might be to obtain fresh security to cover all lending but this will depend on, amongst other things, whether the borrower is willing to grant it and whether the borrower is solvent to lawfully grant it.

Authority

A security review might include checking the status of a corporate borrower’s directors and its articles at the time of the original loan. This would be to ensure that the finance documents were entered into with due authority as this can have a direct bearing on the validity of the finance documents on enforcement and in any insolvency scenario when dealing with the borrower's liquidators or administrators.

However, not all security reviews cover this. Some may contain assumptions and exclusions about execution and authority. As mentioned above, the scope of the review needs to be considered carefully by the lender at the outset.

Document Construction

Finance documents based on Loan Market Association (LMA) precedents often incorporate definitions and clauses which tend to flow from the loan agreement into the security documents. This can become problematic when these documents are reused from previous deals without proper consideration. Key clauses necessary for the enforcement of security documents may be dropped or amended without realizing the impact it has on  the wider finance documents.

A similar issue can arise with the amendment of payment waterfalls in intercreditor deeds, causing conflicts with the waterfall in the security documents or the statutory waterfalls that apply. Potentially, if not dealt with soon enough, the only way to resolve these issues (particularly for receivers, administrators or liquidators) is to seek a Court Order as to how the documents should work. This all adds time and cost to a lender’s eventual realisation and repayment from the security assets.

Guarantees

Guarantees need to be reviewed to check if any limitations or caps were negotiated at the outset. Various elements need to be checked to make sure that the guarantor(s) do not have grounds to challenge the enforcement of the guarantees e.g. lack of independent legal advice (where required) and whether any increased liabilities were suitably notified to the guarantor(s).