Security Documents & Equitable Mortgage
Security over property/assets can be taken over assets in three main ways:
(a) a legal mortgage;
(b) an equitable mortgage; and
(c) an equitable charge.
A Legal Mortgage is created by the registered transfer (which should be stated to be "by way of legal mortgage" to the Lender (or its nominee) which is then registered as the holder of the asset, accompanied by an agreement (under seal or underhand) which sets out the right of the Borrower to have the assets re-transferred to him upon discharge of all liabilities to the Lender.
Advantages of Legal Mortgage
(a) Once the Lender's power of sale (whether arising under common law, statute or the terms of the mortgage agreement) has arisen, it can realise the assets without the involvement of either the court or the Borrower. All rents, interests, dividends are paid to it and any rights accruing on the asset, vest in it. The lender has complete control.
(b) Since the legal title is vested in the Lender which will be a purchaser for value, any prior equitable interests in the assets of which it had no notice at the time the assets were transferred, are defeated.
(c) Since all notices etc regarding meetings of the Company are sent to the registered holder of the assets, the Lender will have notice of any interest or business relating to the assets, thus protecting its security.
Disadvantages of Legal Mortgage
(a) The advantages of a legal mortgage may be outweighed by the resistance that borrowers have to transfer their assets (which may represent subsidiary companies) into the name of a lender or its nominee company, particularly if it is not clear that such a transfer is essential for the lender's security to be sufficiently protected.
(b) Moreover, it may be difficult or impracticable to legally transfer certain assets. For example, for machinery that is currently being used by the borrower for production purposes, taking a legal mortgage would essentially mean taking possession of the machinery and thereby stopping production.
(c) Where interests or dividends paid on the assets are to be retained by the borrower, rather than applied in the reduction of any amounts owing, the Lender will be involved in the administrative cost and trouble of receiving and distributing those dividends to the borrower.
(d) A legal mortgage only takes effect over existing assets. A mortgage of future assets must be equitable.
An equitable mortgage merely gives the Lender a right against the Borrower to have a legal mortgage executed or to share in the proceeds of the sale. If the Borrower fails to meet its liability, the Lender can apply to the Court for an order of foreclosure or sale. In that it is generally unwise to rely upon security which cannot be realised without either the assistance of the Court or the co-operation of the Borrower, a Lender can strengthen its position, without actually taking a legal mortgage, by executing an equitable mortgage through the following means:
(a) require the mortgage to be executed under seal and contain a power of attorney authorising the Lender to sell the assets and to execute (and not merely complete) all necessary transfers (e.g. on a sale or into the mortgagee's own name);
(b) give notice to other parties which may also have an interest of its interest in the assets (for example, in relation to a share mortgage, to the company itself, or in relation to the mortgage of property, any prior mortgagee).
Advantages
(a) An equitable mortgage may meet with less resistance from a Borrower than a legal mortgage since no legal transfer is required;
(b) It is the only practical way to transfer in situations where the borrower needs possessions of the assets to continue its operations and there is no separation of legal title from physical possession.
Disadvantages
(a) The Borrower may fraudulently (or inadvertently) and without the Lender's knowledge sell (or grant a legal mortgage over) the assets. The purchaser will take free of the equitable mortgage if he is a bona fide purchaser of a legal estate without notice. The purchaser may have notice of the charge if it is registered at the Company Registry / Company House (demonstrating the importance of registration).
(b) Unknown to the Lender, there may be prior equitable interests which will prevail over its equitable mortgage whether or not the lender had notice of such interests unless the owner of the prior equitable interests consented, is estopped or was grossly negligent.
(c) The Lender may not be able to procure the transfer to a purchaser of the assets unless and until the transfer into its own name is completed or it takes possession of the assets. Its position may be jeopardised during the interim period.
Assets may be charged with the amount of debt with neither ownership nor possession of those assets or certificates representing them passing to the Lender. No particular charging wording is necessary, merely a clear intention that the relevant assets are to constitute a security. Generally, a mortgage is to be preferred by the Lender over a charge.
Difference between a Mortgage and a Charge
The principal points of difference between a mortgage and a charge are as follows:
(a) a mortgage is a transfer of an interest in the property mortgaged "as a security for the payment of a debt or the discharge of some other obligation for which it is given", whereas a charge merely gives the chargee certain rights over the property charged as security for the obligation (i.e. there is no assignment or transfer of ownership);
(b) an equitable mortgage is treated at law as an agreement to create a legal mortgage, so that the remedy of specific performance, requiring the transfer to the mortgagee of the assets mortgaged, would be available at any time, before or after default, in respect of a mortgage, but not a charge;
(c) upon a default, the remedy of foreclosure is available in respect of a mortgage, but not an equitable charge. In most cases, the mortgagee may prefer to have the cash resulting from the exercise of a power of sale to discharge a debt, rather than holding on to the assets;
(d) a charge must be equitable, whereas a mortgage can be an equitable mortgage or a legal mortgage.
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