A charge is a form of security in return for borrowings, usually secured against a property. The most common form is a Legal Charge, however if a Legal Charge cannot be entered into, then an Equitable Charge is the next possible solution. The Equitable Charge does not take effect in law and does not give the lender a legal interest in the property but a beneficial interest.
When might an Equitable Charge take place?
- Connected parties: If the lender and borrower are relatives, friends, or connected through a pension scheme, the lender may already own an interest in the property. It is not usual for a lender to enter a Legal Charge on a property that they already own. While possible, it might not be upheld in Court if challenged.
- Failure to comply with formalities: A Legal Charge might have failed for some reason i.e. it wasn’t executed correctly or registered correctly and therefore an Equitable Charge might arise instead.
- Second Charges: A lender might be looking to charge a property that already has an existing charge in place. If consent from the existing charge holder cannot be obtained to a second Legal Charge, then an Equitable Charge might be their only other option.
- Leasehold properties: Where the property is leasehold, and the lease contains a prohibition on creating a legal mortgage over the lease.
What are the risks of an Equitable Charge?
- With a Legal Charge, the lender has a power of sale, which enables a forced sale of a property to repay the borrowings in the event of a default. As an Equitable Charge can only take effect in equity and not law, there is no power of sale.
- If a lender needs to recover sums owed, they will need the proprietor’s consent to sell the property. If consent is not forthcoming, either:
- the charge remains until the borrower pays or a sale is agreed; or
- the lender applies to court for a court order to sell.
- When relying on a court to grant an order or decide whether a charge is enforceable and what remedies are available, you are at the mercy of the Judge. The decision is at their discretion, and you cannot predict the outcome. In addition to the unknown, the process can be long and expensive.
- An Equitable Charge cannot be registered against the property’s title. This means prospective purchasers, tenants and lenders will not immediately be aware of its existence and a property could be sold without the lender’s knowledge. We would advise that a notice is entered onto the property’s title confirming that an Equitable Charge is in place. However, depending how the notice is registered, the borrower could apply to remove this.
- The lender will be an unsecured creditor, should the borrower become bankrupt, or the borrowing entity go insolvent. Those with Legal Charges or secured creditors will take priority on repayment.
Alternative options to an Equitable Charge
If a Legal Charge cannot be granted by the borrower over that property, and an Equitable Charge is too risky, then options might be:
- Variation of interest held – the lender (if it isn’t already) becomes a beneficial owner and a Declaration of Trust is entered into changing the interests held in the property. For example, if a lender and borrower jointly own a property in equal shares and the loan amount represents a 25% share in the property, then the lender’s interest is increased to 75% and the borrower’s interest is reduced to 25%. This is presuming the value of the property covers the value of the loan. Obviously, the borrower will have to agree to give up all / some of his interest in the property. If the property is sold at any time, the lender would then receive 75% of the proceeds (or whatever proportion is agreed). If / when the loan is repaid, a new Declaration of Trust can be entered into to reverse the proportions back to 50 / 50. There may be tax implications to this option.
- Legal Charge over a different property – alternatively, the borrower offers a different unencumbered property for security and the parties proceed with a standard first Legal Charge between the lender and borrower.
- Third Party Legal Charge – the borrower offers a different property to be secured that is jointly owned with another party (i.e., a spouse) or owned by a connected company. The third party will need to take independent legal advice and also enter into the charge. The third party is effectively guaranteeing repayment of the loan by the borrower, and if the borrower fails to do so, the third party may lose the property.
How can BHW help?
Our Commercial Property department regularly deal with mortgages. We have a dedicated Real Estate Finance team who can offer advice on how to structure security to best protect your interests.
If you would like to discuss security options further, or obtain a fee estimate, please call 0116 289 7000 or email email@example.com.