Security interests may be taken on any type of property in any of the following ways:
a) By Mortgage of Property (Land/Building/Both)
b) By Creating Charge on Assets (Current/Fixed/Movable/Immovable)
c) Pledge
d) Hypothecation e) Lien
f) Guarantees
a) Mortgages
Mortgage means transferring the conditional right of ownership on fixed assets (property/building/land) by its owner (the mortgagor) to a lender (the mortgagee) as security against some loan facility. The mortgage is recorded in the register of title documents to make it public information, and is cancelled when the loan is repaid in full.
Mortgages may be legal or equitable.
Legal/Registered Mortgage
Legal mortgage is usually recorded in a public register. It is also known as registered mortgage. Legal mortgage is when the borrower (mortgagor) gets the name of the lender (mortgagee) registered in the government records of the property along with the terms of agreement. In this the government levies registration charges for such registration.
In legal/registered mortgage, the borrower remains the legal owner of the property, but the bank
gains sufficient rights over it so that it is able to enforce its right over the security, such as a right to take possession of the property OR sell it for the purpose of recovery of loan in case of default.
After registration of mortgage legally, the bank's lien is recorded in the land register stating that the property is under mortgage and cannot be sold without obtaining an NOC (No Objection Certificate) from the bank.
Equitable Mortgage
Equitable Mortgage is when a borrower mortgages his existing property to secure a loan by submitting his ownership titles and by giving a right to the lender to sell the property in case of his default. In equitable mortgage, the title deeds are kept as a security with the lender.
An equitable mortgage is one which is lacking one or more formalities of legal requirements, such as stamping, filing or registration. Equitable mortgages are recognized under common law to protect the rights and obligations under a mortgage that is not completed in law. However, an equitable mortgage will be subordinate to the priority given to a legal mortgage.
In an equitable mortgage the lender is secured by taking possession of all the original title documents of the property and by getting the borrower sign a Memorandum of Deposit of Title Deed (MODTD). This document is an undertaking by the borrower that he/she has deposited the title documents with the bank with his/her own wish and will, in order to secure the financing obtained from the bank. Moreover, in case of equitable mortgage, lien in the bank’s favour is marked on the said property in revenue record.
Normally, a token mortgage is registered for a minimal amount of the marked-up price of the facility or for a small portion of D.P.Note amount, while to cover the remaining amount of D.P.Note equitable mortgage is created on the property offered as security.
Where no revenue record is available, 100% registered mortgage shall be done.
b) Charge on Assets
In case of a company (private limited or public limited), charge on company assets has to be created and then registered with the Securities Exchange Commission of Pakistan (SECP).
There are different types of charges. These include floating charge, fixed charge, exclusive charge, pari passu charge, ranking charges, etc.
Floating Charge
A floating charge is a particular type of security, available only to companies. It is an equitable charge on (usually) all the company's assets both present and future, on terms that the company may deal with the assets in the ordinary course of business. Sometimes the charge is over just a class of the company's assets, such as its stock or movable or current assets.
The floating charge is useful for many companies, allowing them to borrow even though they have no specific assets, such as freehold premises, which they can use as security. A floating charge allows all the company's assets, such as stock in trade, plant and machinery, vehicles, etc., to be charged.
The special nature of the floating charge is that the company can continue to use the assets and can buy and sell them in the ordinary course of business. It can thus trade with its stock and sell and replace plant and machinery, etc, without getting fresh consent from the mortgagee/lender.
The charge is said to float over the assets charged, rather than fixing on any of them specifically. This continues until the charge 'crystallizes', which occurs upon failure of the company to meet the terms of the loan (non-payment, etc), or if the company goes into liquidation, ceases to trade, etc.
When the charge crystallizes, it then gets fixed on the assets which the company owns at that time, (including any assets acquired up to that date, but excluding any assets which have already been disposed of by the company before that date).
Fixed Charge
A fixed charge is a charge created/secured/registered on a particular asset of the company, e.g., land and buildings, a ship, plant or machinery, shares, intellectual property rights such as copyrights, patents, trade marks, etc.
It is a charge on a specific fixed-asset (such as a piece of land) to secure the repayment of a loan. In this arrangement, the asset is assigned to the lender/creditor/bank and the borrower would need the bank’s permission to sell it. The bank also registers this charge with SECP against the asset which remains in force until the loan is repaid.
Exclusive Charge
When there is charge of only one institution exclusively on some asset of the company.
Pari Passu Charge
When two or more institutions have proportionate charges on the same asset of the company (in proportion up to the extent of their financing).
Ranking Charge
When a company is availing finances from a number of financial institutions and offers the same assets to them then the institution whose charge is registered first would have a claim on the said assets superior to all others and the charge so created/registered would rank 1st of all other charges and would be known as 1st charge. Likewise, the one registered after that would rank 2nd in order of priority of claim lodgement and would be known as 2nd charge. Likewise, 3rd, 4th, 5th, and so on.
Ranking charges tend to be weak securities.
Financing to be allowed against Ranking Charges only in case of highly reputed borrowers and subject to availability of sufficient cushion in the value of the assets of the borrower. Moreover, the ranking charges to be upgraded to pari passu charges within the prescribed time period.
c) Pledge
The transfer of physical possession of movable assets like stocks of raw material or finished goods, certificates, etc., by a borrower to the Bank as a security against some loan/debt.
Note: In case of Pledge, the title or ownership of asset does not pass to the lender / Bank, but only physical possession is transferred to the Bank.
The Bank has the right to sell the pledged asset in the event of a default on the part of the borrower.
d) Hypothecation
It usually involves movable or current assets of the company, like stocks. Hypothecation does not involve physical possession of the security or asset, but involves delivery of a document or other evidence of title to the Bank.
A written agreement, usually known as Letter of Hypothecation, is involved, which authorizes the bank or lender to repossess and sell the hypothecated item in case of a default.
This is a weaker security as compared to pledge as there is no physical control of the Bank over the security.
Hypothecation of stocks is usually demanded in case of Running Finance facilities or financing of raw material or stocks or financing of working capital. Usually a margin (in shape of additional stocks) against the hypothecated stocks is also taken to safeguard the interest of the Bank in case of any price fluctuations.
At BoK this margin ranges from 25% to 35% of the value of hypothecated stocks.
e) Lien
Lien is a legal right/claim to take and hold or possess the property/assets/documentary intangibles/certificates/accounts/deposits, etc., of a debtor as security against a loan or for payment of a loan.
The term lien refers to a very specific type of security interest, being a passive right to retain a
borrower’s property / assets / possessions until the loan facility is fully repaid by the borrower. The right of lien generally arises by operation of law, but it can also be created by express contract.
A Legal Lien is a right to retain physical possession of tangible assets as security against some obligation. It is a form of possessory security, and possession of the assets must be transferred to (and maintained by) the secured party (lender/bank). The right is purely passive; the secured party (bank) has no right to sell the assets - merely a right to refuse to return them until the loan amount is fully repaid.
f) Guarantees
Guarantee is a commitment of a third party on behalf of the principal obligor/detor to fulfill the obligation in case the primary obligor/debtor fails to fulfill his/her obligation. The Bank may also obtain guarantees as securities from the borrower.
These may include:
• Personal Guarantees of the proprietor/partners/directors as well as personal guarantees of the owners of the assets / properties offered as security to the Bank
• Corporate Guarantee / Counter Guarantee of the firm / company
• Guarantee of another Bank / institution / organization (acceptable to BOK).
Based on the above, BOK may hold securities or obtain collateral according to prevailing country laws, and in any of the following forms:
• Equitable Mortgage/ Registered / Legal Mortgage (or a mix of both) of land, building, and property.
• Hypothecation of plant, machinery, current assets, receivables, raw material, finished
goods, inventory, stocks, etc.
• Pledge of goods/stocks/saving certificates/valuables, etc.
• First exclusive charge over assets of a company.
• First joint pari passu charge over assets of a company.
• Floating charge over stocks, current assets or fixed assets of a company.
• Ranking Charge over assets of a company.
• Specific charge over plant and machinery.
• Bank Guarantee and Personal or Corporate Guarantees.
Utmost efforts should be made to obtain a better security. However, in case of well established corporate concerns, with sound track record, strong financial support, adequate and identifiable cash flows, and high credit worthiness, reliance on high valued security can be relaxed.
Collateral should match with the purpose and structure of financing. It must reflect the customer’s operations and business. It may include, but not limited to, assets acquired through financing sanctioned to the customers, e.g. machinery, stocks, etc. as well as current assets, fixed assets, real estate, liquid assets, etc.
