What is Security in a Loan Agreement?

If your company is looking to get a loan from a bank, you may have come across the term “security”. Security is a legal interest that provides lenders with an efficient means to recover the money they lent. If you breach the terms of a loan agreement, the lender could use their broad powers to recover their money. This article will explain the legal concept of security in a secured loan agreement. 

Understanding Loan Agreements

At its most basic level, a loan is a form of contract. A contract is a legally binding agreement between two or more parties, where each party promises to enter into an obligation to obtain a benefit from the other party. A legal obligation means that if one party does not uphold their end of the agreement, you can go to court and ask them to enforce such an obligation. 

In a loan agreement, where the borrower has breached a term of the loan, the lender usually seeks a “debt action”, which is an order by a court telling the borrower to repay the amount. However, if the borrower has run out of money, this can undermine the lender’s ability to retrieve the money they lent. 

Lenders can minimise the risk of this occurring by obtaining a security interest. 

What is Security? 

Banks tend to loan money to companies only if they agree that the bank has the right to claim the company’s assets and sell them to recover the loan amount. That is to say, if the borrower cannot repay the loan amount and therefore breaches the loan terms, the bank still has recourse to recover the amount. 

If the borrower defaults on the loan, the lender can “enforce” against their security. This usually means they will sell the property and use the proceeds of the sale to pay themselves back. Additionally, having security in an asset enables lenders to avoid filing court claims to recover its money. This saves time and expense and incentivises the bank to make secured loans. 

Types of Security 

A lender can obtain three main types of security in the borrower’s property. These types of security include:

• charges, which are commonly referred to as fixed and floating charges; 
• mortgages; and 
• pledges. 

The distinction between these three kinds of security is quite technical. Ultimately, the kind of security a bank takes depends on the borrower’s assets. 

There are also other kinds of agreements that function like security but are not secure from a legal perspective. These include:

• guarantees; 
• comfort letters; 
• negative pledges; and 
• indemnities. 

Practical Considerations

In practice, a security is only adequate if the value of the secured property is at least as valuable as the loan amount. 

To illustrate this point, suppose your company obtains a £100,000 loan. The total value of all of your company’s assets was £500,000. If the bank takes security over all of the company’s assets, it should have no problem recovering its £100,000 (plus interest). 

Alternatively, if the bank obtained security in property valued less than the £100,000 loan, it will likely be out of pocket if it enforces against its security. 

Key Takeaways 

A loan is a contractual agreement where the borrower promises to repay the loan amount according to the loan’s terms and conditions. Sometimes, the borrower cannot fulfil their obligations because they have run out of money. This makes lending risky because the bank may not be repaid. To avoid this, most bank loans are secured, meaning the bank gets special rights to the company’s property. If the company faces financial difficulties, these rights usually require the company to sell the secured property to repay the bank before anyone else. 

If you need help understanding your loan agreement, our experienced commercial lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. So call us on 0808 196 8584 or visit our membership page.

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