What is asset-based lending, in a nutshell?
This is the second in our series of articles considering and comparing jurisdictions in the asset-based lending (ABL) space; in the first in this series – Navigating risks in the UK and German asset based lending markets: a comparative analysis – we contrasted the position in Germany with the UK, highlighting a number of key factors lenders need to consider in each jurisdiction. We are now looking at the Netherlands and the way in which its legal system addresses and accommodates ABL, and how it overlaps with and differs from that of the UK. We focus on the local issues and key risks for an ABL lender in each jurisdiction and the potential impact of such issues and risks on that ABL lender's willingness to lend.
As discussed in our previous article and by way of recap, ABL is a form of lending in which a percentage of the realisable value of a portion of the borrower's assets will be used to determine the sums to be advanced by the lender. The percentage set will be determined by the sum the lender is willing to lend money against in order to ensure that the value of the loan never exceeds the realisable value of those assets, with reserves being created against the loan sum to reflect third party claims to the assets (for example retention of title or liens) that may reduce their overall value, and in relation to UK borrowers, certain preferential claims in UK insolvency proceedings. The value, quality and, crucially, liquidity of the assets (which could include receivables, stock, land, machinery and equipment) are as such paramount, particularly given that enforcement is likely to involve the lender taking control of the assets and converting them into cash. This type of financing suits companies who are rich in receivables and stock and is particularly useful where financing is required on a flexible basis for example for companies whose returns are seasonal or those that are making strategic investments and acquisitions. Borrowing companies may benefit from fewer covenants and favourable pricing depending on the nature and quality of the underlying assets.
Lenders considering making funds available by way of asset-based loans will need to consider various factors including: (1) the types of security that may be taken in the jurisdiction and the ability to enforce the security in a default scenario in the manner the lender wishes; (2) the way in which security is held in a syndicated secured loan and whether the jurisdiction recognises the concept of a security trust; (3) the perfection requirements which if not satisfied may impact the validity and effectiveness of the security; (4) other creditors having priority over its security interests on insolvency or there being competing claims to the assets; (5) vulnerabilities of the security on insolvency and (6) third party costs involved in taking security in that jurisdiction. Lenders will also need to get under the skin of the complexities of lending in the specific jurisdictions such as: any legal restrictions on the granting of security and any applicable regulatory (for example licensing) requirements which may affect a lender's ability to lend in that jurisdiction plus any hidden costs involved in the taking and perfecting of security. Consideration of applicable regulatory requirements is beyond the scope of this article.
What types of security can be taken over certain assets under English and Dutch law and what do they allow the lender to do on enforcement?
Under English law, various options are available:
- Receivables: security is usually taken by the creation of a mortgage over the receivables, which is usually done by way of an assignment. This can be legal or equitable under English law. An assignment will be a legal assignment if it complies with the requirements of s.136 of the LPA (ie must be in writing, absolute, not purport to be by way of charge only and be notified in writing to the third party against whom the assignor could enforce the assigned rights). If any of these requirements fails, there is an equitable assignment which can still be perfected at any point. Future receivables are typically secured by way of an equitable assignment. Notice of the security should be given to the relevant third party (the security provider's debtor). If notice is not given the assignment will be equitable only. Alternatively, charges are also commonly taken over receivables. With a charge, there is no transfer of title involved. The right over the receivable remains with the chargor, but the chargee has a right, if the charge becomes enforceable, to appropriate the asset. It may be helpful to take a charge instead of an assignment where for example, the underlying charge prohibits assignment (although the lender’s counsel should interrogate the assignment restriction and make sure it doesn’t also extend to charges). There are two types of charge, fixed and floating. If a fixed charge is taken over receivables it can impair a company's ability to trade as the chargor will (amongst other things) be prevented from disposing of the asset without lender consent.
- Inventory: security is usually taken by way of mortgage in the form of an assignment or by way of a floating charge – these types of non-possessory security allow the company to operate in the usual course.
- Real Estate: security is generally taken by way of charge by way of legal mortgage, which will need to be registered at the Land Registry (where the land is registered) or at the Land Charges Department (where the land is unregistered). However, security interests over unregistered land protected by the deposit of title deeds do not need to be registered.
By contrast, under Dutch law, the following options are available:
- Receivables: security may be taken over receivables and may be taken by way of a disclosed right of pledge or an undisclosed right of pledge. In terms of perfection requirements, this is dictated by the type of security taken: where security is taken by way of disclosed right of pledge, notice must be given to the third-party counterparty, and where taken by way of undisclosed right of pledge, registration will be required with the Dutch tax authorities. In the absence of perfection, no valid security will be taken. A non-assignment or non-transfer clause can prohibit the taking of valid security.
- Inventory: security may be taken over inventory in the form of a pledge, such security usually being non-possessory. Registration of the security document with the Dutch tax authorities would be required.
- Real Estate: all real estate is required to be registered, and security may be taken over it. All security granted over real estate will need to be executed as a notarial deed by a Dutch notary and registered with the Dutch Land Registry.
On enforcement: in the UK, enforcement options are likely to include the appointment of receivers, the exercise of the power of sale over the assets and taking possession of the secured assets where appropriate. The proceeds from realisation of the assets will then be applied towards expenses incurred during enforcement and followed by repayment of the debt. It should be noted that to appoint an administrator out of court the security holder must have a qualifying floating charge, and lenders may be prevented from enforcing their security when an application for administration has been made or the company has gone into administration.
On enforcement: in the Netherlands, certain overarching requirements need to be borne in mind when considering enforcement. Where assets are to be sold as part of the enforcement strategy, there are additional requirements: selling assets by way of public auction requires the presence of a Dutch notary and selling assets by way of private sale requires an application to court. In contrast to the position in the UK, the creditor is not permitted to take ownership of a secured asset, but the creditor may bid on the asset in a public auction or in a private sale with the consent of the court. If the pledge collateral is subject to an attachment, the co-operation of the attaching party is also required. Similarly to certain moratorium procedures in the UK, the court can order a cooling-off period for up to two months (which can be extended) during which all creditor actions, including enforcements are barred.
What is the position in relation to security trusts?
Under English law: English law recognises security trusts where the security over the secured property is held by a security trustee on trust for the beneficiaries ie the lenders "from time to time". This concept is particularly helpful in secured syndicated loan facilities where participations are transferred from existing lenders to incoming lenders from time to time, as the security will not need to be re-granted to the incoming lender(s) nor re-registered.
Under Dutch law: trusts are an English law concept and as such are not recognised by many other legal systems. The Dutch legal system is one such legal system – it does not recognise the concept of a security trust and will require the giving of parallel debt undertakings to achieve a similar position. Parallel debt provisions will replace the covenant to pay the secured obligations to the lenders under the security trust with a "parallel debt" obligation. Effectively the security provider/borrower under the finance documents assumes a separate covenant to pay the security agent as a creditor in its own right for sums equal to the obligations secured under the finance documents as and when they fall due. This provides an independent right on the part of the security agent to demand payment from the security provider and/or borrower.
What perfection requirements are there and what happens if the security is not registered at an appropriate registry?
Under English law: all security granted by an English incorporated company, LLP or limited partnership (where the security is granted by its general partner and that general partner is a company or an LLP) must be registered at Companies House within 21 days of the security being granted (section 859A of the Companies Act 2006). A failure to register renders the security void against any administrator, liquidator or creditor of the company. When a charge becomes void, the money secured by it immediately becomes payable. The permission of the court (and an order providing the same) would be required to register security past the statutory cut off. It is worth noting that even if the governing law is not English, if the chargor is an English incorporated company or partnership, the registration requirement still applies. By way of example, an English company charging property pursuant to a Dutch law governed security document would need to register it at Companies House.
Under Dutch law: there is no central security registry under Dutch law but asset specific registrations may be required depending on the relevant asset/s. Perfection requirements under Dutch law depend on the relevant security, the underlying assets and include, among others:
- with respect to inventory, registration of the security document with the Dutch tax authorities
- with respect to receivables, where security is taken by way of disclosed right of pledge, notice to the third-party counterparty, and where taken by way of undisclosed right of pledge, registration of the security document with the Dutch tax authorities
- with respect to real estate, a notarial deed executed by a Dutch notary and registration of the security document with the Dutch Land Registry.
Do other creditors have priority on insolvency and can there be competing claims to the assets themselves?
Under English law: the order of priority is broadly as follows: Fixed charge holders, administrator/liquidator fees, preferential creditors (HMRC/tax authority rates and taxes owing plus employee wages and salaries and accrued holiday remuneration), prescribed part (up to £800,000), floating charge holders, unsecured creditors and shareholders. To the extent that a lender takes part of its security package by floating charge there will therefore be claims that take priority over its claim and a portion of the floating charge realisations will be applied towards the prescribed part.
Under Dutch law: the order of priority is broadly as follows: estate creditors, secured creditors, preferential creditors which would include the Tax and Customs Administration, the Employee Insurance Agency and employees with a claim to unpaid wages prior to the entry by the entity into bankruptcy then unsecured/ordinary creditors. There is no equivalent of the UK prescribed part and there is no equivalent of the UK concept of fixed and floating charges. There are certain claims which will take priority over a secured creditor in an insolvency of the relevant entity, notably estate creditors, which may include the fees of the bankruptcy trustee.
Under both English and Dutch law, generally the priority of security interests of the same type is determined by the order in which the security over the relevant assets is created/registered or notified but it is possible to change the ranking of security interests by contractual agreement; in the UK commonly using an inter-creditor agreement.
Retention of title/reservation of title clauses are recognised under both English and Dutch law and may impact the pot of assets available to the asset-based lender. As such, reserves to address potential retention of title claims may be built into the facility in both jurisdictions.
The application of rights of set off may also deplete the assets available to the lender in both the UK and the Netherlands. In the UK, the laws of set off are however favourable to a lender provided in an insolvency scenario there is mutuality of obligations, and while rules 14.24 and 14.25 of the Insolvency Rules 2016 require an account to be taken of sums "due" in respect of mutual debts and claims, "due" has a broad meaning, and includes sums payable in the future and sums that are capable of being ascertained; the debt does not need to be due and payable at the time the account is taken. Under Dutch law, the right of set off is more restricted compared to the UK - set off is only permissible if both debts are, amongst others, due and payable and mutually related. During insolvency proceedings, the right of set off is preserved, but claims must meet specific legal requirements to qualify for set off, providing less flexibility than in the UK.
What are the key vulnerabilities of security on insolvency?
Under English law: assuming that the lender is not "connected" to the company, security may be set aside (1) within 2 years of the onset of insolvency if the administrator/liquidator declares it was a transaction at an undervalue; (2) where granted within 6 months of the onset of insolvency, the transaction may be void for being a preference or (3) within 1 year of insolvency a floating charge may be set aside if not granted for appropriate consideration.
Under Dutch law: security may be subject to challenge by the security provider's insolvency practitioner. The rights are similar to those that apply to preferences, transactions at an undervalue and transactions defrauding creditors under English law. In the Netherlands, security can in certain cases be challenged if it is prejudicial to the interests of other creditors, eg if the grant of security means one creditor is treated preferentially, involves a transaction at undervalue or involves the defrauding of other creditors.
What are the standard third party costs involved in taking security or a guarantee in the jurisdiction?
Under English law: any security documents written in a foreign language need to be fully translated before being filed at Companies House. The filing fee at Companies House is nominal.
Under Dutch law: typically, certain security interests, such as a mortgage over real estate granted by a Dutch company require the involvement of a Dutch notary and the provision of a notarial deed. Further, a power of attorney authorising the Dutch notary to execute the mortgage deed and granted under Dutch law will need to be legalised and if this is not carried out by a Dutch notary it will need to be apostilled.
Are there any local law restrictions on a resident company granting security or a guarantee in favour of it?
Under English law: there aren't any such restrictions, subject to the constitutional documents of the company and the terms of any investor/shareholder agreement permitting such transactions, and subject to the company being able to demonstrate the required corporate benefit for entering into the transactions.
Under Dutch law: there are applicable restrictions under Dutch law, namely that to the extent the security providing company has a works council (a group delegated by employees to represent their interests to their employers), granting security or a guarantee is subject to an unconditional positive works council advice. A failure to obtain any such approval may result in court proceedings to unwind the transaction. Beyond that the position is very similar to English law, in that the constitutional documents and any applicable investor/shareholder agreement of the company must be checked to confirm whether there are any restrictions, and the company will need to be able to demonstrate the required corporate benefit.
What about financial assistance issues?
Under English law: whilst guarantees can be set aside for unlawful financial assistance, this only applies to a public company (or its subsidiary) giving financial assistance of the purpose of the acquisition of shares of a public parent company. This is therefore unlikely in the context of a typical ABL financing.
Under Dutch law: the regulations are similar to English law. An ABL lender should ensure that the ABL financing arrangement does not inadvertently violate Dutch financial assistance rules eg, making sure that the assets secured are not directly or indirectly used to finance share acquisitions that may trigger the financial assistance rules. These rules however only apply to Dutch NV companies and their subsidiaries.
Concluding comments
Understanding the risks and vulnerabilities of lending by way of ABL and taking associated security in an unfamiliar jurisdiction will be of crucial importance to a lender, when making the decision to lend. The factors considered above are not exhaustive but aim to provide a detailed starting point for lenders, to assist them in this process. This is, as mentioned above, the second in a series of articles in which we compare ABL in the UK with various other jurisdictions, so please watch this space for the next in this series!
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To discuss the issues raised in this article in more detail, please contact a member of our Banking and Finance team.
