FINANCE : Critical issues in third party security for bank loans—9

What you need to know:

Besides direct security, the bank may seek a third party security, treated as a guarantee, in practical terms, by which a third party guarantor assumes loan liability of the borrower (principal debtor) in the event of default.

As regards corporate benefit, can it be shown that the directors acted in the company’s best interests in giving guarantee/third party security? Surely, this is uncomplicated if the loan is for the subsidiary, as, in the end, a successful subsidiary brings benefits to its parent company. Yet, it is very difficult—though not impossible—if the loan is for a parent or other subsidiary. If the benefit is not clear in the board of directors resolution, a bank should require the shareholders to sanctify the undertaking of the guarantee/third party security. This would bypass a breach of director fiduciary duties and prevent those shareholders from moving the court to set aside such security. In any case, a bank can take comfort in the legal principles of equity if it acted in good faith, although the directors’ actions are ultra-vires.

Nevertheless, corporate benefit is also critical in the midst of corporate insolvency. A transaction at an undervalue involving a guarantee/third party security can be set aside if the company within goes into administration or liquidation and the benefit it received from giving the guarantee/third party security is significantly less than the benefit it conferred on the lending bank unless it can be proved that the company gave the security in good faith and for value. Similarly, a guarantee/third party security can be set aside if it was given to benefit one creditor over the others (preference) and the company is insolvent when the security is given or becomes insolvent in consequence of giving the security. In undervalue transactions and preferences, timing is of crucial importance, because the Companies Act 2002 has prescribed specific vulnerability periods. To protect against loss, banks should consider the issues discussed above, including incorporating carefully crafted guarantee-like clauses in the third party security agreement; exercising care when varying the underlying loan contract; and obtaining title insurance.

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FINANCE : Critical issues in third party security for bank loans—9

What you need to know:

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