Priorities of Security: an overview

It is far from uncommon for an asset, be it land or any other property, to have more than one form of security over it. But when this happens – when there are two or more competing interests in a property, and two or more creditors entitled to repayment – which security takes priority, and which creditor takes repayment first in the event of the sale of the property, or the debtor’s insolvency?

The basic position

There are two main principles by which the law governs competing securities. The first is the basic notion that “fixed beats floating”. The second is the old maxim qui prior est tempore potior est jure – “he who is first in time is stronger in right”.

The first principle is simple. A fixed charge – that is, a charge secured against one or more specific (i.e. fixed) assets – will always take priority over a floating charge, which is a charge over current and future assets generally. This principle supersedes the chronology of the assets in question; in other words, a fixed charge created in 2020 would still take priority ahead of a floating charge created in 2010.

The second principle is used to refine the question of priority within each category of charge. In other words, it is used as a “tie-breaker” where there are two or more of the same type of charge over a property. So, for example, if there are two fixed charges over a property, then the one that was created sooner (“first in time”) will take priority (“stronger in right”) ahead of the one created later. The same holds true where two competing floating charges exist over a property as well. So, a fixed charge created in 2010 will take priority ahead of a fixed charge created in 2020.

So far, so straightforward.

But what about charges that can either be fixed or floating?

Debentures

The type of charge in question is the debenture. A debenture is essentially a written loan agreement between a lender and borrower. Debentures are sometimes referred to as “fixed and floating charges”, since debentures, as a category of charge, are not always one or the other.

Fisher and Lightwood’s Law of Mortgage states that “a debenture almost invariably creates a floating charge, but it may also or alternatively create a legal charge or a fixed equitable charge”. A debenture can therefore create a fixed or floating charge, depending on the asset over which the loan agreement is created. Most likely, the intention behind the debenture will be outlined in the debenture deed; if it is intended to create a fixed charge, then the deed will provide as such within its terms, and vice versa.

If the debenture creates a fixed charge, then that charge will behave according to the two principles outlined previously, taking priority ahead of floating charges, and ranked in priority between other fixed charges according to the order in which they were created. Similarly, if the debenture creates a floating charge, then that charge will take priority after any fixed charges, after any other floating charges that pre-dated it, but before any other floating charges created subsequently.

Still following? Good, because there’s one more consideration to muddy the waters one step further.

Registration

As we’ve seen, the basic rules are that (1) fixed beats floating, and (2) earlier beats later, in terms of the creation of two charges of equal “fixedness”. However, certain charges are capable of being registered in an asset registry, for example charges created over registered land, which are registrable at the Land Registry. For securities such as these, the date of creation is not the be-all.

So, we have one final rule to consider: where charges are created over registered land, then those charges must be registered at the land Registry. The result of this is that the relevant date for priority purposes is no longer the date of creation of the charge, but instead the date of registration.

This extra rule doesn’t override the first basic principle that fixed beats floating. Therefore, a fixed charge will always rank ahead in priority compared to a floating charge, even if both charges are capable of registration and the floating charge was registered earlier.

However, what if we have two charges, both fixed, both registrable? The simplest way to unpick this is by way of a case study.

Case study

Suppose a company, named C, entered into a debenture owed to a bank, B, in 2010. Subsequently, C takes an advance from a lender, L, in 2020. When the advance is made, L secures the advance by way of a legal charge over C’s property. The question is: whose charge takes priority?

There are two charges in play in this scenario. The first, between B and C, is a debenture, which can be either fixed or floating depending on the intention (and wording) of the debenture deed. The other, between L and C, is a fixed legal charge.

Therefore, applying the principles outlined above:

1. if the 2010 debenture is expressed as a floating charge – in other words, the deed does not specify fixed assets to which it attaches – then L’s 2020 legal charge will take priority ahead of B’s debenture in all circumstances, since fixed beats floating;
2. if B’s 2010 debenture is expressed as a fixed charge – in other words, the deed specifies existing, fixed assets to which the debenture is attached – then B’s debenture will in theory take priority ahead of L’s 2020 legal charge, as qui prior est tempore potior est jure; however
3. as both B’s 2010 fixed charge debenture and L’s 2020 legal charge are capable of registration at the Land Registry, the relevant date for the purposes of priority is the date that both charges were registered at the Land Registry; so
4. whichever was registered first is first in priority. This means that if registration of B’s 2010 debenture at the Land Registry were delayed or forgotten for some reason, then L’s 2020 fixed charge would take priority by virtue of being registered first.

Summary

The law regarding the priority of securities may seem clear-cut at first glance, but there are still potential pitfalls. As always, if in doubt, it is always best to seek legal advice.

At FSP we advise businesses large and small on all aspects of their commercial and property dealings, and we would be delighted to help with any enquiry you may have. Contact Mark Banham: [email protected].