In the third of our four-part series looking at the differences between English and Scottish property law, Tom Hepburn and Carolyn Dewar consider commercial real estate financing
The overarching structure of a commercial real estate finance transaction tends to be broadly the same whether it originates in Scotland or England, as do the commercial terms of the loan agreement. However, when it comes to how a real estate loan is secured, there are significant differences between the two jurisdictions.
These include differences in the available types of security that can be granted by a property owner to a lender to secure a loan, the legal terminology used for the different types of security, how securities are constituted and the legal effect of securities. The aim of this article is to explain the key differences, as well as some of the similarities.
Unless otherwise stated, references in this article to England/English are to both England and Wales/English and Welsh.
The security package
In both jurisdictions, commercial real estate finance lenders will typically seek a full security package over all of the assets involved in the transaction, which may include:
■ the land itself (including any fixtures);
■ rights to any rental income derived from the property;
■ the borrower’s rights to any insurance proceeds;
■ in development deals (where the loan facilitates not only the borrower’s initial acquisition of the property but also the future development of the property), the borrower’s rights under the development documents;
■ the cash balances on the borrower’s bank accounts; and
■ in corporate deals (for example, where real estate is being acquired or developed as part of a corporate acquisition), security over the shares in the borrowing entities.
What we mean when we talk about “security” in this context is a legal agreement between the borrower and the lender, by which the borrower’s asset(s) can be appropriated by the lender in order to satisfy the borrower’s debt in the event of default by the borrower.
In determining the security package available, consideration should be given not only to the location of the property being secured, but also to the origin of the borrowing entities. These factors are key in ascertaining which types of security it is possible for a lender to take and which legal jurisdiction will govern the agreement between the parties.
Types of security
Security over real estate
In England, the most common method of securing real estate is by granting a “legal mortgage”. It offers the most secure and comprehensive form of security interest over English property and provides lenders with the best protection against competing interests (including other security interests) in the property.
The nearest Scottish equivalent of the legal mortgage is the “standard security”. Although the English legal mortgage and Scottish standard security are broadly equivalent, they are governed by separate legislation and rules, which results in numerous differences, including:
■ A standard security must be in a prescribed form, as set out in statute. There is no statutory prescribed form for a legal mortgage.
■ There is a set of standard conditions which are incorporated by statute into every standard security. Most of them can be varied, but some (particularly those relating to enforcement) cannot. There is no equivalent set of statutory standard conditions for mortgages in England.
■ A legal mortgage of registered land should be registered at HM Land Registry in order to protect the mortgage’s priority position. A standard security must be registered in the Land Register of Scotland in order to give the lender a real right in security. If the owner’s title to the property is not yet in the Land Register of Scotland, that title will have to be “voluntarily” registered to allow the standard security to be registered.
■ In both England and Scotland, mortgages/standard securities granted by a UK-registered corporate entity must be registered at Companies House within 21 days, but there are different rules about when the 21-day period starts.
■ A legal mortgage can include security over collateral assets, such as rental income and plant and machinery. A standard security only covers land and buildings, not any collateral assets.
■ Standard securities can be granted over leasehold interests, but only where the duration of the lease exceeds 20 years. In England, a legal mortgage may in theory be taken over any length of leasehold interest; however, from a practical perspective, the shorter the lease length, the less security offered.
■ In Scotland, standard securities are often used to try to secure option agreements and conditional sale contracts because there is no equivalent of the English system of restrictions on title. English mortgages are generally not used for this purpose.
■ A lender can assign its rights under a standard security and legal mortgage to another lender, but the process is much more complex in Scotland than in England and has been the subject of various court decisions over recent years.
■ There are also differences between England and Scotland when it comes to the enforcement of legal mortgages and standard securities.
A standard security is the only competent method of securing a debt over Scottish real estate. However, in England, in addition to a legal mortgage, it is also possible to grant an “equitable mortgage”. An equitable mortgage transfers a beneficial interest in the property to the lender and usually arises when a mortgage is granted but the lender chooses not to, or fails to, complete the formalities necessary for it to become a legal mortgage. There is no Scottish equivalent to the English equitable mortgage.
Note that the Scottish Law Commission is currently conducting a review of the law of standard securities and published an initial discussion paper, on pre-default aspects, in June 2019, recommending a series of reforms.
Security over associated contractual rights
An “assignment in security” (in England) or “assignation in security” (in Scotland) may be used to create security over contractual rights (eg rights under an insurance policy or a development contract). The key differences are:
■ In Scotland, it is common for an owner of property which is leased to occupational tenants to grant a separate “assignation of rents” to the lender, giving the lender the right to collect the rental income directly from the tenants. In England, because a legal mortgage can include a security over rental income, there is no need for a lender to take a separate assignment of rents.
■ There are differences in how assignments/assignations in securities become legally effective in creating (as opposed to perfecting) a security right, in particular regarding whether notice is required to be served.
Floating charge
In both jurisdictions, a “floating charge” is often used to create security over all the assets (or a class of assets) owned from time to time by a borrower. In Scotland, a floating charge is a statutory creation and can only be granted by a company or a limited liability partnership; this is not the case in England. As the name implies, the charge “floats” over the borrower’s assets until such point as it becomes fixed (known as “crystallisation”).
A floating charge over English assets will crystallise automatically at common law if certain events occur (eg the borrower ceasing to carry on its business), and others can be set out contractually in the floating charge deed (eg the borrower attempting to create a security interest in favour of another creditor).
Under Scottish law, it is not possible to make contractual provision for when a floating charge will automatically crystallise. Crystallisation under Scottish law is dependent on the appointment of a receiver or liquidator to the borrower.
Security over bank accounts/cash deposits
In England, an “account charge” is commonly used to create a fixed charge over the borrower’s key bank accounts and floating charges over all other bank accounts of the borrower.
Under Scottish law, an “account assignation” can theoretically be used to create a form of security over specified bank accounts and credit balances. However, this is rare, and it is more common practice in Scotland for a lender to seek comfort via a “set-off clause” in the loan agreement (ie a clause enabling the lender to seize the borrower’s deposits in the event it defaults on the loan).
Security over shares
In England, a fixed charge over a company’s share capital can be created by way of a legal mortgage or an equitable mortgage. However, legal mortgages are not commonly used for share charges in real estate finance transactions as they require the transfer of ownership of the shares to the lender (which has registration and stamp duty implications), whereas equitable mortgages do not.
In Scotland, a fixed charge over a company’s share capital can only be achieved by transferring the shares into the name of the lender or one of its nominees, which must also appear as the owner of the shares in the register of members.
Debentures
Under English law, it is possible to grant a “debenture” (or “security agreement”) which incorporates a number of different types of security, thereby creating fixed and floating charges over all of the borrower’s assets in one document.
In Scotland, there is no equivalent to the debenture as regards fixed security, so fixed securities over each class of asset must be documented separately.
Final words
This article provides only a high-level summary of some of the differences between the two systems – it is by no means an exhaustive list. It is therefore important to seek legal advice from a lawyer who is qualified within the relevant jurisdiction or, even better, from a dual-qualified solicitor who will be able to comprehensively translate the differing terminology and concepts.
Tom Hepburn is a senior associate in real estate (dual-qualified) and Carolyn Dewar is an associate in banking at Dentons
In the next, and final, article in this series, we will be exploring the differences and similarities between the enforcement of property rights under English and Scottish law
READ MORE:
Part 1 – English and Scottish law: The basics
Part 2 – English and Scottish law: Fundamental differences remain
Part 4 – English and Scottish law: Enforcing across the border
