Understanding how to enforce security under a loan agreement is crucial for lenders seeking to protect their interests when a borrower defaults.

The Underlying Loan Contract

A loan contract is an agreement between the lender and borrower that sets out the rights and responsibilities of each, including the amount of money to be loaned and the repayment terms. The loan contract is incredibly important as this is what gives rise to the underlying debt.

Failure to Pay: Breaching the Contract

The repercussions for when a party breaches their obligations under the contract depend on two things:

1. What did the party do?
2. What does the agreement say?

The breaching party may commit a minor offence, which the innocent party may simply forgive and take no further action. However, where the breaching party fails to comply with the agreement in a serious manner or in a way that deprives the innocent party of substantially all the benefits of the contract, it may be sufficient to constitute a ‘repudiatory breach’. A prime example is when the borrower fails to repay the lender the loan repayments under the loan contract as and when they fall due.

It is important to note that just because a repudiatory breach has occurred, it does not mean the contract is automatically terminated. It is up to the innocent party whether or not they terminate. If the innocent party decides not to terminate, then this is known as ‘affirming’ the breach. The innocent party should be cautious in how it responds to any repudiatory breach. An innocent party can inadvertently ‘affirm’ the breach by way of their conduct.

Damages Sought

All mortgage and loan agreements will contain specific provisions on what the consequences are when either party breaches the contract. A common clause is the ‘accelerated damages clause.’ An accelerated damages clause permits the lender to demand all amounts owing under the agreement (including future instalments) to be paid immediately upon termination.

Parties should take care when drafting accelerated payment clauses. They may be considered a penalty clause if it imposes a detriment on the breaching party that is highly disproportionate or oppressive and will not be enforceable in full. An example may be a clause which demands interest on the amount outstanding at an exorbitant rate, which is well above the commercial norm.

Securing the Debt

Security is something which is given as collateral for the underlying debt. This may, for example, come in the form of a personal guarantee or a charge over a property.

Where the innocent party has terminated the agreement, several options are available to them. A common factual scenario is where the borrower has failed to make the loan repayments and the lender has accordingly terminated the agreement. Depending on what security is held, the lender could look to enforce via various methods, such as appointing an administrator under a qualifying floating charge, appointing receivers over a fixed charge, commencing possession proceedings or commencing a money claim against a guarantor. The lender should always consider what steps need to be taken before enforcing its security, e.g. by making a formal demand on the person/entity who has provided the security. 

It is important to note that just because the lender has a charge over property, it does not mean they are guaranteed repayment. Proceeds from the sale must be allocated in accordance with the law on priorities of charges. Whether a lender will be paid is therefore dependent on the available equity.

Need advice?

If you would like more information and assistance on understanding your obligations under commercial loan agreements and enforcing your rights upon termination, contact our Litigation & Recoveries team at online.enquiries@LA-law.com.