Lenders beware of limited recourse charges - featherweight security

By David Lyons.

Key Points:
In support of project specific financing, lenders may elect to take what is known as a "featherweight charge" over the borrower's assets. The primary benefit of such security is the ability to retain the "value" of the security upon the appointment of an administrator.

In today's business and commercial environment, it is common for a company undertaking numerous projects to demand that a lender provide funding on a limited recourse or project specific basis instead of using a special purpose vehicle as the borrowing entity. However, lenders should beware of the limitations surrounding these types of funding arrangements.

Limited recourse funding arrangements are adopted in financing transactions where funds are advanced on a project specific and project risk basis. Typically, this form of lending is made purely on the revenue strength and potential takeout of a project which the project's sponsor/s have brought to the lender/s for funding. These types of funding arrangements often require, for commercial reasons, that all security is to be limited to the assets of the particular project ("Project Specific Assets") rather than all the assets and undertaking of the borrowing company or companies.

While this seems commercially viable, one of the risks facing lenders is the enforcement of such security in the event the borrowing company goes into voluntary administration.

Risk of voluntary administration to lenders

Under the Corporations Act 2001 (Cth), once a company goes into voluntary administration, a person cannot enforce a charge on the property of the company except with the written consent of the administrator or with the leave of the court, unless the person who holds the charge holds the charge over the whole or substantially the whole of the property of the company. During administration, a person who holds a charge of the latter type is able to enforce that charge within the first 10 days following appointment of the administrator.

Accordingly, if a charge is not over the whole or substantially the whole of the company's assets and undertaking, a lender may have to wait until the second meeting of creditors, which is usually 30 days (but may be extended) before the charge may be enforced. This time restriction can be an added impediment to the ability of a lender to take immediate action in the event of a default and usually in the event of serious default a lender's right to take immediate action is of paramount importance.

Benefits of featherweight charge

However, there is a mechanism to assist lenders where they are restricted to taking charges limited to Project Specific Assets. A lender may consider adopting what is referred to as a featherweight floating charge.

The featherweight floating charge is a charge:

1. which is taken over all the assets and undertaking of the chargor company but is floating only and does not fix on any assets unless there is an event of default under the charge;
2. in which the only event of default in the charge is the appointment of an administrator under the Act.

The featherweight floating charge satisfies the lender because they can enforce their security immediately upon the appointment of an administrator and avoid waiting until the second creditors meeting. On the other hand, the charge also suits the borrower in that the lender cannot enforce its security over the company's assets that are not part of a particular project or development ("Other Assets") unless the company enters voluntary administration.

Limitations of featherweight charges

However, there are some limitations to this type of charge. It will be recorded against the borrowing company at Australian Securities and Investments Commission and this may well not be palatable as far as the borrower is concerned and could breach any negative pledge covenants that the borrower may have entered into. In addition, the security structure of a borrowing company may become more complicated because the charge would not restrict the creation of other charges, including featherweight floating charges. In addition, releases may be required for incoming fixed charges over Other Assets which relate to other projects and which would rank ahead of the lender's featherweight floating charge.

Accordingly, borrowers may be reluctant to grant such charges, fearing that they may complicate the running of their business to some extent and that they may breach other covenants the company could have with other existing lenders. These fears could be mollified to some extent by providing that the money secured by the floating charge is limited to a nominal sum, usually the last dollar of debt secured pursuant to the specific charge.

Summary of criteria

A featherweight floating charge should:

• be a floating charge over the whole assets and undertaking of the company
• only fix to the assets of the company when there is an event of default in accordance with the particular charge
• have as its only event of default, the appointment of an administrator under the Act. However, this should not include the circumstance where an administrator has been appointed as a result of actions taken by the lender
• not prevent the borrowing company from granting other charges, including other featherweight floating charges, to other lenders in relation to its Other Asset
• provide that the lender must agree to give a release to any other chargee that takes fixed security over Other Assets and that any such fixed security will rank in priority to the lender's featherweight floating charge
• provide that any other featherweight floating charges over the assets of the project or Other Assets will rank equally and
• not restrict the borrowing company's dealings with its Other Assets, provided the company has not yet entered administration.

While featherweight floating charges are not commonly used, they are a tool lenders should consider for limited recourse or project specific financing arrangements.