Companies which borrow money on security should not assume that the lender's rights are restricted to those set out in the loan agreement.
In fact, the security documents may give the lender far wider remedies than those in the loan agreement. And, as a recent case shows, the lender may be free to exercise those rights without regard to the loan agreement.
14 days notice
Thunder Enterprises lent money to Didasko. The loan agreement allowed Thunder to call in the loan on the happening of an "event of default" as defined in the loan agreement. However, before doing so, Thunder had to give Didasko 14 days notice.
The loan was secured by a charge. The charge document allowed Thunder to "immediately" enforce the charge on the happening of an event of default. Event of default was defined as having "the same meaning as in the loan agreement" (although the charge document itself also defined some additional events of default).
On 4 May, Thunder gave Didasko 14 days notice of its intention to call in the loan (on the basis that an event of default had occurred as defined in the loan agreement). Didasko presumably got a bit of a shock when, the very next day, Thunder also appointed administrators to the company, apparently on the grounds that the same act of default had also made the charge enforceable.
Didasko complained to the court that, before appointing administrators, Thunder should have given the 14 days notice required by the loan agreement. Didasko pointed out that the charge was tied to events of default as defined in the loan agreement. This, it argued, meant that Thunder's enforcement rights under the charge also imported the 14 day notice period covering events of default in the loan agreement.
The charge was separate
The court disagreed. It noted that the charge was a separate document from the loan agreement. All that the charge document imported from the loan agreement was the definition of an event of default. It had not imported the 14 day notice period as well.
There was a practical business reason for this.
The purpose of a charge is to provide the lender with some security for its loan. If the lender thinks that the company will not be able to repay the loan, it can afford to give the lender a notice period to fix the problem, because it has the security to fall back on.
On the other hand, there is nothing behind the security for the lender. If company can't repay the loan and the property covered by the charge has already vanished, the lender is out of pocket. A lender who is worried about the security may not have the luxury of allowing the company time to rectify an event of default that - regardless of its effect on the repayment of the loan - imperils the existence of the security.
It therefore made sense to read Thunder's rights under the charge document as being quite separate from its rights under the loan agreement.
Interestingly, the loan document said that, in the event of inconsistency between the loan document and the security document, the loan document would prevail. Didasko argued that there was such an inconsistency, because the loan agreement required 14 days notice before the lender could act on an event of default, while the charge allowed it to act immediately.
In effect, the Court's response was that there was no inconsistency:
- the loan agreement required 14 days notice before calling in the loan;
- the charge allowed immediate steps to enforce the security.
Because these were two separate actions, there was no inconsistency in setting different time limits on each.
The Court particularly drew attention to the fact that the charge provided for events of default additional to those listed in the loan documentation. This supported the conclusion that events of default under the charge performed a different function from events of default under the loan.
Check the documents
Both lenders and borrowers can take lessons from this case.
Borrowers obviously need to check both loan and charge documentation to ascertain what events of default they're subject to. Any different rights that the lender has under the loan and the charge also need to be checked. Given the complexity of much commercial documentation, this is a matter on which professional advice should be sought.
For their part, lenders should ensure that their ability to enforce their charge is not impaired by any notice period in the loan agreement. Every commercial loan transaction is unique, and it is within the bounds of possibility that there are some situations in which the charge documents have been drafted in such a way as to subordinate them to the loan agreement. If a Court finds that that is the case, it would be very difficult for the lender to argue that the Court should ignore the plain words of the documents. Again, this is a matter on which professional advice should be sought.