Although there are a few outliers, Warren Buffett being the prime example, most businesses and high-net-worth people rely on credit to grow their profits and wealth. And those who lend to them are either secured or unsecured creditors. To find out how these two types of lenders differ, read on below.
What is a Secured Creditor?
A secured creditor is a creditor that lends money on the basis that if the debtor defaults on repayments, they have a legal right to repossess the assets they have lent money on and sell them to get their money back. The classic example of this is when a bank lends a mortgage so a borrower can purchase a property. The borrower signs a mortgage agreement, which states that if they miss a certain number of repayments, the bank has the right to take back possession of the property and sell it to satisfy the debt owed. The same applies to car finance – the finance company can seize a vehicle and sell it to recoup the money owed on the loan taken out to purchase it.
The Different Types of Security
Security over an asset can take the following forms:
Fixed Charge
A fixed charge is held over assets, for example property, buildings, or vehicles. Several types of company assets can be subject to a mortgage or fixed charge, including:
- Property and Buildings: The mortgage is proven via a fixed charge document registered at Companies House and a document filed at the Land Registry.
- Chattels: A fixed charge can be made over chattels, provided that the chattel is identifiable, e.g. by its description or a serial number. The evidentiary document for a fixed charge over a chattel is also registered at Companies House.
- Intangible Assets: Such as intellectual property rights.
Floating Charge
A floating charge is not fixed to a specific asset. This provides the lender flexibility to put a charge on assets that can change as a business grows and diversifies. Floating charges can be placed on stock, cash, inventory, and fixtures and fittings (to name but a few). In most cases, the lender will keep a close eye on the financial health of a business which has borrowed money on a floating charge.
How Can Secured Creditors Enforce Their Charge?
Lenders can only enforce their security within the legal parameters of the mortgage or loan contract. Therefore, if a payment default occurs, the priority is to have an Insolvency Solicitor check the relevant agreement. If there is no right to seize and sell assets under the agreement, statute or common law, the creditor will need to apply to the Court for permission to take such a step.
The secured creditor can choose to appoint a Receiver to preserve and sell the assets over which the secured creditor has a charge. Any payment demands they make must comply with the terms of the mortgage or loan agreement.
When it comes to property, a mortgagee has the right to take possession of the property as soon as the ink has dried on the mortgage document. But until the right to sell the property occurs (due to payment default and as set out in the mortgage agreement), they can only use the right of possession to preserve the property.
What is an Unsecured Creditor?
An unsecured creditor lends without receiving a fixed or floating charge over the borrower’s property or assets. Unsecured creditors include:
- Credit Card and Loan Companies
- Utility Providers
- Suppliers of Goods and Services
- HMRC
- Landlords
An unsecured creditor relies on the promise that the debtor will pay. This promise can be made through a verbal or written contract. For example, many small service providers, such as freelancers, may do work for you without a formal written contract. However, verbally (or via email) they have agreed to do work for you and in return, you promise to pay them the price they have quoted.
Secure Creditors vs Unsecured Creditors: The Key Differences
The biggest difference between secured and unsecured creditors is that if the debtor becomes insolvent, secured creditors take priority when it comes to who gets paid first. This is why unsecured creditors such as credit card companies charge such a high rate of interest – it is to balance the risk of not being paid by a percentage of their customers who fall into insolvency.
If the debtor defaults on making payments on an unsecured loan, the creditor can apply to the Court to get a County Court Judgment (CCJ) and instigate enforcement proceedings if the CCJ is ignored.
Why Does the Distinction Matter?
Secured creditors enjoy several advantages over unsecured creditors, i.e. their risk is lower, they are first in line to be paid if the debtor falls into insolvency, and therefore, they generally charge less interest. The latter has advantages for borrowers; however, although an unsecured creditor charges more interest, borrowers benefit from knowing there is no charge over their assets. This is beneficial, especially in cases where a business borrows a relatively small amount, i.e. £15-20k.
In the case of debtor insolvency, both secured and unsecured creditors should seek legal advice to understand their position and ability to get as much of their money back as possible. This can include proposing a CVA or appointing a Receiver or Administrator.
How We Can Help
As experts in insolvency law, we can provide advice and representation on all insolvency matters. Contact us on 0330 173 6983 or send us an email for more information.
