Corporate Loan: What exactly is the bank taking as security?

THE COMPANY IS BORROWING RM3 MILLION. WHAT EXACTLY IS THE BANK TAKING AS SECURITY?

A company applies for RM3 million in financing to purchase machinery and expand its operations.

The bank approves the facility. The Letter of Offer describes the proposed security package:-

• A legal charge over the company’s factory.

• A debenture over the company’s assets.

• An assignment of certain receivables and insurance proceeds.

• Personal guarantees from the directors.

The business owners focus on the financing amount, repayment period and monthly instalments. They assume that the factory is the only asset exposed if the company is unable to repay the facility.

That assumption may be incorrect.

Corporate financing is often supported by several layers of security. Each document serves a different purpose and may affect the company, its related entities and its directors in different ways.

Before accepting the facility, a business owner should understand not only how much the bank is prepared to lend, but also what the bank will be entitled to rely upon as security.

1. Start by identifying the parties involved

The borrower, security provider and guarantor are not always the same person.

The operating company may be the borrower. A related company may own the property offered as security. The holding company may provide a corporate guarantee, while the directors provide personal guarantees.

This means that a single financing facility may create obligations for several parties within the business structure.

The documents should clearly identify:-

• The entity receiving the financing.

• The owner of each asset offered as security.

• The party assigning its contractual rights or receivables.

• The company or individual providing a guarantee.

• The obligations secured by each document.

This distinction becomes important when the group restructures its business, disposes of an asset, introduces a new investor or seeks further financing.

2. A legal charge over property is more than proof that the bank holds the title

Where land or a building is offered as security, the bank may require a legal charge to be registered over the property.

The company generally remains the registered owner and may continue using the property for its business. However, its ability to sell, transfer or create further security over the property will be subject to the registered charge and the financing documents.

If the property is already charged to another financier, the existing facility may need to be redeemed or the financiers may need to agree on their respective priorities.

The title should also be reviewed for restrictions in interest, existing encumbrances and any consent required from the relevant authority. These matters can affect both the security documentation and the proposed date of disbursement.

3. A debenture may cover substantially more than one asset

The word “debenture” is sometimes treated as if it were merely another standard banking document.

Its effect can be much wider.

Depending on its terms, a debenture may create fixed security over specified assets and a floating security over certain present and future assets of the company.

The assets covered may include machinery, equipment, inventory, book debts, bank accounts, intellectual property and other parts of the company’s undertaking.

A floating charge may allow the company to continue dealing with relevant assets in the ordinary course of business while the facility remains in good standing. That flexibility, however, remains subject to the terms of the debenture.

The company may also be restricted from granting security to another financier, disposing of material assets or making changes that could affect the value of the bank’s security.

The precise scope must therefore be determined from the document itself. It should not be assumed that a debenture is limited to the particular asset purchased using the financing.

4. An assignment can give the bank rights over the company’s income stream

A bank may also require an assignment of rights under a contract, rental arrangement, insurance policy or other source of receivables.

For example, if financing is granted to undertake a particular project, the bank may require the project proceeds to be paid into a designated account. If a commercial property is financed, the rental proceeds may form part of the security package.

The assignment documents may regulate where the money is paid, how it may be withdrawn and whether the underlying contract can be amended or terminated without the bank’s consent.

Notices may also need to be issued to the relevant customer, employer, tenant, insurer or contractual counterparty.

For a business that relies heavily on its receivables for daily operations, these terms must be considered as part of its cash-flow planning.

5. A fixed deposit offered as security may no longer be available as working capital

Some facilities require a fixed deposit or other cash collateral to be placed with the bank.

Although the money remains associated with the company, it may be blocked, assigned or subject to a right of set-off. The company may therefore be unable to withdraw or use it freely while the facility remains outstanding.

The documents should be checked to determine when the deposit may be released and whether it secures only the particular facility or all amounts owing to the bank.

This is especially important where the company maintains several facilities with the same bank.

6. A guarantee is not the same as security over an asset

A personal guarantee does not, by itself, create a registered charge over every asset belonging to the director.

It does, however, create a personal contractual obligation. If the company defaults and the guarantee becomes enforceable, the bank may pursue the guarantor in accordance with the guarantee and the applicable legal process.

The director’s exposure is therefore not necessarily limited to the value of his shares in the company or the amount he initially invested in the business.

The guarantee should be reviewed to determine whether it is:-

• Limited to a stated amount or unlimited.

• Given individually or jointly and severally with other guarantors.

• Restricted to one facility or expressed as an “all monies” guarantee.

• Continuing in nature until formally discharged by the bank.

• Supported by separate security over the guarantor’s personal property.

A director who resigns or sells his shares is not necessarily released from an existing guarantee. A written release from the bank may still be required.

7. What does “all monies” mean for the security package?

The amount stated in the Letter of Offer may not be the same as the total amount secured.

An “all monies” provision may extend the security to principal, interest or profit, default charges, fees, enforcement expenses and other liabilities described in the documents.

Depending on the wording, the security may also cover further advances or other banking facilities granted to the borrower.

The value of the secured asset does not automatically place a limit on the borrower’s liability. If the proceeds recovered from the security are insufficient to settle the secured obligations, the remaining amount may still be claimed from the borrower and any liable guarantor.

A business owner should therefore ask a precise question: does this security support only the RM3 million facility, or does it support a wider range of present and future liabilities?

8. Registration and perfection of security are not administrative formalities

Sections 352 and 353 of the Companies Act 2016 address the registration of charges created by a company. Registrable charges include, among others, charges over land, book debts, floating charges and credit balances in deposit accounts.

Where section 352 applies, the prescribed particulars are generally required to be lodged with the Registrar within 30 days after the charge is created. A failure to register can have serious consequences for the effectiveness of the security against the company’s liquidator and creditors.

Registration with SSM may not be the only step required. Depending on the asset, the transaction may also involve registration at the land office, stamping, notices of assignment or other measures required to complete the security.

The company’s solicitors and company secretary should therefore coordinate the documentation and registrations within the applicable timelines.

9. Can the security package be negotiated?

The extent of the security will ultimately be subject to the bank’s credit approval. Nevertheless, the appropriate time to raise concerns is before the Letter of Offer and security documents are accepted.

The company may seek clarification on:-

• Which asset secures each facility.

• Whether the security covers one facility or all liabilities to the bank.

• Whether any guarantee can be capped.

• Whether assets may be disposed of or replaced in the ordinary course of business.

• The circumstances in which a partial release may be obtained.

• Whether existing assets and facilities are being cross-collateralised.

• What happens to the security after repayment or refinancing.

• The costs of valuation, documentation, stamping and registration.

The bank may not agree to every proposed amendment. However, understanding the position early allows the company to decide whether the financing structure is commercially suitable before it commits to a transaction.

Security is not merely the bank’s protection if something goes wrong.

It can affect how the company operates, uses its cash flow, deals with its assets and obtains future financing throughout the duration of the facility.

A well-structured corporate loan should support the company’s growth without creating security obligations that its owners did not fully understand.