Potential economic and legal changes in the loan market

    Participants in the loan market and their advisers have much to think about. Finance directors may consider refinancing early to obtain finance committed beyond Brexit, in case liquidity decreases as the process evolves. Lawyers may need to consider changes to the laws regarding security. Rich Eldridge, partner, head of corporate banking, and John Chater, senior associate, corporate banking at Penningtons Manches LLP, consider the issues.

    Potential liquidity contraction

    The UK is due to exit the EU on March 29, 2019. The terms of the exit and the subsequent relationship with the EU are being negotiated.  If it appears Brexit will produce an unexpected outcome, the appetite of banks to lend to affected businesses could change. 

    Businesses reliant upon a migrant workforce may be particularly vulnerable. Banks may anticipate EU citizens in the UK at the time of the referendum being allowed to continue to work in the UK. Although this is a possible outcome of negotiations, until an exit deal is agreed it is uncertain. If some EU citizens lose the right to work in the UK this could result in a substantial loss of labour. Although employees who have been exercising treaty rights in the UK for at least five years can apply for permanent residence, it is uncertain whether this will continue after the UK exits the EU.

    Businesses reliant upon low-skilled migrant workers may be particularly concerned about migrant workers in the UK at the time of the referendum being able to continue to work in the UK if, post Brexit, new low-skilled migrant workers are only allowed to work in the UK for a limited period.

    Banks may be less willing to lend to affected businesses until they produce sufficient post-Brexit data to demonstrate their viability. Businesses with finance due to mature shortly after Brexit may be unable to refinance. If a business is unable to raise new finance to repay expired finance it may become insolvent.

    Even if an exit deal allows EU citizens in the UK at the time of the referendum to continue to work in the UK, the Brexit process could

     

    Penningtons-1395-Rich-Eldridge
    Rich Eldridge

    still result in a loss of labour greater than anticipated.

    While an exit deal is being negotiated more migrant workers than anticipated may move to another EU country where there is less uncertainty. 

    Banks may fear an insufficient supply of domestic labour to fill more gaps than anticipated could lead to greater competition for staff causing higher wage costs. This could significantly reduce the profitability of affected businesses. If a business is unable to absorb the increased cost or pass it onto its customers the business may be forced to close.

    Businesses not reliant upon a migrant workforce may also be vulnerable to a liquidity contraction if an exit deal is not as anticipated. For example, businesses which are reliant upon trading with businesses in the EU may be affected. Banks may anticipate an exit deal providing for trade without significant tariffs, but this is uncertain. If significant tariffs are imposed on goods exported from the UK, banks may be less willing to lend to affected businesses until they produce sufficient post-Brexit data to demonstrate their viability.

    Penningtons-1395-John-Chater
    John Chater

    Macroeconomic factors may result in a reduction in the appetite of banks to lend to businesses which, at first sight, seem relatively immune to the impacts of Brexit. For example, further falls in sterling may lead to higher inflation, increased interest rates and decreases in asset values. This could affect the ability of many businesses to borrow. Higher interest rates would impact upon debt serviceability. Lower asset values would impact upon loan-to-value ratios. 

    If in the future banks consider the likelihood of one or more of these factors materialising to have increased, this may cause a liquidity contraction.  A perception of an increased risk may cause a liquidity contraction, irrespective of whether the risk materialises.

    Businesses with loans maturing in the next few years may wish to consider refinancing now, rather than risk there being less credit available in the foreseeable future. If there is less credit available businesses may have to pay more for it and accept less favourable covenants. Businesses may be unable to refinance and could become insolvent.

    Providing security could be about to change

    The Secured Transactions Law Reform Project was established to consider the effectiveness of the law and how it can be improved. The Project has published discussion papers on certain aspects of security. 

    Potential changes to the law considered include replacing the distinction between fixed and floating charges, filing notice of security at Companies House before creation as well as determining priority by the date notice of security is filed at Companies House. Below we consider these aspects as they relate to security provided by companies.

    The Project considered replacing the different types of consensual security interest with one concept. This would replace the distinction between fixed and floating charges.

    Currently the distinction between fixed and floating charges can be significant. A floating charge is subordinated on insolvency to a certain extent. Preferential creditors and the expenses of an insolvency rank ahead of floating charge holders. Some of the proceeds from selling assets subject to a floating charge are allocated to unsecured creditors.

    Whether a charge is fixed or floating depends upon the amount of operational control the security holder has over the assets. Whether a security holder has sufficient control for a charge to be fixed can require complex analysis. The answer can be debateable and result in litigation. 

     

    The Project thought the distinction between fixed and floating charges, based on operational control, should be abolished, and that it could be replaced by a distinction based on the assets subject to the security. 

    The Project thought security over inventory, receivables and money could be subordinated, and that subordinated security could include other types of what are sometimes called “circulating assets”, such as raw materials and crops.

    Replacing a distinction between types of charge based on operational control with those based on the assets would simplify the law. Advantages of simplifying the law include making it easier for overseas lenders to understand. This may increase funding from overseas, thereby stimulating the economy.

    The Project also considered advance filings and priority. Currently the law provides for security registerable at Companies House to be registered after creation. If security required to be registered at Companies House is not registered within 21 days, beginning on the day after creation, it will be void against creditors, a liquidator and an administrator. 

    Provided security is registered within the 21-day period, priority is determined by the date of creation, not the date of registration. A lender funding and taking security on the same day, as often happens, risks its security ranking behind security created earlier which is subsequently registered within the 21-day period.

     

    The Project suggested a scheme under which security could be registered before creation. The Project thought the default priority rule should be: the first to register has priority. This would enable a lender to advance funds without the risk of a prior created security interest being subsequently registered and having priority. A creditor could still register security after it is created. The 21-day period would be abolished.

    The Project also suggested a scheme under which, if registration relates to security not yet created, the register would show this. The parties would decide how long the registration is to last. If security is created during this time the creditor would be obliged to update the register within a specified period. If updated within this period the date for determining priority would be that of the initial registration. If updated after this period the date for determining priority would be that of the update.

    Note: Specialist advice should be obtained before taking, or refraining from taking, actions based on comments in this article which is only intended as a brief note. © Penningtons Manches LLP, 2017.

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