To register or not to register: Considerations when securing loan facilities

There has been an emerging trend in the private lending space of private lenders accepting unregistered security positions, something Macpherson Kelley’s Banking and Finance team has observed in practice. This can include signed but unregistered mortgages and personal property security agreements, such as General Security Agreements (GSA), to be held in escrow until a trigger event such as default. Often, this situation arises in mezzanine/junior lending positions driven by a senior lender’s insistence on conditions subsequent of no further encumbrances and a borrower’s desire not to breach covenants under their existing loan facilities.

But what are the risks for lenders with these arrangements, how can they mitigate those risks, and is it really necessary to hold security unregistered?

Establishing priority as a lender

Often, borrowers ask a junior lender to take a position of ‘second unregistered’ priority on real property (for example, a ‘second ranking’ unregistered mortgage or GSA). However, lenders have no established priority until they register their security.

When security is unregistered, it’s difficult to assess a lender’s priority position, relative to other potential creditors, or how many times the same security and ranking position have been pledged to other undisclosed lenders. Leaving security unregistered also means that lenders cannot take advantage of the priority rules¹.

To monitor the risk of unregistered security being defeated by another creditor’s registration, lenders should conduct regular searches of that security, whether this be title searches of the property, or searches of the grantor on the Personal Property Securities Register (PPSR).

However, the risk remains that if a lender conducts a search and recognises a new registration against that borrower or security property, the “horse may have already bolted”, and that lender’s security position may have already been superseded. Lenders should ideally ensure that they hold other security in order to secure their position and not rely entirely on the ‘unregistered’ position.

Validity of security

An unregistered mortgage runs the risk of becoming unregistrable through circumstances that are outside of the control of the lender, which can include (but are not limited to):

• Caveats: If an interested party lodges a caveat on the security property, the lender will be unable to register their mortgage behind that caveat without the caveator’s consent.
• Subdivision of property: If the landowner lodges a plan of subdivision with the relevant land authority and that plan is registered, the previous lot on the plan description shown on the ‘unregistered’ mortgage will be cancelled, and therefore the mortgage may become unregistered.
• Change of ownership: If the landowner transfers the property to a new owner without the lender’s consent, the mortgagor will become obsolete, and the signed mortgage cannot be registered against the new landowner as the mortgagor has changed.
• Other changes of process: Land registry forms or process may be updated from time to time, and the ‘unregistered mortgage’ held until a trigger event may become unregistrable.

To ensure that an unregistered mortgage remains valid, lenders should regularly report with and contact the landowner and conduct regular searches of the security property.

Lenders should also ensure that they obtain appropriate powers of attorney and further assurances clauses whereby a borrower needs to ensure that they keep any ‘unregistered security’ current. However, lenders should be aware that electronic conveyancing does not necessarily apply to powers of attorney, and the power of attorney may need to be “wet ink” signed and registered with the relevant Land Registry before it can be actioned.

Risks of caveats

Frequently, junior lenders also consider that they can simply lodge a ‘caveat’ at the relevant time and not document a proper mortgage.

Caveats do not give the holder any established priority to the underlying interest protected, and a lender would be forced to seek Court assistance to enforce its rights. It should be borne in mind that each State has a different caveat regime, and caveat lending is not at all effective in Queensland.

Vesting risk

Under the Corporations Act 2001 (Cth), there is a vesting risk if a GSA is not registered on the PPSR within the prescribed timeframes (20 business days after the date of creation of the security interest)². If the GSA is registered outside of this window, and an insolvency event impacts the security provider within 6 months after the GSA’s registration, the GSA will vest in the liquidator. The lender will then become an unsecured creditor.

There is no clear mitigation step to ensure that any unregistered personal property security does not vest in the liquidator without registering that security on the PPSR. In practice, our lawyers have seen some lenders elect to hold these GSAs in escrow, with the parties covenanting that the GSA will not come into full force and effect until a particular trigger event (for example, an event of default, or a condition subsequent at a future date). Holding the security by way of escrow is by no means a clear way of mitigating the risk, and it would be open to a Court’s discretion to find that the GSA has vested. Another step which does not eliminate all risk is a further assurances clause whereby the security provider needs to ensure that they re-execute any GSA when required bolstered by powers of attorney.

Property Law Act protections

Many people may not be aware that in Queensland at least, the Property Law Act entrenches a borrower’s right to mortgage their equity in the land, and the execution of a further mortgage cannot constitute an event of default under a borrower’s existing loan facility to a prior-registered lender, or otherwise, be used to found any escalation or penalty³. However, this does not mean the borrower is completely safe from other repercussions for doing so (for example, depending on the terms of the facility, further advances in a construction facility may be withheld). This entrenched right also strictly applies to real property mortgages only, and similar protections do not apply to GSA’s or other personal property security.

Deeds of priority

A deed of priority may be obtainable with a senior lender, whereby each lender agrees to the order of priority of security and the order of their debt repayment. However, deeds of priority are only effective in circumstances where the borrower is willing to alert the senior lender of the incoming junior lender. Despite determining the priority of a lender’s unregistered security, deeds of priority are typically drafted heavily in the senior lender’s favour, with the potential for the junior lender’s rights to enforce their security and recover their debts being fully subordinated to the senior lender.

Often, this is an over-reach by the senior lender as junior facilities draw on security from different sources, but a deed of priority and subordination will frequently prevent recourse, despite the senior not having the benefit of that security.

As a consequence, these deeds of priority rarely achieve any ‘balancing’ of interests between the junior lender and senior, and as seen by our lawyers, frequently result in the borrower not being able to procure much-needed mezzanine funds.

Do ‘unregistered’ arrangements achieve the borrower’s purpose?

Borrowers should keep in mind that, depending on the drafting, rarely do these ‘unregistered’ arrangements achieve their purpose when the ‘unregistered’ security will likely still result in a feared breach of the covenants.

Borrowers are frequently in a ‘no win’ situation. The junior funds are usually needed for cost overruns to complete a project, but current practice by senior lenders mean that they are usually in a situation where they are unable to secure those funds.

Where to from here

Overall, junior lenders should ensure they obtain adequate security overall, whether through a mixture of registered or ‘unregistered’ security or personal guarantees.

More generally, it’s evident that there is a clear legislative intention to enable borrowers to mortgage their equity in their security property. However, senior lenders are increasingly sidestepping these protections in the way they structure their facilities. It may be time for legislators to act in this area, in a way that ensures that a senior lender’s rights are not prejudiced by the grant of a second encumbrance.

Please contact our Banking & Finance lawyers if you have any queries about the above or would like to discuss different security arrangements for your future loan facilities.

¹ Eg Property Law Act 1974 (Qld) s 82.
² Corporations Act 2001 (Cth) s 588(FL).
³ Property Law Act 1974 (Qld) s 80(4).

The information contained in this article is general in nature and cannot be relied on as legal advice nor does it create an engagement. Please contact one of our lawyers listed above for advice about your specific situation.