No matter what, business will always carry a degree of risk. However, whether you’re lending money or giving a client extra time to pay for services, there is no need to expose yourself to more risk than necessary by not including safeguards to secure that debt.
Think about security clauses like driving a new car instead of driving around in a car from the 1980s. Yes, the new car will cost more to purchase, and the old one will still get you from point A to point B, but when a crash happens, you’ll be glad you had airbags and seatbelts in place.
By building rights to secure your debt into your agreements, you can create a legal right over the debtor’s assets; meaning their promise to pay you won’t be mere words, it will have a tangible asset backing it up.
Keep reading and you’ll find some insight into some of the common methods that you may wish to consider utilising to secure your next commercial agreement.
Guarantees
One of the simplest ways to protect yourself is through a personal guarantee/director’s guarantee.
When you are owed money by an entity, whether that entity is a person or a company, your claim can generally only be brought against that entity and its assets. This means that if the entity’s assets are limited, the amount you may be able to recover may be significantly less than that which you are owed.
For example, if a debtor owes you an unsecured debt of $20,000.00, but only has $15,000.00 in assets, you stand to be out of pocket $5,000.00 as well as any fees you have incurred in recovering the debt.
This situation can be avoided by having a third party or, where relevant, the director of the debtor company, provide a guarantee at the commencement of the agreement; this person is a “guarantor”. In the event that the debtor becomes unable to pay its debt to you, the guarantor will become liable for the debt on the same terms as the debtor.
Mortgages over property
When you think of methods of securing a debt, you most likely think of a mortgage over a property. Mortgages are the preferred security method for most lenders who fund the purchase of real estate as they provide a reliable method for recovering debt by allowing the lender to sell a tangible and consistently valuable asset.
By being empowered to sell the mortgaged property in the event of default by the debtor, you can be assured that you will be able to recover the moneys owed to you. A properly documented and registered mortgage not only empowers you to be able to sell the mortgaged property in the event of default by the debtor, but it also prevents the debtor from dealing with the property without your consent.
Second mortgages can be difficult to implement, however as most properties are subject to a mortgage from the lender who provided the loan to purchase the property. A second mortgage can still be registered against the property, however the first lender’s consent will be required, and a second registered mortgage is far less secure, as there needs to be enough equity in the property to secure both mortgages.
Caveats
Much like a mortgage, a caveat is registered over a property, however, does not provide the same power of allowing the lodging party to sell the property upon the default of the debtor. Instead, a caveat effectively freezes the property, preventing the owner from dealing with it any way without the lodging party’s consent. This includes preventing the sale of the property (unless the debt is repaid) or the debtor registering any further interests against the property.
By registering a caveat against a property, you can ensure that one of the debtor’s key assets can not be disposed of without you receiving some of the proceeds of that sale. The registration of a caveat is also generally less complex and less expensive than registering a mortgage.
Caveats are a great way to protect your interests, particularly in short-term arrangements, and if the amount owing is smaller. However, unless there is an agreement for a caveat to be put in place to secure a debt, it can only be placed on a property if the debt being secured was used to assist with the purchase of that property (including mortgage repayments) or for the improvement or maintenance of the property.
Personal Property Security Interests
Not only does not every debtor own property, but lots of properties do not serve as a viable asset for security. Instead, your interest as a creditor can be registered against a multitude of other assets on the Personal Property Securities Register (“PPSR”).
Security interests can be registered against specific assets such as:
- Vehicles;
- Machinery and equipment; and
This method of security is particularly useful where money is loaned to an entity to purchase that specific asset and is called a “PMSI” (purchase money security interest). When registered properly, a PMSI can generally give you the highest priority security over that asset.
So which one should you use?
There is no one size fits all approach to securing a debt and we have by no means covered every form of security in this article.
The right to lodge a mortgage or a caveat is useless in circumstances where the debtor has no real property to enforce against. A guarantee is equally compromised if the guarantor has no capital or assets which will allow for enforcement against them.
The best form of security in any given circumstances, will depend on a multitude of factors and the best approach may involve a combination of methods.
Conclusion
If you are preparing to enter into any commercial arrangement, we recommend taking the time to speak with a member of the Lynn & Brown Lawyers commercial team to discuss your options for securing the money owed to you.
Peace of mind in commercial transactions comes from knowing that any money owed to you is secured by an appropriate method and that your risk exposure has been minimised as a result.
About the Author: This article has been authored by Sam Richardson. Sam joined Lynn and Brown Lawyers as a law clerk in 2021 during his studies at Murdoch University and has stayed with us as a commercial lawyer following his admission in 2024. Supported by the talented and experienced commercial team at Lynn and Brown Lawyers, Sam enjoys working with small businesses, both assisting with their exciting beginnings and to navigate troubling disputes. Sam is passionate about learning new skills and aiding his team in providing the best possible service to our clients.
