A crucial piece to development finance lending is the security that is provided for the lending. We explore below what this comprises, the purpose of the security for the funder and how this impacts you as a borrower.
Mortgage
A mortgage is the primary security that a lender will seek when lending against property. The word comes from the Old French word mortgage which translates literally as ‘dead pledge’ (mort = dead, gage = pledge). This is because the ‘deal dies when the debt is paid or when payment fails’.
A mortgage is a security instrument that gives a lender an interest in the subject property. This allows the lender to take possession of the property in the event of the borrower defaulting on their loan.
For development lending a lender will require a mortgage over the property being developed. As the developed properties are normally the primary source of repayment for a loan the lender will want to ensure that they have control over the flow of funds from the completed properties. This will ensure that they are able to take control of the project in an event of default and bring it to completion to ensure repayment of their debts.
More than one mortgage can be placed against a property and at times there will be other mortgages put in place on development property for various reasons. Each mortgage has a ranking associated with it (i.e. first ranking or second ranking) and that will normally be governed by a Deed of Priority and Subordination (DOPAS). We discuss the DOPAS further in our blog on mezzanine finance, however, in simple terms this governs what rights each mortgagor has. The primary financier for a development project will require a first mortgage on the property to ensure they are sufficiently secured in the event of default.
As a borrower the key thing to understand and consider here is if you are able to offer a mortgage over the property being developed and acknowledge that in the event of default the lender can take control and dispose of the property.
Personal Guarantee
A personal guarantee (PG) is in simple terms a promise from an individual to repay a loan to an entity. Providing a personal guarantee means that in the instance the entity is unable to fully repay the loan the individual can be pursued personally for the repayment.
A personal guarantee is almost always required for development lending. If the LVR on a project is very low and the other metrics of the project are strong a lender may consider a ‘non-recourse’ loan, however, this is very uncommon and it is most likely a Personal Guarantee will be required.
A lender will often seek personal guarantees from any directors, trustees or major shareholders of an entity. Where there is more than one person providing a personal guarantee the guarantee will be ‘joint and several’. What this means is that the lender can pursue the guarantors for recovery as they please, i.e. they can pursue the entire recourse from one guarantor rather than in a piecemeal fashion from each different guarantor. This is in place to ensure the lenders can take the path of least resistance to cover their lending and is important to understand if you are entering into a guarantee alongside any others.
If one individual is significantly wealthier or has easier / better assets to sell down to recover the outstanding funds the lender may pursue that guarantor in the first instance. When entering a guarantee alongside others consider your own position and make sure you have legal advice as to what your obligations are and what risks you are taking on.
Another point often raised by borrowers is that they do not own anything in their personal names and thus query the value in a personal guarantee. Outside of providing another avenue for recourse, a personal guarantee also provides a lender comfort that the borrowers / controlling interests are standing behind their project.
If a lender cannot repay the loan by it’s other securities, it can pursue the personal guarantees and if they are not able to make the lender whole then they have the means to seek bankruptcy for those guarantors.
Whilst their other assets may be protected, bankruptcy has many implications for someone (such as cessation of directorships) which in itself can impart leverage on the borrower from the lender. This is a tool that can be used to ensure that the borrowers act in the best interests of the transaction and lender.
Any person providing a personal guarantee should consider what the potential recourse of this could be. Given the risk we recommend that anyone providing a personal guarantee be able to effect a level of control in the prospective development.
General Security Agreement (GSA / GSD)
A General Security Agreement (or Deed) (GSA) grants a security interest to a lender over ‘all present and after acquired property’ for the entity and, crucially, amongst other things allows the lender ability to appoint a receiver over the company.
A General Security Agreement is therefore an important security for all lenders that gives them recourse to future cash flows from the company (i.e. proceeds from sale of property) as well as mechanisms to manage their interests in the event of a default.
Similar to a mortgage, more than one General Security Agreement can be granted over a company and these are then ranked. The primary lender for a development will often require a first ranking General Security Agreement to ensure that they are the ones in control in the event of a default. This is one reason developers will often set up Special Purpose Vehicles for each development as this enables them to grant each lender for different projects their respective first ranking general security agreement.
If more than one lender held a general security agreement under a single entity for different projects there is ‘cross default risk’ which means that if one project goes into default it will drag the other project into default as both are under the same entity and the provisions under the general security agreement are triggered to enable recourse.
A general security agreement or deed is perfected once it has been registered on the Personal Property Security Register (PPSR). A search of the register will return what charges are held over a particular company or asset.
Specific Security Assignments (SSA / SSD)
A specific security assignment (or deed) is as it sounds, security over a specific asset to do with the development project. This encompasses things like a civil or construction contract, performance bond, pre-sale contracts or consents. The effect of these deeds is to allow the lender to step right into the shoes of the developer if there is a default.
These are important for a lender as the repayment of the loan is reliant on the completion of the development so the lender wants to ensure that they are in a position to complete the project if things go pear shaped.
A specific security assignment differs from a general security agreement in that it provides direct security over a particular asset rather than something more general in nature. A Specific Security Assignment may include things such as;
- An undertaking from the borrower which prevents the borrower from making any changes to the contract.
- Assignment over the benefits of the underlying agreement to the lender; and;
- The creation of special powers in favour of the lender (such as the ability for the lender to enforce its rights under the contract in the event of default).
As with a general security agreement, a specific security assignment or deed is perfected once it has been registered on the Personal Property Security Register (PPSR).
There may be other securities sought by a funder in particular situations, however, the above are the four most common and frequent for property development. Understanding these, their risks and value to a lender is an important step to making sure you make the most of the funding relationship with your lender.
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