AUTHOR: TOM FARRELL
On a number of recent real estate finance deals we have advised on, the question has arisen as to whether an assignment in favour of the lender is the most appropriate security in all circumstances in respect of certain assets.
On a typical real estate finance transaction, an assignment over the borrower’s rights under any key contracts or other documents it is party to (such as lease documents and insurance policies) will be assigned by way of security to the lender as part of the standard security package. In order to perfect such an assignment, notice of assignment will be served at completion on any counterparties to such assigned contracts. The purpose of such notice serves several functions:
- Priority: Service of notice ensures that the assignment takes priority over any subsequent assignment granted by the assignor (albeit any such subsequent assignment would likely be a breach of the borrower’s obligations under the finance documents).
- Legal assignment: The service of notice ensures that any assignment takes effect as a legal, rather than an equitable assignment. Under a legal assignment, the lender is able to take action directly against any counterparty without the assignor having to join such proceedings.
- Amendment and termination: Service of notice ensures that the assignor is prevented from amending or terminating the rights that have been assigned to the detriment of the lender.
The form of notice will inform the counterparty that the assignor has assigned its rights to the lender, but will typically also direct the counterparty to continue to deal with the assignor, unless and until a further notice is served confirming that a default has occurred under the finance documents and that the counterparty should deal with the Lender. This has the effect of making any such assignment conditional upon such further notice being served and ensures that the parties are able to exercise and enforce their rights under the contract in the usual way until such additional notice is served.
The case of Mailbox v Galliford Try (2017) brought the issue of security assignments to the fore and led to greater focus and consideration around the nature of security over contractual rights and whether an assignment is an appropriate form of security in all circumstances. In that case, the developer had assigned its rights under a building contract to a lender pursuant a debenture. The developer purported to sue the contractor under the building contract. The contractor argued that the developer was not able to do so as the developer had assigned its rights under the contract to the lender and had served notice on the contractor to that effect. However, the notice in this case was different from the typical form of notice that would be served on a real estate finance transaction in that it informed the contractor that the lender was the party entitled to exercise all rights under the contract immediately upon service of the notice at completion of the financing i.e. the assignment was not conditional upon a further notice being served to advise that a default had occurred. The court ultimately held that the developer could sue the contractor as there had been an express re-assignment of the contractual rights back to the developer prior to the action against the contractor being commenced. Without this re-assignment, the result would arguably have been different given the unconditional nature of the assignment.
The judgment in the Mailbox case has led to more thought being given to the nature of security taken over contractual rights, particularly in relation to development documents. An assignment may not always the most appropriate form of security (even where the notice provides for the borrower to be able to continue to exercise its rights pre-default) - this is particularly relevant in the context of development financing. We note that the approach taken in respect of development documents in the LMA form of security agreement for use on development transactions is to take a charge over development documents rather than an assignment. Depending on the circumstances, if a charge is taken over development documents at the outset, it may be prudent to include within the security document the option for the lender to call for an assignment if required in future.
Notwithstanding the approach to security over development documents on development financing transactions, security over contractual rights should in most circumstances take the form of an assignment by way of security, with notice served on the counterparty to confirm that the assignee may continue to exercise their rights until further notice is served.