Whether you are a start-up with a hunger to make it big, an existing business thinking of expansion or a person struggling with cash flow – at some point in time you will ask yourself whether or not to apply for a loan.
Providing security for debt funding
Regardless of the type of financial institution you choose to approach for a loan, as a borrower in South Africa, chances are almost 100% that you will be required to provide some form of security (or collateral as some may call it) to the financial institution in order for it to reduce its credit default risk in relation to such loan.
A borrower can provide security to a lender by (i) granting a mortgage bond over its immovable property, such as its office building or house, (ii) pledging the rights, title and interest that it may have in any securities, such as shares in a company or (iii) ceding in security its rights, title and interest in claims and receivables, such as book debts and insurance contracts.
Security over tangible movable assets
Lenders and borrowers, however, generally overlook the possibility of a borrower granting security over its tangible movable assets as an alternative security method to those mentioned above. Think of printing machinery in a printing business; game on a game reserve; stock-in-trade on the shelves of a retailer; or even the artwork hanging in your house – all of which are tangible movable assets with value that can be used as security for a loan.
Security over tangible movable assets (other than ships and aircraft) can be granted by a borrower by way of a pledge or a notarial bond (whether specific or general).
A pledge would require that (i) the borrower and the lender enter into an agreement pursuant to which they agree that the applicable movable assets are pledged in favour of the lender and (ii) such movable assets are physically delivered to the lender. As such, the borrower will no longer be able to use any of these assets in the ordinary course of its business (or for personal benefit) until such time as the loan granted by the lender to the borrower has been fully repaid and the lender returns the movable assets to the borrower.
A pledge will therefore not be a suitable form of security in circumstances where the borrower needs to retain physical possession of the movable assets, for instance, if the borrower uses such assets to conduct its business.
General and Special Notarial Bonds
It is in these circumstances where a notarial bond becomes essential, as physical delivery is not required when a borrower grants a notarial bond over its tangible movable assets as security for a loan.
As a borrower you have a choice to grant either a special notarial bond over specific tangible movable assets or a general notarial bond over all your tangible movable assets. When making this choice, keep in mind that a borrower can freely dispose of its movable assets even though a general notarial bond has been granted over such assets. The general notarial bond is therefore ideal for when the borrower owns movable assets such as stock-in-trade and animals on farms or game reserves. Once a special notarial bond has been registered, the lender will be deemed to have taken possession and delivery of the relevant movable assets and, as such, the borrower will not be able to alienate them.
A special notarial bond must meet the requirements set out in the Security by Means of Movable Property Act, 1993, the most important of which is that all assets covered by a special notarial bond must be described clearly and accurately in order to ensure that, upon enforcement of the applicable security, such assets are specifically identifiable through reference to the bond only, without the need for additional extrinsic evidence.
All notarial bonds, regardless of whether general or special, must, within 3 months after execution, be registered at the applicable deeds registry in the area where the borrower lives and conducts its business.
Enforcement of security granted pursuant to a notarial bond
Should the borrower fail at any time to timeously comply with its obligations under the loan agreement, a special notarial bond will (prior to the borrower becoming insolvent) permit the lender to sell such assets and use the sale proceeds to repay the outstanding amount owed by the borrower under the loan, without having to obtain prior judgement against the borrower.
If the borrower granted a general notarial bond to a lender and a default under the loan occurs, then the lender will need to perfect its security and will only be able to procure a sale of the tangible movable assets of the borrower after (i) it has successfully approached the High Court for a court order directing that such assets should be attached and (ii) physical possession of such assets is obtained through the execution of such order by the sheriff.
Insolvency of a borrower
Security granted pursuant to a special notarial bond constitutes a form of real security over the movable assets specifically identified in the bond and, as such, a lender’s claim secured by such security will rank first in relation to the specific assets upon the insolvency of the borrower. Taking possession of the movable assets after the borrower becomes insolvent is, however, not possible.
Should a lender be unable to perfect its security under a general notarial bond (as described above) prior to the borrower becoming insolvent, then the lender will merely have a personal right against the borrower after such insolvency occurs. Regardless of the unsecured nature of the lender’s claim, the lender will still enjoy a limited statutory preference above the claims of the borrower’s concurrent creditors as a result of the security provided under the general notarial bond.
Ranking of lenders’ claims
If the borrower has granted various notarial bonds over the same movable assets, then the ranking of a lender’s claims in respect of such assets will depend on the type of notarial bond it holds. In the case of a general notarial bond, the lender that perfects its general bond pursuant to a court order first-in-time, will have preference above the claims of other creditors in whose favour similar general bonds have been granted. In the case of a special notarial bond, the lender granted security first-in-time will have priority over other creditors wishing to enforce their special notarial bonds over the same assets.
Conclusion
So, next time when you consider applying for debt financing, remember that the value of your tangible movable assets and the willingness to grant a notarial bond over such assets may be sufficient to persuade a lender to lend you some money.
Nadia Smith
Nadia has a BCom and LLB and was admitted as an attorney in 2006 after having completed her articles at Jan S De Villiers Attorneys (now Werksmans). Nadia then joined Freshfields Bruckhaus Deringer LLP in Amsterdam as an associate for 4 years before returning to ENS as a senior associate in the banking and finance department. Nadia joined Caveat Legal in 2015.