Featherweight securities and administration risk – make sure you have sufficient security
Featherweight security and administration risk are unique to Australia and often misunderstood or overlooked in the market.
In this article, our Finance team step through administration risk, outline the benefit of featherweight security, and set out some key concepts that should be considered and addressed.
- Financiers taking security from a company that does not capture the whole (or substantially the whole) of that company’s assets should consider taking a featherweight security;
- A featherweight security should be drafted to ensure that the company is not restricted from dealing with its assets, other than where an administrator is appointed, and the amount secured by the featherweight security should be limited to a nominal amount;
- The featherweight security interest must be appropriately registered on the Personal Properties Security Register (PPSR) on time;
- The registration of the security should describe the interest in a way that is clear to any party searching the register that the security is intended to be ‘featherweight’; and
- Financiers should be careful when asked to provide partial PPSR releases in respect to a featherweight security interest, to ensure the financier continues to hold security over the whole (or substantially the whole) of the company’s assets.
What is ‘administration risk’?
Administration risk is the risk that, during the administration of a company, a financier (or other third party) is restricted from enforcing its security by operation of section 440B Corporations Act 2001 (Cth) (Corporations Act).
The restriction applies to all security interests (including mortgages and security agreements), subject to certain exceptions, and acts effectively as a ‘freeze’ or moratorium on the enforcement of security interests during the course of the administration (which will usually run for one to two months, but can be extended by the administrator or by Court order). It does not, in itself, give the administrator power to deal with assets contrary to a secured party’s interest, or forever restrict enforcement by the secured party, but is rather designed to ensure the administrator has time to fully consider and implement arrangements as part of the administration. However, in some circumstances, the associated delay could impact the value of the security – for example, where a sunset date under a contract is nearing, or where there is volatility in the market.
There are exceptions to these restrictions. In particular, a secured party is not subject to the moratorium if:
- the administrator consents in writing (section 440B(2)(a));
- the Court has given leave (section 440B(2)(b));
- enforcement action was undertaken before the administration began (section 441B); or
- the person (section 441A):
- holds security over ‘the whole, or substantially the whole, of the property of a company’; and
- before or during the decision period (a 13 business day period commencing on the date the administration begins), the secured party enforces the security interest in relation to all the secured property (whether or not in the same way for all property).
When does administration risk arise?
Administration risk exists whenever a company (rather than an individual, or other entities such as associations) grants security over less than substantially the whole of the company’s assets. This occurs most commonly, when security is granted over a limited category of assets or a particular asset, such as a mortgage over real property, or specific security over shares, project assets or interests, or certain receivables or accounts. As such, administration risk will not arise where a company has granted a general security agreement over all of the assets and undertakings of the company. It does not apply on the appointment of a liquidator or receiver.
On some transactions, a financier may accept, on a commercial basis, that administration risk exists and does not require steps (such as taking a featherweight security interest) to avoid the risk. For example, a financier may accept the administration risk on the basis that the assets subject to the specific security are not the primary recourse assets in an enforcement scenario (and those primary recourse assets are not potentially subject to any statutory moratorium, by virtue of the financier having security over substantially all of the assets of that obligor). This will depend on the nature of the transaction, the value placed on the specific security, any additional security that is held and the creditworthiness of the borrower and other security providers.
Avoiding administration risk using featherweight security
A common approach to avoiding administration risk is for a financier to take a ‘featherweight security’ in conjunction with other specific security from the company.
A featherweight security is a ‘light touch’ security interest which:
- is over all assets and undertakings of a company;
- does not prevent dealings with the featherweight collateral (i.e. operates as a ‘floating’ charge) unless, and until, an administrator is appointed; and
- is enforceable only where an administrator is appointed to the company.
In this way, the featherweight security ensures that the financier is entitled to rely on the exemption under section 441A of the Corporations Act (by having security over the whole of the property of a company), and can avoid the moratorium period under section 440B of the Corporations Act by enforcing its security during the decision period.
Drafting featherweight security agreements
Featherweight security arrangements can be incorporated within a specific security deed or agreement (or mortgage), or documented separately.
The amount secured by a featherweight security is typically limited to a nominal amount (for example, $1,000), and is described as being the last amount owing (to avoid it being able to be ‘paid out’ by the company).
A featherweight security should not restrict the company dealing with its assets (except to the extent covered by a specific security or mortgage), but should rather give the company full flexibility unless an administrator is appointed.
Common concerns and options to resolve
Notwithstanding that featherweight security is required to manage the administration risk from a financier’s perspective, a borrower may object to granting a featherweight security on the basis that registering an all-assets security may create additional administrative burdens for the borrower (for example, requests for releases in relation to assets which are sold in the ordinary course of trading).
These concerns can be mitigated by:
- incorporating provisions in the featherweight security that acknowledge that the security interest will rank behind any other security interest over the same property, which should give other secured parties some comfort as to their priority; and
- ensuring the featherweight security interest is registered on the PPSR in such a way that clearly identifies it as a featherweight, so that third parties searching the PPSR are aware of the ‘light touch’ nature of the security.
Where the grantor is dealing with its assets and requests that a financier provide a partial release of a featherweight security or a ‘letter of no interest’ confirming that the featherweight security does not secure particular collateral, the financier should be careful to ensure that, after providing any release or letter, the financier continues to hold security over the whole (or substantially the whole) of the company’s assets.
Our Finance team regularly assists with transaction structuring to manage administration risk, and can support you to ensure any issues are identified and appropriately managed. For assistance or further information, please contact the team below.
This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.