FORMS OF SECURITY AS RELATES TO DEFERRED PAYMENT OBLIGATIONS
1 June 2021
We certainly find ourselves living in interesting times. As experts warn of an impending third wave of Covid-19 infections, businesses (armed with lessons learned from a previous “hard lock down”) gear themselves to better mitigate the resultant risks, as well as take up the associated opportunities arising from a possible further downturn in the economy.
Having regard to economic and financial uncertainty, coupled with traditional financiers’ (generally) reduced risk appetites as relates to the funding of businesses and asset acquisitions, businesses are forced are forced to look towards innovation in order to “make business happen”. Resultantly, there has been a significant increase in vendor funded type transactions in recent months.
Vendor funding essentially entails a transaction in terms of which a seller (the vendor) lends money (or otherwise defers payment) to a purchaser (the borrower) so as to enable the borrow to buy the vendor’s products, assets or property.
Vendor funded transactions can take a multitude of forms. A well-known example would however be where Mr. A subscribes for shares in ABC (Pty) Ltd at an agreed subscription price. As opposed to the subscription price being paid in cash, Mr A cedes his entitlement to receive dividends in ABC (Pty) Ltd to ABC (Pty) Ltd until such time as the subscription price has been liquidated in full. Resultantly ABC (Pty) Ltd (the vendor) funds Mr. A’s (the borrower’s) acquisition of shares in ABC (Pty) Ltd, which funding is secured by way of a cession of the proceeds arising from future dividends accruing to Mr. A on account of his shareholding in ABC (Pty) Ltd.
The nature of the particular vendor funded transaction may bring about several nuances, as well as statutory inhibitions and prescripts which would have to be carefully considered prior to the transacting parties entering into such transaction. Amongst such considerations would be the legislative constraints contained in the National Credit Act No. 34 of 2005 and the Broad-Based Black Economic Empowerment Act No. 53 of 2003.
As with any deferred payment arrangement, the vendor would be prudent to require some form of security for purposes of ensuring fulfilment by the borrower of its obligations in the particular vendor funded transaction. This article highlights some (but not all) of the types of security which vendors could consider insisting upon as security for the due performance by a borrower of its obligations arising from a vendor funded transaction.
The Deeds Registries Act No. 47 of 1937 governs the manner in which immovable property can be made available as security for the fulfilment of a borrower’s obligations. The most common form of security in immovable property is created by way of a mortgage bond. Mortgage bonds are required to be registered in the applicable deeds’ registry, whereupon the vendor is afforded a real right against the immovable property. In the event of the borrower defaulting on its obligations in terms of the vendor funded transaction, the vendor would be entitled to obtain an order of court permitting the lender to sell the immovable property by way of a sale in execution, whereupon the net proceeds of the sale in execution would be utilised to settle the borrower’s obligations towards the vendor.
The vendor could procure security by requiring that a suitable third party bind itself as surety for the borrower’s obligations as arise from the vendor funded transaction. In terms of a deed of suretyship, the third party would bind itself to the vendor and hold itself liable for the obligations of the borrower, upon the borrower failing to fulfil its obligations towards the vendor in terms of the vendor funded transaction.
A pledge is an agreement entered into between a pledgor (borrower) and a pledgee (vendor) in terms of which moveable property is delivered (by way of transferring possession) and pledged as security for the fulfilment of the borrower’s obligations. Ownership of the moveable property remains that of the vendor, while the movable property is held in pledge. Where the borrower fails to fulfil its obligations, the vendor may proceed to take ownership and/or sell the moveable property whereupon the net proceeds of the sale in execution would be utilised to settle the borrower’s obligations towards the vendor.
A notarial bond is an agreement entered into between a mortgagor (borrower) and a mortgagee (vendor) in terms of which the borrower makes available movable property as security for the fulfilment of the borrower’s obligations. Notarial bonds are required to be registered in the applicable deeds’ registry. Unlike a pledge, the borrower retains possession of the movable property. A notarial bond (unlike a mortgage bond) does not confer a so-called “real right” in security to the mortgagee. Consequently, a general notarial bond only affords the vendor a preference over unsecured claims in the borrower. In the event of the borrower defaulting on its obligations in terms of the vendor funded transaction (not dissimilar to a mortgage bond), the vendor would be entitled to obtain an order of court permitting the vendor to sell the movable property by way of a sale in execution, whereupon the net proceeds of the sale in execution would be utilised to settle the borrower’s obligations towards the vendor. Notarial bonds normally take one of two forms:
- A general notarial bond granted over movable property described generally as opposed to specifically identifiable moveable property; or
- A special notarial bond granted over specifically identifiable moveable property.
A cession is a form of security entered into by the cedent (borrower) and cessionary (vendor) in terms of which the cessionary grants a cession over moveable property in favour of the vendor as security for the fulfilment of the borrower’s obligations. An example would be the borrower ceding its right, title and interest in any entitlement to receive dividends form certain shares until such time as the borrower’s obligations have been fulfilled. Cessions normally take one of two forms:
- A cession in securitatem debiti where ownership and title in the movable property remains that of the borrower; or
- An out-and-out cession, where ownership and title in the property passes to the vendor but provision is made for ownership and title in the movable property to be transferred to the borrower once the borrower’s obligations have been fulfilled.