Are you using it? Last month I wrote about how a creditor was the winner in a statutory trustee appointment Statutory Trustee sale—creditor wins. It occurred to me that an equitable charging clause is a debt recovery tool that not only do few suppliers know exists, but many do not appreciate just how powerful this tool can be.
To explain, suppliers often require a signed credit application before they enter into a trading relationship with a company. Suppliers also may take this opportunity to include a director's personal guarantee, which gives suppliers the power to pursue the director personally for any unpaid company debt—allowing them to pierce the corporate veil. But often this is as far as any credit application will go. A more potent tool to insert into a credit application, is an 'equitable charging clause' that provides the supplier with an equitable interest in any real property the director personally owns. So, not only can the supplier pursue the director personally, but can claim against any real property. This is a 'super priority' in respect of any proceeds from the sale of the property (subject to any pre-existing securities registered on the property); particularly should the director go bankrupt.
So, what do I mean by 'super priority'?
Typically real property has a mortgage over it. An equitable charging clause provides an opportunity to lodge a caveat against the property that ranks secondly only to the property's mortgage. Therefore, in the event the property is sold all proceeds will firstly be used to satisfy the mortgagee's loan. Once the mortgagee is paid out, the caveat holder is then entitled to any proceeds, until their debt is satisfied—ahead of the owner! In effect, the caveat holder is a secured creditor over the property.
So, assuming a supplier has an equitable charging clause in their credit application, how is it enforced?
If a supplier finds themselves in the position whereby a company is unable to pay their debt, they can make a demand upon the director under their director's personal guarantee and lodge a caveat over the director's interest in real property. In Queensland, the supplier then has three months to enforce this caveat, which means they need to commence legal proceedings by applying to court to confirm their equitable interest. At this point they will usually seek to have a statutory trustee appointed over the property. Any appointed statutory trustee is then required to sell the property and distribute the proceeds in a particular priority. Typically, the proceeds are distributed firstly to any mortgagee, then secondly to any other 'secured creditors', which includes any caveat creditors, and then any surplus proceeds are paid to the property's owner (the director).
However, it is critical to note, in Queensland (other states have different rules) a caveat must be 'enforced' within three months of it being lodged, or the caveat will lapse. If it lapses, a creditor cannot lodge a new caveat (on the same grounds). Further, the creditor will also lose their equitable interest in the property and therefore rank as an 'unsecured creditor', along with any others.
So, by seeking appropriate legal advice, a supplier can insert equitable charging clauses in all of their personal guarantees. In doing so, they give themselves the following advantages:
- To become a secured creditor over property owned by a director.
- If the company is struggling to pay its debts, the supplier can lodge a caveat over the property.
- To use the caveat as leverage to have the director pay their debt ahead of other creditors (the director won't want their property sold and often do what they can, to pay out the debt)
- If the debt is unpaid, the supplier can enforce their rights (within three months of lodging the caveat) to have the court appoint a statutory trustee to sell the property and the supplier has a secured interest in that property.
At Worrells, we are frequently appointed statutory trustees over properties. In most cases those holding a caveat receive some or all of their debt from the sale. Had they not had their equitable charging clause, it is unlikely they would have received any money.
We strongly suggest that all suppliers, service providers (including accountants and solicitors) and other businesses seek appropriate legal advice to determine if their position allows an equitable charging clause to be in their credit applications. My view is this is one of the most under-utilised debt recovery tools that makes the difference of being paid, or not being paid.