Security Package: What the Lender Can Claim

A security package is the set of rights a lender holds over identified property. If the borrower fails, the lender can claim that property rather than queue with everybody else. A first charge is paid out of that property before a second charge sees anything. An unsecured claim holds no property at all and reaches only what is left. On one invented realisation of Rs 68,00,00,000, that left Rs 8,00,00,000.

A loan document does two separate jobs, and almost everybody meeting one for the first time folds them into a single thing. The first job is bookkeeping: it records what is owed, at what rate, and by when. The second job is entirely different in kind. The second job attaches that debt to things: a shed with a roof on it, a row of machines bolted to a floor, a pile of unpaid customer invoices, the shares in a subsidiary company. Attaching the debt to identified property is the security package, and its whole purpose is to make the lender's position depend on that property rather than on the borrower's willingness to pay. Every line in that package answers one question, and the answer decides what the lender actually holds: what exactly does this reach?

The difference is already familiar, even to somebody who has never read a loan agreement. Two people lend Rs 2,00,000 to the same neighbour on the same afternoon. The first takes a gold chain and puts it in her own cupboard. The second takes a promise, warmly given and entirely sincere. Six months later the neighbour cannot pay. The first person is holding a chain. The second is holding a conversation. Nothing about the neighbour differs between the two stories. The whole of the difference sits in what each lender took at the start, and that is what a security package is: the answer, written down in advance, to what the lender holds when the money does not arrive.

What is a security package, and what is actually in one?

A security packageThe set of rights a lender holds over identified property of the borrower. is not a single object. A security package is a list, and each item on the list is a separate right over separate property. Read as a label it says almost nothing. Read line by line it says everything. Each line names a property and a position on that property, and those two facts together are the whole of what the lender can go and get.

The unit of that list is a chargeA right over identified property that lets a lender claim it if the borrower fails.. A charge is not money and it is not a percentage. A charge is a right attached to named property of the borrower, and the lender can call on that right if the borrower fails to do what the document says. Take the property away and the charge has nothing to bite on. Leave the property out of the list and the charge never reached it in the first place. A charge is only ever as wide as the property it names, and a package is only ever as wide as the sum of its lines.

Position 1 of the loan book held by Nilgiri Direct Lending Fund I, an invented lender, is the cleanest illustration of that. The loan is senior secured, Rs 50,00,00,000 at a cash coupon of 13.5 per cent, and 13.5 per cent is the rate this fund contracted for rather than a rate read off a market. Its package has exactly two lines: a first charge over fixed assets, and a first charge over receivables. Two lines, and they reach two completely different kinds of thing.

Each of those two kinds of property has a name. A fixed chargeA charge over specific property that stays where it is, such as a building or a machine. attaches to identified property that sits still and can be pointed at: this building, that lathe, the transformer in the yard. A floating chargeA charge over a changing pool of property, such as stock or receivables. attaches to a pool whose contents change while the business carries on trading: the receivables ledger, the stock in the warehouse. The business keeps selling stock and collecting invoices, and the charge follows the pool rather than freezing any one item inside it.

The household version runs like this. A jeweller who lends against a gold chain has a fixed charge in spirit: one chain, in one cupboard, and it is either there or it is not. A supplier who takes security over everything on the shelves of a kirana shop has a floating charge in spirit: the shop must go on selling rice and restocking rice, or there is no business left to lend to, so what the supplier holds is a claim on whatever happens to be on the shelves rather than on any particular sack. The trade is between certainty about the item and permission for the business to keep operating, and a package usually contains both kinds because a business is made of both kinds of thing.

What does each line of a package actually reach?

Only what it names. A security package is read emotionally rather than literally, and that four-word answer is worth stating bluntly. A schedule with four charges on it feels sturdier than a schedule with one. The feeling is often wrong. Four charges over four things nobody would buy reach less than one charge over the one asset the business cannot run without.

So the map below is drawn the boring way, on purpose. Down the left is the property of one borrower, invented for this illustration. Across the top are three lenders to that same borrower: one holding a first charge over the fixed assets and the receivables, one holding a second charge over the fixed assets only, and one holding nothing at all. Every cell answers a single question: what does that lender reach out of that property? Notice that the answer changes down a column as well as across a row, because a charge stops dead at the edge of the property its line names.

The bottom row is worth a moment. A residue remains once every charge above it has been satisfied, and the bottom row is where that residue sits, so most of the argument about security lands there. For lenders A and B it is a top-up they hope never to need. For lender C it is the entire holding. Same borrower, same day, same pile of property, and one of the three is standing in a completely different place because of what was or was not written down at the beginning.

What does a second charge get out of the same property?

Whatever is left of that property once the first charge has been paid in full, and not one rupee before. The residue after the first charge is the whole mechanic. A first chargeThe charge over a property that is paid before any other charge over the same property. and a second chargeA charge paid only out of what is left of that property once the first charge is met. can sit over exactly the same building, and both documents will use the same word, and the two lenders are in wildly different situations.

Everyone understands this from property already. A household takes a home loan from a bank, and years later takes a top-up loan from somebody else against the same flat. If the flat is ever sold to clear both, the bank is paid out first, in full, and only then does the second lender see anything. If the flat fetches less than the bank is owed, the second lender receives nothing at all, and receives nothing not because the flat was worthless but because it was not worth enough to get past the first claim.

Work it as arithmetic. The arithmetic is what makes the point unarguable. Take one named property with two charges over it, invented for this illustration: a first charge securing Rs 60,00,00,000 and a second charge securing Rs 20,00,00,000, so Rs 80,00,00,000 of claims sit on one thing. Move the amount that property realises and the second charge does not shrink gently, it switches on and off. At Rs 40,00,00,000 realised, the first charge takes the whole Rs 40,00,00,000 and is still Rs 20,00,00,000 short, so the second charge receives nil. At Rs 75,00,00,000 realised, the first charge takes its Rs 60,00,00,000 in full and the second charge reaches the remaining Rs 15,00,00,000 of its Rs 20,00,00,000, or 75 paise in the rupee. Costs of realising are ignored throughout. Ignoring them keeps the arithmetic clean and slightly flatters both lenders.

What is the difference between security over a thing and a promise by a person?

Security over a thing and a promise by a person differ in kind and not in degree, and the difference trips people because both arrive as paper, both are signed, and both feel like protection. A charge attaches to property of the borrower. A corporate guaranteeA promise by another company to meet the borrower's obligation, reaching no property of the borrower., a parent company's undertaking, a comfort letter or a support letter attaches to nothing of the borrower's at all. Each of them is a promise made by somebody else, and what it is worth depends entirely on that somebody else and on what that somebody else has when the day comes.

Go back to the neighbour with the gold chain for a second, and add a third lender. The third lender takes no chain. Instead the neighbour's elder brother signs a letter saying he will see the debt paid. Is that useless? Absolutely not; the letter may turn out to be the most useful of the three documents. But notice what the letter changed. The letter changed nothing about the neighbour. The letter added a second person to ask, and it asked the lender to take a view on that second person instead. An undertaking by a person swaps one question for another: not what property the lender can reach, but who else the lender can ask. The two have nothing in common.

None of this makes an undertaking a lesser thing. A promise from a substantial parent company may be reached far more easily than a charge over machinery for which no buyer can be found quickly. The point is not ranking the two. The point is that they answer different questions, so a reader who files them both under the heading of protection has stopped reading at the moment the document became interesting.

What does an unsecured claim reach when the money runs out?

Only what is left, and this is the sharpest instance in this guide because the case entity has already put a number on it. A claim that is unsecuredHolding no charge over any property, and ranking as an ordinary claim. holds no charge over anything. An unsecured claim is not a weaker charge. An unsecured claim is the absence of one, and what stands in its place is a position in the queue for whatever remains once every charge has been satisfied.

Position 5 of the book held by Nilgiri Direct Lending Fund I is subordinated debt of Rs 20,00,00,000 at 16.0 per cent, and 16.0 per cent is again the rate this fund contracted for. The record states plainly that position 5 is unsecured and that it ranks behind a bank. The ranking is load bearing, and it is the reason position 5 is worth working through in full. The borrower missed a coupon in the fund's Year 3 Quarter 1 and did not cure it, and the enterprise behind the position was sold in a distressed sale for Rs 68,00,00,000. A distressed sale fetches what somebody will pay quickly, so Rs 68,00,00,000 belongs to this case alone.

Here is what the Rs 68,00,00,000 met. The bank's senior secured term loan of Rs 60,00,00,000, carrying a first charge over fixed assets and receivables, was paid in full: 100 paise in the rupee. The fund's unsecured Rs 20,00,00,000 reached the residual Rs 8,00,00,000, or 40 paise in the rupee. Nothing was left by the time the queue got to the ordinary shares of the borrower, so those shares reached nil. Check the arithmetic in both directions: Rs 60,00,00,000 plus Rs 8,00,00,000 is Rs 68,00,00,000, and Rs 20,00,00,000 less Rs 8,00,00,000 leaves Rs 12,00,00,000 that the fund did not recover. Measured against the whole realisation rather than against the claim, the fund reached 11.8 per cent of everything that came in. The arithmetic is 8 divided by 68, or 0.1176.

One distinction belongs here before the argument moves on. Position 5's 16.0 per cent is this fund's own contracted rate, exactly as position 1's 13.5 per cent is, and neither is a statement about what anything costs anywhere. The reach of a claim is a separate matter from what that claim is worth. Nothing in the arithmetic makes holding a charge worth what it costs, or standing without one a mistake, or any position in an order of claims safer, better or worth holding.

Forty paise and 11.8 per cent are two different fractions with two different denominators, and mixing them is the single most common way to make a false sentence about a recovery. Forty paise in the rupee measures what came back against what was lent. Eleven point eight per cent measures what came back against what the sale produced. Both are true of the same event and neither one can be substituted for the other.

Where are a company's charges recorded, and why does a lender care?

A charge that only the borrower and one lender know about is a problem for the next lender through the door. So charges created by a company are recorded in a public register, and a charge recorded that way is a registered chargeA charge recorded in a public register so that other lenders can see it.. In India, anything to do with a company's registered charges sits with the Ministry of Corporate Affairs at mca.gov.in. Forms, timetables, fees and consequences change often enough that the current text at mca.gov.in is the only reliable statement of them, and a plausible wrong number would be worse than no number at all.

A register changes what a package can be read for. The register converts a private arrangement into something a stranger can check. A lender considering a new loan is not only asking what property the borrower has; it is asking what of that property is already spoken for, and a register is how that second question becomes answerable at all. Think of a resale flat. Anybody can be told the flat is unencumbered. A buyer wants a way to look, independently, at whether somebody else has a claim recorded against the flat. Independent checking is the whole function of a register.

What did the extra charge over a subsidiary's shares actually add?

The answer is worth working out in advance. Position 3 of this book is mezzanine debt of Rs 30,00,00,000 secured by a second charge, and it went into a workout after breaching a leverage covenant. The meaning of a workout is covered separately. One of the things that came out of that workout was an additional charge over the shares in a subsidiary company. The question is what that charge reaches, and specifically whether it reaches the machines inside the subsidiary.

A charge over shares reaches the company, not the contents of the company. A company and its contents are different objects, and the difference is entirely practical. Enforcing a charge over a named machine ends in holding a machine. Enforcing a charge over the shares in a subsidiary ends in holding the subsidiary: its machines, yes, and also its bank borrowing, its unpaid suppliers, its lease commitments and its tax position, every one of them still owed to whoever they were owed to the day before. Taking the shares takes the company complete with its own queue of claims. Taking the assets clear of those claims is a materially different thing.

None of that makes the additional charge worthless. Whether the shares in that subsidiary are worth anything is a valuation question, covered separately, and it depends on things this record does not fix. The additional charge unambiguously added a further identified property the fund can reach, standing alongside the second charge it already had. The additional charge changed nothing about the second charge itself. The second charge still reaches only the residue of the property it names.

What does the word secured hide when it is written in a schedule?

How many of this invented book's eight positions have a package at all?

Four of them, and the honest answer to what happened to the other four has two halves rather than one. The loan book held by Nilgiri Direct Lending Fund I cost Rs 2,40,00,00,000 across eight positions. Positions 1, 2, 3 and 4 each have a stated security package: a first charge over fixed assets and receivables on position 1, a first charge over all assets on position 2, a second charge plus the additional charge over a subsidiary's shares on position 3, and a first charge on position 4. The four secured positions cost Rs 1,60,00,00,000 between them, or 66.7 per cent of the book by cost.

Position 5 is stated to be unsecured. The unsecured ranking is the fact the whole of the arithmetic above rests on. Its Rs 20,00,00,000 is 8.3 per cent of the book by cost.

For positions 6, 7 and 8, being Rs 60,00,00,000 and 25.0 per cent of the book, the record simply does not state a security package either way. The distinction is not pedantry. Not stated is not the same as none. A reader who fills the gap with a guess has quietly converted an absence of information into a fact, and a schedule built that way looks exactly as confident as one built from documents. The record does fix other things about those three: position 6 is a bilateral loan of Rs 25,00,00,000 at 14.0 per cent, position 7 is a Rs 20,00,00,000 participation in a larger facility shared across six lenders, and position 8 is an obligation with a face value of Rs 30,00,00,000 bought for Rs 15,00,00,000. Every one of those rates is this fund's own contracted rate. None of those facts fixes what any lender could reach.

Who actually reads a security package, and what does each of them get from it?

Four kinds of reader come to the same document with four different questions, and watching them read it is the fastest way to see why the package sits at the front of the file rather than in an appendix.

A bank's credit officer is reading for the property. The officer wants to know what is named, whether the register shows anything already sitting over it, and whether the lines cover the assets the business genuinely cannot operate without. The officer is not reading the package to decide whether the borrower can pay; that is a separate discipline with its own methods and it is not what this document answers.

An analyst at a fund considering a subordinated position is reading for the space above. Everything already charged is space the analyst's own claim stands behind, so the interesting lines in a package are frequently somebody else's. The fund stood exactly there on position 5, and the ranking behind a bank was the first thing the record fixed about that position.

A finance director at the borrower is reading for what is left to pledge. Every line given away is a line that cannot be given to the next lender, so a package written today shapes what the company can raise in three years. The security package is one of the few documents whose most important consequences fall on somebody who has not arrived yet.

And a trade supplier, who signs no loan document at all, is reading nothing and is affected anyway. A supplier extending thirty days of credit on a delivery of packaging is an unsecured claimant by default, standing in the same queue that the unsecured lender chose deliberately. The household version is a street vendor who supplies vegetables to a small restaurant on weekly credit. He never signed anything, he holds no charge over the fryers, and if the restaurant closes he discovers, all at once, exactly what a place in a queue is.