COLLATERAL LENDING: What is the Cost of collateral lending and opportunities for reform

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The preferred approach to mitigating the risk inherent in a credit relationship between a lender and borrower is usually through the use of collateral. Both lenders and borrowers benefit from the pledging of collateral using well-designed and well-operated collateral processes. Legal claims are reduced when the secured creditor is allocated the assets pledged as collateral or the proceeds of the sale of assets, which eliminates the need for extensive litigation or the receivership or liquidation of companies. Information asymmetries are reduced when the borrower’s risk preferences are limited by the implied loss of valued assets. Secured credit reduces the risk of excessive borrowing as borrowers are restricted by the amount of collateral owned. Finally, borrowers that pledge collateral are granted a lower financing cost.

In Ghana, the collateral process is hampered by legal, regulatory and operational constraints. Since the option of collateral is limited, two scenarios have developed in Ghana:

  1. The cost of loans makes capital equipment more expensive for entrepreneurs relative to their counterparts in industrial countries, and, consequently, businesses postpone buying new equipment or finance it incrementally out of their own limited savings.
  2. Credit is rationed by lenders and therefore is limited to the larger and more established firms. Small businesses, in particular, are limited by the scarcity of financing, and the lack of new investment dampens productivity and limits income levels in the overall economy.

 

Principles of an Effective Collateral Process

The collateral process and surrounding legal and operational environments include three main components:

  • The creation of security interests;
  • The perfection of security interests, including public knowledge of their existence and priority; and
  • The Enforcement of security interests.

Obstacles to effective collateral processes affect each of these three components. Increasing difficulty, expense and uncertainty related to the creation of security interests prevent public understanding of the perfection of security interests and cause the enforcement of security interests to be slow and expensive.

Process Creation and perfection of collateral

Creation and perfection of collateral occurs when a borrower who has an interest in property, or who holds the power to transfer the interest, transfers it to a lender as collateral in exchange for a loan facility. (Property is used in the widest meaning of the word here – anything that can be possessed.)

Security interests created in Ghana must be perfected to render them valid and enforceable against the grantor and as notice to the world. When a security interest in property is superior to other interests and claims to the property, it is said to be perfected. Put simply, perfection is the validation of legal documents. It involves the taking of additional steps to render the rights created under a legal document effective against third parties and/or to retain its effectiveness in the event of default by a party. Generally, the collateral perfection process is as follows

  1. Search and due diligence: Search at the appropriate land registry or registries (and sometimes survey department) to find out the legal ownership of a property. Due diligence on the identity of the owner to ensure we are dealing with the right person or entity. Landed collateral process starts with search to verify ownership and if any encumbrance on the property.
  2. Creation: drafting of legal documentation to enable the bank take security, signing the security and witnessing the signatures of the parties
  3. Perfection: payment of stamp duty if required, consent if required, and registration at the appropriate land registry, BoG Collateral Registry or other government department
  4. Enforcement: Realization of the asset

Hitherto charges over moveable assets from non-corporate entities could not be registered.  The Registrar General department is used for registration of collateral of corporate entities.

The collateral registry created by Borrowers and Lenders Act, 2008 [Act 773] is intended to widen the collateral base beyond landed property which is usually the main collateral taken from non-corporate entities. Collateral over movables can now be registered at the Collateral Registry. The collateral registry is to principally register charges and collaterals created by borrowers to secure credit facilities provided by lenders

It is the security that is registered. But of course the security is based on documents. It is the responsibility of the lender to ensure the proper documents are in place and properly described when inputting it into the Collateral Registry database. If you don’t put in the correct details if anyone conducts a search based on the right details your charge will not show up. Hence inputter and authorizer to ensure correct information is provided. The search and due diligence on the property will confirm that land certificate is correct and that a borrower manufactures land title for same property and presents it to another bank. The charge document will not be drafted until title document is confirmed via a search report. Each stage of the process in critical. The next stage is built on the foundation of the previous process i.e. 1. Search and due diligence 2. Creation 3. Perfection 4. Enforcement

Generally, perfection involves

  • The stamping and
  • Registration of the security documents with public registries.

 

  1. Stamping

Stamping is the making of an impression on a legal document, by a public authority in pursuance of law and for which a tax or duty is exacted.

In Ghana, stamping is administered by the Land Valuation Division of the Lands Commission on behalf of the Ghana Revenue Authority under the Stamp Duty Act, 2005 (Act 689) (the “Stamp Duty Act”).

Under the Stamp Duty Act, all security documents are required to be duly and properly stamped to render them admissible in evidence and enforceable in the courts of Ghana. An unstamped or insufficiently stamped document will therefore not be admitted into evidence in court and a person cannot rely on it to make his case.

Security documents may be stamped upon payment of the appropriate stamp duty. It must be noted that, while some security documents may be expressed to be exempt from stamp duty (either by the Stamp Duty Act or under some binding agreement such as a bilateral trade agreement), such security documents are required to be stamped as “exempt” regardless of the exemption.

Security documents must be stamped within two months of execution or as the case may be, within two months after first receipt in Ghana, where the security documents were executed outside Ghana.

The Stamp Duty Act allows for late stamping of security documents upon the payment of a penalty of GHS 30. However, where the unpaid stamp duty exceeds GHS 30, there is a further penalty by way of interest on the unpaid stamp duty at a rate of 5% per annum, from the date of execution up to the time when the interest is equal in amount to the unpaid stamp duty.

Security documents are subject to ad valorem tax in Ghana. Primary security is subject to stamp duty at a rate of 0.5% of the secured liability/obligation while any auxiliary security is subject to stamp duty at a rate of 0.25% of the secured liability/obligation.

Where after stamping, the security document is subsequently amended to increase the secured liability, the security agreement is required to be stamped-up. Stamp duty of 0.5% or 0.25% as the case may be; shall be payable on the difference between the secured liabilities.

In Ghana, stamping precedes registration with other registries in Ghana. Security documents therefore cannot undergo other forms of perfection unless it is fully stamped. Further, any person who registers an unstamped security document for purposes of official records commits an offence and is liable on summary conviction to a fine.

  1. Registration

Registration is the act or process of recording or enrolling specified information in an official or public register or records.

Generally, all charges in the form of security are required to be registered in the public registries to serve as notice of the creation of the charge to the world.

There are three main registries that security documents must be registered with in Ghana.

  1. Companies Registry

Under section 107 of Companies Act of Ghana, 1963 (Act 179) (the “Companies Act”), a security created by companies incorporated in Ghana are required to be registered with the Registrar of Companies. Any unregistered security created over the assets of a company is void as a security and all monies secured by the charge becomes immediately payable.

Particulars of the security created (with the security document annexed) are required to be registered with the Registrar-General’s Department of the Ministry of Justice and Attorney General which performs the functions of the Registrar of Companies (the “Companies Registry”).

All securities created must be registered within twenty-eight (28) days of the creation of the security, however, the courts may grant an extension of time for the filing of a security document on justifiable grounds.

Registration of a charge with the Companies Registry constitutes actual notice of the creation of the charge (but not the contents of the security document) to persons dealing with the company from the date of registration.

It is worth mentioning, however, that pledges or possessory liens on goods, charges by way of pledge, deposit, and letters of hypothecation or trust receipts, bills of lading, promissory notes and bills of exchange are exempt from this requirement of registration.

On successfully completing registration, the Companies Registry issues a certificate of registration as evidence of registration.

Regarding release of a security duly registered, companies are required to commence the process by application in a prescribed form to the Companies Registry. The Registrar of Companies, upon proof of satisfaction in whole or in part of the debt for which the charge was given or the release of the whole or part of the property charged, will issue a memorandum of satisfaction.

  1. Collateral Registry

The Collateral Registry is an online registry set up under the Borrowers and Lenders Act of Ghana, 2008 (Act 773) to record all registration of charges pledged by borrowers to secure credit facilities provided by lenders.

A borrower (any person who has concluded a credit agreement with a lender) or any person interested in a charge or collateral is required to register the particulars of the charge or collateral created in favour of a lender with the Collateral Registry. The security created must be registered within twenty-eight (28) days of the creation of the charge or collateral.

An unregistered charge or collateral is of no effect as security for a borrower’s obligations for the repayment of the money secured and the money secured immediately becomes payable despite any provision to the contrary in any contract.

Only charges created from February 1, 2010 and covering GHS 500 and above are eligible for registration with the Collateral Registry.

In the case of companies, the requirement to register charges created is in addition to the requirement to register charges created with the Companies Registry.

Regarding the release of a security duly registered, the Registrar shall issue a memorandum of release of debt in the register and furnish the borrower with a copy of the memorandum, upon application (online) in prescribed form with proof of payment in part or whole of the debt secured and release of the whole or part of the property secured.

3, Lands Registry

There is no timeline for the registration of a mortgage, however, the mortgage created shall not have effect until duly registered.  Registration of the mortgage constitutes actual notice of the particulars of the security to all persons and for all purposes from the date of registration of the charge.

A mortgage may be discharged by an endorsement on the mortgage instrument or by way of a separate document (a deed of discharge).

 

Enforcement of collateral

The Borrowers and Lenders Act 2008 (Act 773) provides that prior to enforcement of security, the secured party must deliver a 30-day notice of default to the borrower and allow the borrower 30 days to remedy the breach. The notice of default must be registered with the Collateral Registry, and should contain the date of default under the relevant finance document(s) and the date on which the borrower receives the notice. After the 30-day period, the registrar of the Collateral Registry will issue a certificate confirming the enforcement of security. Other than with respect to land (on which see below), all realizations of charges over non-cash assets must be by way of auction sale. Any disposal of land subject to a mortgage is typically permissible only under a court- approved sale arrangement or by an out-of-court auction organized in accordance with the Auction Sales Act 1989 (PNDCL 230). The net proceeds of enforcement must be distributed in the following order:

  • Amounts required to discharge reasonable costs the chargor incurred in realizing the security;
  • Amounts required to discharge legal expenses to the extent the credit agreement permits
  • Amounts required to discharge the secured obligations
  • Amounts the borrower owes to persons who have a subordinate charge in the secured assets
  • Amounts the borrower owes any other person who has given the secured party notice of its interest in the secured assets. The balance of net proceeds, following these distributions, must be returned to the borrower

Out-of-court enforcement regarding any asset is generally permitted under Ghanaian law. Governmental consents are only required prior to enforcement of security if the security is granted over an asset in which a Ghanaian governmental or statutory authority has an interest, or is in respect of a governmental authorisation or license.

Generally, there are no restrictions on who can enforce a security interest over assets in Ghana, provided that the person seeking the enforcement is the secured party, its trustee, agent, assignee, successor or transferee. From a practical perspective, a secured party that is a foreign entity can require a local receiver to act on its behalf.

 

Insolvency / bankruptcy proceedings

Primary legislation for bankruptcy and insolvency in Ghana in respect of limited liability companies is contained in: (a) Act 179 which applies to voluntary insolvency (also referred to as private liquidations), and (b) the Bodies Corporate (Official Liquidation) Act 1963 (Act 180) which applies to an insolvent company (the Company Insolvency Rules).

  • Members’ voluntary winding up / private liquidation: Voluntary liquidation is only available if the company is solvent. The members of a company may wind up the company if the: − Directors swear an affidavit that the company is solvent − Company passes a special resolution to wind up the company voluntarily, with the resolution providing for the appointment of the liquidator. After the company’s debts have been paid, the company’s number is struck off the Companies’ Register with notice published in a public gazette.
  • Creditors’ winding up: If a company is insolvent, its liquidation must be by official liquidation whereby the company may be placed into receivership or be wound up by its creditors. Under Ghanaian law, official liquidation may be commenced by either: − A special resolution of the company − A petition to the Registrar of Companies by a company member or creditor − Conversion from a private liquidation (where it is determined that the company cannot, in fact, pay its debts) − A petition to the court by a member, creditor or Registrar of Companies Note, the Company Insolvency Rules do not apply to statutory corporations or State-owned entities, which instead must be wound up by a legislative instrument issued by the President.

 

Constraints to the collateral process in Ghana

Weak and dispersed legal framework:

There are many statutes regulating the creation and perfection of collateral. Collateral perfection in Ghana is legislated by different laws. First a collateral charge needs to be registered with the Registrar General in accordance with the companies’ code, then with the land commission for land title/land registry and then with collateral registry in accordance with the borrowers and lenders act[1].  Each of these channels of collateral charges have equal priority in law. So a bank needs to register with all the channels.  The laws lack uniformity and result in a convoluted conveyance system. For example, freedom to contract has been severely curtailed by the statutes that inhibit property rights through archaic procedures and regulations. In addition, stamp duty is expensive both in its direct cost and in the method of its collection;

Multiplicity of registries

There are a multiplicity of registries, including:

  1. companies registries (section 107 of the Companies Act, 1963 (Act 179) to register charges with the Registrar of Companies) ,
  2. DVLA (vehicle registration) ,
  3. land commission (under Land Registry Act 1962 (Act 22) or Land Registry Act 1962 (Act 122) and
  4. collateral registry (If collateral charge document was created after February 1, 2010, it should be registered with the Collateral Registry in accordance with the Lenders and Borrowers Act, 2007 (Act 773)  .

Injunctions

Furthermore, the process of realizing the loan amount outstanding from security liquidation (enforcement) has proved to be very cumbersome and costly for lenders. The owners of property obtain court injunctions and restraining orders, which sometimes make it difficult to dispose the said property leaving the  lender with unrealized securities and non-performing loans.

The first line of defense for many borrowers when faced with the threat of repossession of an asset is an injunction. An injunction is a judicial remedy issued at a court’s discretion. It may either prohibit or restrain a party from performing a certain act (prohibitive) or require the respondent to perform certain actions in preparation for court.

An injunction may be sought as a final remedy or at a preliminary stage before trial (an interlocutory/interim injunction). In most cases during debt recovery, an interim injunction is sought pending the outcome of trial.

In determining whether to grant an interim injunction, the courts apply three principles:

  1. That the claimant can show that there is a serious issue to be determined;
  2. That the court considers where the balance of convenience lies. Important things to consider will be: a) the court’s ability to quantify likely damages; b) the sufficiency of the claimant’s cross-undertaking in damages (if the defendant is successful at trial); and c) the sufficiency of the defendant’s financial resources to compensate the claimant (if the claimant is successful at trial);
  • If there is no imbalance, then the status quo is preserved.

In theory, the court must be satisfied that the claim is not frivolous or vexatious and should not attempt an in-depth assessment of either party’s case and the likely outcome of the infringement proceedings at trial. In practice, borrowers routinely obtain injunctions from courts restraining lenders from enforcing their rights of recovery. This discreditable practice is highly prevalent despite the statute being fairly clear on the nature of statutory power of sale, statutory notice and the remedies to an aggrieved party. Courts have argued that in trying to be just, they have faced difficulty in getting lenders to justify the hefty interest rates and penalties routinely imposed on borrowers upon default, which often causes confusion over the amount actually owed.

Though there have been cases where the courts have resolved not to grant indulgence to defaulting borrowers, in most cases injunctive relief has been granted, and borrowers are aware that their chances of avoiding the loss of the pledged asset via the courts is very high. As a consequence, lenders prefer to renegotiate and find alternative ways of arriving at settlements with borrowers, upon the understanding that the courts are highly unlikely to provide them with redress.

 

 Stamp duty as a deterrent to creating security interests

Stamp duty is a large component of the cost of collateral. In addition to the cost, the archaic physical collection process and procedures further complicate the collateral process.

Incomplete and unreliable search methods

Weak enforcement mechanisms

The realisation process in Ghana is slow and expensive. Even in instances of uncontested realisations, the lender has to issue notice of more than 30 days in the case of immovable property. The lender or other enforcer is also often required to obtain consent to facilitate a sale, which makes the success of the process dependent upon independent (or sometimes not so independent) public officials. In the event that the matter becomes contentious, the recovery process is hampered by the costly and highly procedural judicial process.

Court system

Commercial courts have been established to expedite the realisation process, but this has been ineffective as there is a shortage of judges and judicial officers. This has resulted in a severe backlog of cases, resulting in cases taking a minimum of three years and up to a maximum of ten years before resolution. Furthermore, there is a general perception among lenders that the courts will not resolve the issue in their favour, and that, if they do, it will be too late for any meaningful recovery to take place, as assets will have been sold, lost or damaged.

Weak insolvency framework

Based on the 2017 Barclays African Group Financial Market Index[2],   Ghana generally scored well, based on their enforcement of netting and collateral positions. However, the report noted that Ghana’s insolvency framework is the weakest in the index. Despite adhering to international standard master agreements, with the exception of Global Master Securities Lending Agreement (GMSLA), and enforcing netting and collateral positions, it fails to adequately resolve insolvency without incurring high recovery costs for creditors. On average, the payment recovery rate is 23 cents on the dollar, 12 cents below that of South Africa.

The length of the foreclosure proceedings can vary from less than 1 year to up to 5 years. Creditors have less incentive to start the foreclosure proceedings if they know from the start that the proceedings may take years (with longer proceedings typically favouring degradation of collateral) and debtor discipline may be lower, as debtors may be less inclined to meet their payment obligations if loan enforcement is not a credible deterrent. IMF data tends to show that the level of NPLs is lower in countries where the foreclosure period is shorter.

Recommendations

Unified land registration

There are currently two land statutes dealing with immovable property in its various forms in Ghana; deed registration and title registration. There should be one unified code of law relating to immovable property, as it is imperative that land, both urban and rural, becomes a viable source of collateral.

Reform Stamp duty

The current stamp duty is costly, unfair and cumbersome. It needs to be either substantially reformed or replaced. One option would be to replace the stamp duty with a tax on bank debits. The benefits of this tax would be immediacy and ease of collection, the lack of forms or any other bureaucratic procedures, fairness (those who spend more pay more) and fiscal gains.

 

Alternatively, the Stamp Duty Act could be reformed to make it more responsive to circumstances by establishing low rates that depend on the property or interest being created, by whom and for what purpose. In addition, the process of paying stamp duty needs to be revised to allow for non-physical presence, immediate payment and receipting.

Single registry

Integrate all channels of registration of collateral charges: companies registries (section 107 of the Companies Act, 1963 (Act 179) to register charges with the Registrar of Companies) ,  DVLA (vehicle registration) , land commission (under Land Registry Act 1962 (Act 22) or Land Registry Act 1962 (Act 122) and collateral registry (If collateral charge document was created after February 1, 2010, it should be  registered with the Collateral Registry in accordance with the Lenders and Borrowers Act, 2007 (Act 773)  so that a charge over collateral registered at one or more channels automatically get registered at all the other channels

Judicial system for repossession

The current procedures for repossession are not effective as courts readily grant injunctions allowing borrowers to stop the realisation process pending the resolution of a dispute. While the litigation continues, the borrower is able to enjoy the asset. This has in many cases resulted in the asset being lost and/or dissipated, making the lender unable to recover, if at all, the amount owed. To overcome this, I suggests the following solution:  Strengthen the out-of-court system for repossession. The statute already covers the events of default and repossession; therefore such repossession needs to proceed only upon court notification and not approval, which would normally require a hearing process. In the case of the need for injunctions, for these to be granted, the borrower would need to deposit with the court the asset or the principal amount owed until the case is determined. The court holds the asset in an escrow account.  This would ensure that no party benefits when real disputes occur.

 Alternative dispute resolution mechanisms

Lenders shy away from alternative dispute resolutions as, under the current form, these typically do not enforce repossession. It would appear that currently arbitrators seek to mediate between the parties rather than enforce the contract. Therefore, alternative dispute resolution mechanisms should obligate fulfilment of contractual obligations, particularly in terms of enforcement of security.

 Increase in number of specialized commercial courts

Commercial courts have been established to expedite commercial disputes. After initial success, these courts have begun to experience backlogs as the courts sit only in Nairobi and have a shortage of judges and other judicial officers. There is therefore a need to increase the number of judges and judicial officers, as well as to establish regional commercial courts. An additional area that could be explored is the creation of separate courts to deal with debt recovery within the commercial court system.

Strengthen the insolvency framework in Ghana

Specific proposals for legal and judicial reforms in Ghana include:

 

  • The provisions of the Companies Act, 1963 (Act 179), the Bodies Corporate (Official Liquidations) Act, 1963 (Act 180), or any other enactment relating to corporate insolvency or liquidation should be enhanced to include : (1) expedient in-court approval of settlements negotiated out of court ; (2) post-commencement financing recognizing creditor priority to enable financing for the firm during restructuring (3) inclusive restructuring involving all creditors (including secured and public creditors)  (4) pre-insolvency processes that enable restructuring before reaching nonviability; (6) simplified and cost-effective insolvency processes for SMEs enabling a fresh start for entrepreneurs within a reasonable time period and (7) the facilitation of various restructuring tools, such as debt-equity swaps (for example, through removing the requirement for shareholders to approve corporate changes).
  • Fixing the loopholes in the Borrowers and Lenders Act that encourages some borrowers to sue banks on some issue such as contesting the quantum of the loan amount indicated in the demand letter and making possession of collateral difficult.

[1] BOG collateral registry is intended to widen the collateral base. Hitherto charges over moveable assets from non corporate entities could not be registered. Registrar General is only in relation to corporate entities

 

[2] See page 33 of https://www.omfif.org/media/3677495/barclays-africa-group-financial-markets-index-2017.pdf

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