The security package in structured finance

A package to be designed, not accumulated

In structured finance (leveraged acquisitions, project finance, group refinancings) the lender does not rely only on the borrower's creditworthiness. It relies above all on the cash flows of the transaction and the assets that generate them, and the security package is there to protect them.

The temptation is to ask for everything: a pledge over the shares, a mortgage over the real estate, an assignment of every receivable, guarantees from the shareholders. An oversized package, however, costs money in taxes and formalities, constrains the running of the business and is sometimes less solid than it looks, because some security does not hold up when a crisis comes.

A balanced package gives the lender control over the assets that matter and a quick way out on default, while leaving the borrower room to run the business. To build it, one has to start from the structure of the transaction, not from the list of available security.

Before the security: the structure of the transaction

The first question is not which security to ask for, but where the value and the cash flows are. In many transactions the debt is incurred by a special purpose vehicle or a holding company, while the real estate, contracts and customers sit in the operating companies.

In that situation the holding company's lender is structurally subordinated to the creditors of the operating companies: in a crisis, they are paid first out of the subsidiaries' assets. Three tools, often combined, close the gap:

• the share pledge, which allows the lender to take control of the corporate chain;
• security or guarantees granted by the operating companies, which give the lender direct recourse to their assets;
• a post-closing merger between the vehicle and the acquired company, which brings debt and assets into the same entity, in compliance with the rules on leveraged mergers (art. 2501-bis of the Italian Civil Code).

The choice between these tools depends on the nature of the assets, the tax regime, the limits on financial assistance and how well the security would stand up in insolvency proceedings.

Pledge over shares and quotas: control, voting and enforcement

The share pledge is the cornerstone of almost every package. Its value lies not so much in the price of the shares themselves as in the ability to transfer the whole company, with its contracts and licences, to a new buyer.

Three aspects need careful handling.

1. Voting rights. By law, unless otherwise agreed, the vote belongs to the pledgee (art. 2352 of the Civil Code), a rule also applied to quotas in an S.r.l. (art. 2471-bis). In practice the vote stays with the shareholder until a default occurs, and passes to the lender only after a trigger event.
2. Transferability. The articles of association may contain pre-emption or consent clauses that hinder a forced sale of the shares. They should be checked and, if necessary, amended before the pledge is created.
3. Enforcement. The sale of the pledged asset follows procedures laid down in the Civil Code (art. 2797), while an agreement allowing the creditor to appropriate the asset on default is as a rule void (art. 2744).

If the pledgor and the lender fall within the scope of the financial collateral rules (Legislative Decree 170/2004), the picture changes. The parties can agree on appropriation of the shares at a value determined by pre-agreed criteria, and enforcement is quicker, even where insolvency proceedings are under way. Checking this possibility at the outset can change the effectiveness of the whole package.

Mortgage, special lien and non-possessory pledge

Mortgage. When the value of the transaction lies in real estate or fixed plant, a mortgage remains the strongest security (art. 2808 of the Civil Code). Its cost depends largely on the tax regime. For medium and long-term loans it is possible to opt for the substitute tax (art. 15 of Presidential Decree 601/1973), which absorbs the taxes on the security. The regime was designed for banks and has been extended, subject to conditions, to certain non-bank lenders: this must be checked case by case.

Special lien. For medium and long-term loans to businesses, the law allows a lien to be created over movable assets used in the business, such as plant, machinery, raw materials and products (art. 46 of the Consolidated Banking Law, TUB). The lien does not take the assets away from the borrower, who continues to use them, but it requires written form and registration in a dedicated register.

Non-possessory pledge. Introduced in 2016 (art. 1 of Decree-Law 59/2016), it allows a business to pledge movable assets, including future assets, without delivering them to the creditor. Effectiveness against third parties depends on entry in an electronic register. The creditor can also enforce through faster procedures including, if agreed, appropriation of the asset at an appraised value. It is a useful tool for businesses with significant inventory or equipment, and is still under-used in practice.

Assignment of receivables and pledge over receivables and accounts

In structured finance, receivables are often the most important security, because they represent the flows from which the debt will be repaid. The two main tools are assignment by way of security and pledge.

For both, the decisive issue is perfection against third parties. An assignment takes effect against the assigned debtor only after notice or acceptance (art. 1264 of the Civil Code). Against other creditors and later assignees, a certain date is also needed (art. 1265). Similar rules apply to a pledge over receivables (art. 2800).

When the receivables are numerous or future, notifying each debtor individually is impractical. The rules on the assignment of business receivables (Law 52/1991) allow bulk assignment, including of future receivables, with simplified perfection rules, but only if the statutory requirements as to the parties are met.

The receivables typically involved include:

• receivables from customers and those arising under the transaction contracts (construction, supply, operation, offtake);
• insurance proceeds, also protected by loss-payee endorsements in favour of the lender;
• claims against the seller under the warranties in the acquisition agreement;
• balances on dedicated bank accounts, over which a pledge is created.

Receivables owed by public authorities deserve specific attention, because their assignment follows its own rules and often requires the consent, or the absence of objection, of the authority concerned.

Personal guarantees and intra-group guarantees

Suretyship and independent guarantee. A suretyship (fideiussione, art. 1936 of the Civil Code) is accessory: the guarantor may raise against the creditor the defences available to the principal debtor. If it covers future obligations, it must state the maximum amount guaranteed (art. 1938). In structured finance an independent guarantee is common, payable on first demand with a waiver of defences. The courts accept its validity, but its characterisation depends on the overall content of the document, not on the words "on first demand" alone.

Shareholder guarantees. Personal guarantees from the shareholders or the entrepreneur are often requested in mid-sized transactions. They should be sized, in amount and duration, to the risk they are meant to cover: an unlimited guarantee weighs on the shareholder's future choices more than the lender needs.

Intra-group guarantees. When a company guarantees the debt of its parent (upstream) or of a sister company (cross-stream), two checks are needed.

• Corporate benefit. The guarantee must serve an interest of the guarantor company, including in light of the benefits it derives from being part of the group. Otherwise the directors are exposed to liability and the guarantee itself may be challenged.
• The prohibition on financial assistance. In acquisitions, the target company may not, as a rule, guarantee debt incurred to purchase its own shares, except in compliance with the procedure laid down for an S.p.A. (art. 2358 of the Civil Code). For an S.r.l. the prohibition is even stricter (art. 2474).

This is why guarantees from acquired companies are often given only after the merger with the vehicle, or are limited to facilities other than the acquisition facility.

How security holds up in a business crisis

Security proves its worth when the borrower runs into difficulty. That is when it must be measured, and the check must be done when the package is put together.

Timing of creation. In judicial liquidation, voluntary pledges and mortgages created for pre-existing debts can be clawed back: within one year before the opening of proceedings if the debts were not yet due, within six months if they were (art. 166 of the Business Crisis and Insolvency Code, CCII). Security created at the same time as the loan is better protected. It is therefore advisable to sign the loan and the security on the same day, and to avoid granting security later for existing debts.

Exemptions. Acts carried out under a certified recovery plan, a restructuring agreement or a composition with creditors are not subject to clawback, under the conditions set by law. In refinancings of businesses under strain, placing the new security within one of these instruments is often the lender's real protection.

Protective measures. On entering a crisis resolution procedure, the debtor can request measures that stay creditors' enforcement actions. Even a secured lender may be blocked for a period. Financial collateral over accounts and shares, where it falls within Legislative Decree 170/2004, enjoys stronger protection.

The balanced package

Each form of security protects a different asset and comes with its own critical point to check. The table summarises the main choices.

A package is balanced when each form of security has a clear function and none needlessly duplicates the others. It must allow the borrower to run the business: to sell non-core assets, use working liquidity, and release security as the debt is paid down.

Finally, clear rules are needed between the lenders, especially when there are several of them or they rank differently. An intercreditor agreement and a security agent establish who decides on enforcement and how the proceeds are shared. A security package is judged on the day it is needed, and that day is prepared at signing.