Deed of Priority: How Two Lenders Rank

A second secured creditor appears when a business borrows somewhere besides its bank: a finance company lending against plant, a vendor leaving part of a price outstanding, a second mortgage over the premises. Each holds a claim over the same assets, and the law has a default answer to who ranks first. Under the personal property securities laws of New Zealand and Australia, priority between registered interests generally follows the order of registration, and an all-monies general security agreement carries that place to later advances (in Australia, where the agreement provides for them). Registered mortgages over land rank in the order the register shows.

The default suits the first lender and worries the second. A bank that registered first could double its lending next year and the extra would still rank ahead. A deed replaces the default with a bargain: the first lender keeps its place for a defined amount, and the second knows the most that can stand in front of it. New Zealand's statute allows this kind of subordination in section 70 and Australia's in section 61, and each country's banking association publishes standard forms written to those sections.

Every deed is negotiated, but the parts recur. It names the collateral it covers, which may be everything the debtor owns or only part: a bank can rank first over debtors and stock while a finance company ranks first over the machines it paid for. It ranks the security interests. And it defines the priority amount, which in the New Zealand banking association's two-party form has three layers:

The interest period is there because a business in trouble stops paying interest well before its assets are sold, and a cap on principal alone would let the arrears eat the first lender's cover. A stated period gives the second lender a figure it can calculate. The deed then sets the order for proceeds, commonly: the first lender to its priority amount, the second to its own, then the first lender's excess, then the second's. In the New Zealand form either lender may still enforce, and one that receives more than its share holds the excess on trust for the other.

A seafood processor, constructed for this page like every figure in it, banks with a lender that registered an all-monies general security agreement first. A finance company later lends US$1.3m against processing lines the processor already owns and takes a second-ranking security interest over the same assets; because it is not financing their purchase, it has no purchase money priority to fall back on. The three sign a deed: the bank ranks first up to US$4.0m plus six months' interest at its rate of 9% and its costs; the finance company ranks next up to US$1.5m on the same pattern. The caps and the interest period are the example's, not a market norm.

Over the next two years the bank lends more, for a freezer store and a larger seasonal line. When the processor fails, the bank is owed US$5.40m and the finance company US$1.40m. The receiver's sale of the business, after its own costs and the claims the law pays first, leaves US$6.00m.

The shortfall is US$0.80m either way. The deed decides who carries it. Without a cap, the bank's later lending would have ranked ahead, and the finance company, which lent once against machines worth more than its loan, would have lost more than half of what it was owed. With the cap, the loss falls on the lending the bank chose to add after the deed was signed.

The nearest neighbour is the intercreditor agreement, and the difference shows in what the junior creditor gives up. Under a typical deed of priority it gives up its place in the queue for a capped sum. Under an intercreditor agreement written for senior and mezzanine lenders funding an acquisition, the junior lender usually also agrees to wait before enforcing, to accept limits on what it is paid while senior debt is outstanding, and to let the senior lenders release security on a sale. Subordination of debt differs again: a shareholder who agrees to be repaid after the bank has postponed the debt itself, secured or not.

Over land, the ranking can also be put on the register. In New Zealand, a mortgage priority instrument registered under the Land Transfer Act 2017, signed by the mortgagor and the mortgagee whose mortgage moves down, changes the order of registered mortgages. Australian registries record the same kind of change on their own forms, such as a postponement of mortgage in New South Wales or a mortgage priority form in Queensland. In England and Wales, the Land Registry alters the order of registered charges on an application made by, or with the consent of, any chargee whose priority is made worse. The commercial terms, including the cap, often sit in the lenders' own deed.

DEFINED IN ONE PARAGRAPH → · WHAT YOUR BANK HOLDS AS SECURITY → · THE ALL-MONIES CLAUSE →

For the first lender, the priority amount becomes a limit it lends under. A bank that agreed a cap of US$4.0m and is asked for a fifth million is lending the new money behind someone else, and the credit paper should say so: the extra is covered by assets outside the shared collateral, or the deed is renegotiated with the second lender's agreement, or the bank lends knowing where it ranks. Files go wrong when nobody tracks the facility against the cap.

For the second lender, the cap is the number its decision rests on, and it reads the definition closely: whether interest runs for a fixed period, what counts as costs, whether the figure reduces as realisations are applied, and which assets the deed covers. For the borrower, the deed is often the condition that lets the second loan happen at all; a bank asked to consent under its negative pledge will commonly want one first.

THE PPSR → · PERFECTION, AND WHY IT COMES FIRST → · REFINANCING AND SWITCHING BANKS →