Guidance for Loan Noteholders: Understanding the Loan Note Instrument and Security Trust Deed

1. The structure

A secured loan note issue of this kind — a loan note being a form of secured debt instrument — typically involves three related documents: a Loan Note Instrument, which sets out the terms on which the notes are issued and held; a Debenture, under which the issuing company grants fixed and floating charges over its assets in favour of a security trustee; and a Security Trust Deed, which sets out how the security trustee holds and administers that security on behalf of noteholders. The security trustee's obligations are limited to those specified in the Security Trust Deed itself.

2. Why does a Security Trustee exist?

It helps to understand why the security trustee role exists, and why it works this way, because this explains why the role is administrative rather than something broader.

When a company issues secured loan notes, the security package is typically put in place before any notes have been bought by investors. At that point the eventual noteholders are unknown and cannot be identified. The security is instead granted to, and held by, a trustee, on trust for whoever the noteholders turn out to be from time to time. The trust structure exists to give the security somewhere to sit before, and independently of, who ends up investing.

The trustee holds the security, not the obligation. The obligation to repay the notes always remains with the company, and the ability to meet it rests with the company's directors, who alone are responsible in law for the company's financial position and decisions. That responsibility cannot be passed to, or assumed by, a security trustee: if it could, this would dilute directors' own accountability, to the detriment of the company's creditors generally, not only its noteholders.

It is also important to understand what the security itself actually is. The charge held by the security trustee is a legal right of recourse against the company's assets — it is not, itself, an asset with a known or fixed value, and it is not a guarantee that sufficient value exists to repay noteholders in full. Where a charge is taken over one specific, named asset — in the way a mortgage is taken over a particular house — that asset can be identified and valued directly. A charge of the kind typically used in structures like this is different: it extends over the whole of a company's present and future assets, as a class, rather than any one named or valued asset. The total value of those assets, set against the company's total liabilities to all of its creditors, is a separate question from whether the charge exists, and it is a question that only the company and its officers are in a position to know at any given time. Holding security of this kind gives the security trustee, on behalf of noteholders, a right of recourse to the company's assets on enforcement — typically by appointing a receiver or administrator to realise them. It does not, by itself, establish what those assets are actually worth, or whether they will be sufficient to repay what is owed.

Holding security for noteholders as a class is not the same as overseeing the company's compliance with its obligations, and arrangements of this kind do not typically create any such oversight role. Where an independent party is given an express role reviewing a company's financial position — as an auditor reviews accounts — that role is set out in detail in its own right; it is not something to be inferred from the mere existence of a trustee.

There is also a practical reason for using a trustee rather than each noteholder holding a share of the security individually: it avoids every creditor having to act independently, and potentially against one another, to enforce their own claim. It also ring-fences the charged assets for the class of noteholders specifically, keeping them separate from the pool available to unsecured creditors — which is why secured creditors invest on the basis that those particular assets are available to them ahead of others.

It is also worth understanding that a charge is only enforceable against the company that actually granted it. Where the issuing company is part of a wider group, and funds raised from noteholders are lent on to another group company under an intercompany arrangement, the security trustee's charge does not automatically extend to that other company's assets — equivalent security or a guarantee typically needs to be put in place at that other company as well, for the security to reach assets held elsewhere in the group. Ensuring that obligations to investors and creditors are correctly effected is always the responsibility of the company's officers, as they alone know the mechanics and effect of the obligations they have put in place.

Because noteholders can change — loan notes of this kind are often transferable, and can be bought and sold repeatedly during their life — the trust is set up from the outset to hold the security for whoever the noteholders are from time to time, as a class, rather than for a fixed, permanently named group. The obligation owed by the company's officers does not change with this: it is fixed and clear to them regardless of who currently holds the notes or any individual holder's risk appetite.

Given all of this, it is not reasonable to assume that a security trustee is performing any role beyond holding security for noteholders collectively. Investment suitability, the credit risk of the company, and an individual's own risk appetite are matters for investors and their own advisers — not for the security trustee, whose role runs to a changing, originally unascertained class of noteholders, not to any individual. In practice, the true scope of a security trustee's role is sometimes described inaccurately by those promoting or advising on an investment, and the creditworthiness of a company — and the true value of its assets relative to its liabilities — can be misunderstood, or can change over time. None of this is something a security trustee is responsible for. If you are ever unsure what a security trustee's role does and does not cover, the simplest step is to ask.

3. The role of the Security Trustee

A security trustee typically holds the security created by a debenture on trust for the noteholders collectively. Its role is generally administrative and mechanical: it holds and, where instructed in accordance with the relevant deed, enforces the security. A security trustee does not typically have an independent duty to investigate a company's financial position, to monitor payments as they fall due, or to act on the instruction of any individual noteholder. It acts in accordance with the terms of the relevant deed, and in particular on the instructions of noteholders holding the specified majority required by that deed.

4. What happens if a payment is not received

Loan note instruments commonly provide that non-payment becomes a formal Event of Default only after a noteholder has given notice to the issuing company that a payment is overdue, and a specified cure period has passed without payment being made. Whether an Event of Default has occurred in a particular case depends on the wording of the relevant instrument.

A security trustee does not, and generally cannot, advise noteholders on whether an Event of Default has occurred. This is typically a matter for the noteholder to establish, if necessary with independent legal advice, by reference to the terms of the instrument. Under instruments of this kind, it is typically the issuing company — not the security trustee — that must receive formal notice that a payment is overdue in order to start the default process described above. A noteholder may, in addition, choose to inform the security trustee that they consider a default has occurred, so that the trustee is aware of this; however, this is not, of itself, the step which starts the formal default process, and it does not, of itself, entitle or require the security trustee to take any action.

5. Who can instruct the Security Trustee

A security trustee typically cannot act on the instruction of a single noteholder, however large or small that noteholder's holding. Deeds of this kind ordinarily require instructions to come from noteholders holding a specified proportion of the notes in issue (often more than half, by nominal value) before the trustee will act, and certain more significant steps — such as releasing security or agreeing material amendments — often require a special resolution passed by a higher threshold (commonly 75%) of noteholders at a duly convened meeting or on a poll.

6. Coordinating with other noteholders

Loan note instruments typically give noteholders the right to inspect the register of noteholders maintained by the issuing company, and to take copies of and extracts from it, at all reasonable times during office hours (sometimes subject to payment of a reasonable fee determined by the company). This right is exercised directly against the issuing company, which is required under the instrument to maintain the register and make it available, rather than against the security trustee. Instruments of this kind do not usually restrict the right to any particular purpose, although it is often used by noteholders wishing to coordinate with one another.

Although exercising this right can require coordination and effort, it exists for an important reason: the right to inspect the register, and the company's corresponding obligation to maintain it and make it available, are among the principal means by which noteholders, acting collectively, can hold a company to account. Company directors owe duties to the company under the Companies Act 2006, including, where the company is or may become insolvent, duties that require them to have regard to the interests of creditors as a class. A breach of those duties may in some circumstances expose directors to personal liability. Whether this applies in any particular case depends on the specific facts, and noteholders with concerns about a company's compliance with its obligations should take their own independent legal advice.

Similarly, if a noteholder requires a copy of the instrument, their loan note certificate, or any other loan note document, this should be requested directly from the issuing company, not from the security trustee. A security trustee holds the security documents in its capacity as trustee, does not typically have any obligation under the deed to provide loan note documents to individual noteholders, and does not usually maintain a distribution facility for that purpose.

7. Why the majority-threshold structure exists

The purpose of requiring a specified majority, rather than allowing any individual noteholder to instruct the security trustee, is to protect the collective interests of all noteholders. It prevents a single noteholder, or a small minority, from directing enforcement action that could affect the interests of the wider body of noteholders without their knowledge or agreement, and it ensures that significant decisions — such as accelerating repayment or enforcing security — reflect the collective view of noteholders as a whole. For example, where notes have fallen into non-payment, individual noteholders cannot each separately instruct the security trustee to enforce the security; noteholders holding the specified majority of the notes in issue need to give written instructions to the trustee for it to act.

8. A common misconception: does the Security Trustee monitor the Company's financial position?

It is sometimes assumed that a security trustee is responsible for monitoring the company's finances and activities on noteholders' behalf. This is not correct, and arrangements of this kind do not typically imply such a responsibility. A role of that kind would, by its nature, need to be explicitly defined — with clear boundaries and safeguards — given the significant responsibility it would represent. Such a role is not typically defined in security trust deeds of this kind.

The company's own directors are already legally responsible for running the company, keeping its statutory records up to date, and reporting on its financial position. There is no basis for assuming a security trustee has some separate, unwritten job of checking up on the company as well, on top of the duties the directors already carry.

A company's charges, accounts and other filings are public record, available to anyone, for exactly this reason: so that creditors and investors can review and monitor companies that interest them for themselves. Noteholders are expected to consider this information and, where appropriate, to monitor the company they have invested in. If the information is confusing or hard to interpret, that is a good reason to get independent professional advice — either before investing or at any point afterwards — not a reason to assume that someone else, such as the security trustee, is monitoring the position on your behalf, unless that has been explicitly documented. Where advice you have received appears to contradict the actual terms of the documentation you have received, that advice should be challenged and corrected.