Collateral under a Loan Agreement

Collateral is property –  whether movable or immovable, tangible or intangible – that is offered as security for the repayment of a sum of money borrowed by a person or company. Collateral is given as an assurance that the Lender will obtain (full or part) repayment of the loaned sum in the event of breach by the Borrower of their obligation to repay the Lender under the underlying contract.

In Kenya, various lending institutions have various thresholds for what is acceptable collateral for the credit they offer based on the principles that valuable collateral is:

1. Liquid or can be easily liquidated;
2. A pledgeable asset owned or controlled by the Borrower; and
3. Is easily collected by the Lender.

The most popular collateral sought in Kenya includes land and equipment or machinery. Beyond this, parties to a loan agreement can consider the following assets as viable and valuable collateral.

Alternative Collateral other than Land and Equipment/ Machinery

Account Receivables/ Collectible Debts owing to the Borrower

With regard to a Borrower (an individual or a company) having many customers and a large quantity of account receivables on their books (because customers buy goods on an installment/PayGo basis) e.g., agricultural companies, solar companies, etc; the  Borrower can take advantage and offer their account receivables as collateral when seeking loans from Kenyan or foreign investors.

This collateralisation works by pooling many account receivables owed to the Borrower company. The cashflows from payments by account receivables debtors are used to repay the loan thus securing the loan owing to one or several principal Lenders. Parties can consider account receivables as viable collateral for a loan because the Lender gets paid out of cashflows from a constant pool of revolving customers of the Borrower and may indeed be the missing link for financing SMEs across Kenya and Africa.

Intellectual Property

This is an intangible asset that can have significant value depending on the value attributed to the brand of the particular company that is the Borrower.

Intellectual property that has been registered at the Kenya Industrial Property institute (KIPI) and/or internationally can be used as collateral. This includes: registered patents for inventions; registered industrial designs for making large quantities of products with a  special appearance that are a product of industry or handicraft; registered trademarks, technovations and utility models.

For instance, a trademark of a known and reputable brand is valuable collateral, as underlying the brand name is the implicit access to the customers and clients of the borrowing company such that the Lender is assured that in the event of default on the loan obligations, the Lender can leverage continued access of the Borrowers customers and clients who transact with the Borrower on the strength of the name of its brand.

The instrument by which a Lender takes security over intellectual property is a deed of assignment whereby the Borrower absolutely assigns its rights, title and interest over the intellectual property to the Lender. This assignment is discharged by repayment of the loan in full. Parties must ensure they register the assignment as per the provisions of the Movable Property Security Act and the Industrial Property Act in order to perfect the security under Kenyan Law.

Shares ,Treasury Bonds or Bills

These are attractive assets to use as collateral because they are easily liquidated and once pledged and the pledge perfected by notifying the relevant governing authority as the case may be (whether the Central Bank of Kenya, the Central Depository Settlement corporation, the Company’s Registry or  the Collateral Registry); it is difficult for the Borrower to dispose of or otherwise deal in the Treasury Bonds or Bills or Shares in a manner inconsistent with the lien that the Lender has over these kind of assets.

Further, Treasury Bonds/Bills are relatively stable assets as they are backed by the Government of Kenya.

Inventory

Stock or inventory can be used as collateral for borrowing. This may be existing stock or future inventory. The value of this type of collateral depends on the kind of inventory available as collateral.

For instance, in a developing country like Kenya, a financier may look to agricultural harvests e.g. grain like maize/barley; or other valuable agricultural commodities as collateral for a loan investment in the Borrower.

In the event of default, the stock would be sold or otherwise disposed of/dealt with for the benefit of the Lender and the proceeds given to the Lender. This can be an attractive type of security for financiers investing debt in primary agricultural producers. The Lender must assess the type of inventory to use as collateral and consider factors such as:

1. is the inventory easily saleable; or
2. is the inventory highly perishable; or
3. does the inventory consist of finished goods or half/finished goods?

Certainly, these considerations determine the ease of liquidating this class of collateral – and consequently the likelihood of the Lender’s debt being satisfied.

Perfecting Securities

Perfecting securities is the means by which a secured Lender acquires priority to other persons that acquire (or may acquire in the future) a lien over the same asset used as collateral. Perfecting a security interest simply means registering and notifying third parties promptly of your security interest in a particular asset used as collateral.

In some cases, the failure to perfect a security interest can even render that interest invalid or unenforceable.