The main question on the lips of an unsecured creditor, particularly in today’s uncertain financial climate, is – what happens if my debtor does not pay me?
Unlike a secured creditor, an unsecured creditor is one who has taken no rights against any property of the debtor. In other words, he or she does hold anything as security for the loan that (s)he has made to the debtor. An unsecured creditor does not, therefore, not have remedies such as the entitlement to sell property of the debtor that has been charged to secure the debt, and does not have priority with respect to repayment of the loan vis-à-vis secured creditors in the event of the debtor’s insolvency.
The principal recourse against a borrower who does not pay his or her debt would be to take legal action against him or her. If such an action is successful, the creditor is awarded judgment against the debtor. What is the effect of a judgment awarded by the court? A judgment does not, by itself, create security in favour of the creditor against the debtor. It also does not ensure that the debtor will pay the amount that the court has said he or she owes to the creditor. So what, a creditor may ask, does that do for me, and how do I get repaid?
There are various steps which a judgment creditor can take to get him or her a step closer to being repaid. The one of which this article seeks to provide is a brief overview of the charging order.
Where a debtor, under a judgment of the court, is required to pay money to a creditor, the court may, to enforce the judgment, make an order that creates a charge over such property of the debtor that the court sees fit. This order is called a charging order. A charging order may be granted over land, stock (which includes shares, securities and dividends arising from them) and other personal property of the debtor. Normally, a judgment creditor would be seeking to obtain a charging order over land, which would usually be the asset of most value owed by the debtor.
This article does not seek to describe the steps to be taken in order to obtain a charging order, except briefly to say that it must, of course, be granted by the court, the application must be supported by an affidavit which must contain specific information as identified by the Supreme Court (Civil Procedure) Rules, 2008 (the “Rules”), and that copies of any provisional charging order and the affidavit must be served on interested persons. Charging orders may be interim or final. By making a final charging order, the court confirms that the charge imposed by the interim charging order continues, although the final order may modify it. It should be noted that one category of interested persons that are to be notified is any unsecured creditors, and that the court will take into account, when determining whether or not to make a charging order, whether any other creditors of the debtor are likely to be unduly prejudiced if the order is made.
What is the effect of a charging order? In summary, the unsecured creditor becomes a secured creditor. The Bankruptcy and Insolvency Act defines “secured creditor” as “a person holding a mortgage, pledge, charge or lien on or against the property of the debtor or any part thereof as security for a debt due or accruing due to him from the debtor…”. A court may, upon the application of a creditor in whose favour a charging order has been granted, enforce the charging order by ordering the sale of the relevant property so that the proceeds of the sale can be used to repay the creditor’s debt.
Rule 48.11 states that this application must be supported by evidence on affidavit, notice must be served on the judgment debtor and, subject to the court’s discretion, on all interested persons of whom the judgment creditor is aware. This rule goes on to say that the court may give such directions as it deems appropriate to secure the expeditious sale of the land charged, at a price that is fair to both the judgment creditor and the judgment debtor.
One very important point relating to the effect of charging orders relates to their priority. If the debtor has already granted security in favour of another person or entity from whom (s)he has borrowed money and the creditor has or should have had notice of the charging order, then the charging order takes subject to any such prior mortgages or charges. In other words, the fact that the charging order is granted by the court does not give it priority over, for example, a mortgage taken by another creditor, such as a bank, that is first in time. It will, once registered, take priority over other securities that may be put into place after it.
In summary, an unsecured creditor’s recourse against a debtor that does not pay is to commence legal action and to obtain a judgment against the debtor. If the judgment debt is not paid, the judgment itself does not create security for the judgment creditor. A charging order is one of the means of enforcing a judgment debt. It makes an unsecured creditor a secured one, but a charging order will be subject to any security that was put in place before it. It can also be seen that the recourse of an unsecured creditor is heavily dependent on the involvement of the court, so the issues of time and cost need to be taken into account. While there are many circumstances in which a secured creditor may become involved in court proceedings also, it is still advisable, when lending money, to stay secured and not to wait for judgment day.
 Fisher and Lightwood’s Law of Mortgage (12th ed.), p.133.