In situations when someone has an obligation to fulfil payment or an obligation to perform something else (such as delivery of asset, liability under guarantees in an agreement) the creditor often wants some security from the debtor/the fulfilling party to ensure the fulfilment. The creditor may be a bank or for example a party to an agreement. In a sale and purchase agreement the seller may want to secure the payment of the consideration from the purchaser and the purchaser respectively may see a need for a security for a seller’s warranties. Further, a landlord often wants some kind of security from the tenant in order to secure payment of the rent.

In Sweden the most common forms of securities are discussed below.

  1. Pledge (in assets in a company, in shares or in real estate)
  2. Bail/guarantee (parent company guaranty or personal guaranty)
  3. Bank guaranty
  4. Escrow
  5. Insurance
  6. Undertaking not to reduce equity

1. Pledge

A right of pledge can be established in tangible assets, in shares in a company and in real estate. For all pledges to be valid it is necessary to sign a pledge agreement and to establish a right in rem. As a general rule possession of the asset constituting the security must be physically transferred to the creditor, in order for the creditor to have a binding security. In order to have a pledge in real estate and in all the tangible assets in a company (business mortgage) a mortgage deed must be issued, and the mortgage deed be transferred to the creditor. If there are no existing mortgages one must bear in mind that there is a cost (stamp duty) for issuing mortgages. Mortgage deeds may be physical but also electronic (in which case the transfer of the mortgage deed is made through an electronic system). Mortgage deeds are handled by authorities.

Pledge in shares in a company does not need mortgage deeds and thus no actions from authorities. The same goes for pledge in a specific tangible asset, however since the asset according to the general rule must be in the creditor’s possession pledge in a specific asset is often not applied.

A right of pledge gives you two major advantages over unsecured creditors.

Firstly, you have the right of immediate execution. This means that you can execute (“sell”) the pledged property and that you can recover the money from the sales without having to go to court first.

Secondly, you are a separatist in case of bankruptcy. This means that you do not have to file your claim in the bankruptcy and that you may also proceed to execution if your debtor goes bankrupt.

In the case of the establishment of a right of pledge, it is of course important that the value of the pledged asset exceeds the amount of the claim to avoid having to write off part of the claim.

2. Bail/guarantee

A third party can stand surety for a debt of another. A common example is the director-shareholder who stands surety for the financier (the bank) if his company cannot repay part of the loan. If asked to provide a guarantee as a private person, one should always consider that the consequences may be severe should one be obliged to fulfil the guarantee. The most common guarantee is the parent company guarantee.

A guarantee can be executed as a joint and several guarantee or as an ordinary (secondary) guarantee. In case of a joint and several guarantee the party and the guarantor are as much liable for the fulfilment and creditor can therefore choose which of the party and the guarantor should fulfil according to the original obligation. In case of the ordinary guarantee the creditor must first make a claim against the party, and only if the party may not fulfil according to the original obligation the creditor may claim the guarantor.

3. Bank guarantee

In the case of a guarantee, a third party – often a bank – undertakes to pay you a sum of money if you claim it as the beneficiary. This is generally the case if the debtor fails to pay his debt to you.

The most common example in practice is the bank guarantee on demand.

4. Escrow

In certain cases, a party can be asked to deposit an amount on a specific bank account, with an instruction to an escrow agent only to make payments from the bank account following an instruction from both parties or a non-appealable ruling from a court or arbitrators. Escrow is often used in sale and purchase agreements where the purchaser needs security from the seller with regards to the sellers warranties or undertakings in a sale and purchase agreement. The purchaser then deposits part of the consideration on an escrow account, which shall be released – after joint written instruction – when the seller is no longer responsible for warranties/undertakings. A deposit is also often used as a security for a tenants obligation to pay rent.

5. Insurance

In certain transactions the parties agree that an insurance company shall take over the seller’s liabilities for the warranties in the sale and purchase agreement. Since such liability for the insurance company comes with a substantial cost and a thorough due diligence investigation by the insurance company the solution is only recommended where there is a high value of the transferred assets. Some sellers, such as investment funds, put high importance in knowing the potential risks due to a transaction and such funds often has a close date and may not have pending liabilities. For such sellers the solution with an insurance company may be of interest.

6. Undertaking not to reduce equity

If a party in a transaction is a private person and is not willing to issue a personal guarantee the party (a company) may undertake not to reduce the company’s equity during the time under which the party has a liability towards the other party. Such an undertaking should always also be signed by the shareholder in the company.

7. Bankruptcy

In case of bankruptcy a creditor’s right to collect compensation from the assets in the bankruptcy estate is determined by the creditors security to the assets. The order of priority is specified by law.