What is credit security?
When a creditor makes a loan to a debtor, the creditor does so with the hope and expectation that the debtor will repay the loan, usually with interest. In order to incentivise the debtor to repay the loan on time and in full, a creditor might want to insist on the debtor providing it with some sort of security for the repayment of the loan.
“Credit security” is the generic term given to different arrangements that provide creditors with security for the repayment of loans. Commonly, credit security arrangements give the creditor a right to claim possession of and sell property owned by the debtor in order that the proceeds of the sale of that property can be applied to repay the loan in question.
There are many different kinds of credit security arrangements that are recognised in South African law. Typical examples include mortgage bonds, notarial bonds, pledges, cession agreements, suretyships, guarantees, indemnities and the like.
There are different formalities required for the establishment of these different types of security arrangements and different costs involved in each case. All of these securities operate in different ways. It is therefore necessary for a creditor to assess carefully which type of security would best meet its needs in any given case.
What is a notarial bond?
A notarial bond is a form of credit security that is registered in the Deeds Office over some kind of movable property that the debtor has put up as security for its obligations to the creditor in terms of the loan. Typical examples of movable property bonded notarially are vehicles, jewellery, valuable artworks, and Kruger Rands.
However, any movable property whatsoever can be bonded provided that it is movable and tangible (i.e. it has physical existence and occupies time and space).
Because this type of security is registered at the Deeds Office, our law regards all others as having notice of the existence of this credit arrangement. This means that the creditor who registers the notarial bond first in time, will “rank” first - i.e. will get the “first bite” at the proceeds of the property sold.
Any creditors who register notarial bonds afterwards (i.e. second or subsequent bonds) or any creditors who have other (non-registered) security rights in that property, will rank after the creditor that registered the notarial bond first (with one exception - a prior pledge, the scope of which is beyond this article).
Drafting and registration
A notarial bond is drafted by a Notary Public, signed by the parties concerned and then registered in the Deeds Office over the movable property concerned.
Protection afforded by notarial bonds
Once the bond has been registered, it entitles the creditor to obtain a court order to take possession of the property that has been bonded, sell it and to use the proceeds to satisfy the debtor’s obligations to the creditor in terms of the loan agreement.
It also gives the creditor a secured ranking (which means that the creditor will be paid out first from the proceeds of the sale of the movable property concerned before any other creditors of the debtor) in the event of insolvency or of the sale - in execution by another creditor - or in the ordinary course by the debtor.
Notarial bonds are a particularly useful kind of credit security in the South African market place, for two reasons.
The first reason is that many debtors have movable property that can be used as security but they are unable to “unlock” the value of these movables because most lenders only want security over land (in the form of a mortgage bond). A lender who is willing to take security in the form of a notarial bond over movables (which is just as secure in law as a mortgage bond over immovables) will have a much wider target market and can thus attract and do more business.
The second reason that notarial bonds are particularly useful in the South African context is that the debtor remains in possession of the movable property even though it has been bonded in favour of the creditor. This means that more debtors are willing to bond their movables (as opposed to a situation where the property concerned would need to be handed over physically to the creditor as in the case of a pledge), because the debtors can keep the property safe in their possession whilst they are repaying the loan.
For example, many debtors could use their vehicles as security to raise a loan. However, if they didn’t have access to their vehicles they wouldn’t be able to travel to their place of employment or otherwise earn the income that they need in order to repay the loan. This appeals to a would-be credit consumer and creates business for a lender.
All in all, although notarial bonds provide a lender with a very strong form of security in terms of the South African law, they are widely under-utilised in the South African market.
Additional benefits of notarial bonds
The rights of a creditor to claim from a debtor in terms of a special notarial bond only prescribe after 30 years (and not after 3 years as the case with most normal loan agreements that are not secured).
- Registration costs
The registration cost of notarial bonds is ordinarily based on a tariff set by the Law Society of South Africa, which is itself based on the value of the movable property, and which means that the cost is usually affordable to the debtor (who is most commonly made responsible for bearing the cost of the registration of the notarial bond).
A notarial bond can encumber not only the movable property itself but any fruits of the movable property - like rental earned on the lease of the movable property, or if the movable property is the kind of thing that would produce young (like a flock of sheep, of a herd of cows), then the offspring of the movable property can also be encumbered.
This gives the creditor additional security over and above the value of the movable property on its own (because the value of the security will now include any fruits of the movable property), and it is not necessary for a creditor to register further notarial bonds over the fruits as and when they come into existence.
The above reasons make notarial bonds a particularly attractive option for lenders in the South African context, where many active and would-be credit consumers do not have immovable property to mortgage as security for a loan.
Hundreds, if not thousands of South Africans join the ranks of the employed and economically-active (and thus potentially credit-consuming) populace every day. Notarial bonds are a secure, recognised, and relatively inexpensive method of securing debt.
Credit providers and lenders in South Africa are encouraged to start making better and more widespread use of this security arrangement as it will open up the credit market and help to simulate an ailing economy, and unlock the value of movables held by those who could contribute to the economy in this way.