Businesses go into business in order to make money. The profit motive is generally the biggest motive for entrepreneurs to venture into business and face the various risks of running and building a business. The start-up process in itself already requires a significant amount of resources from the business owner or owners which normally includes time, effort, and money.
But sometimes, this is not enough and the business needs to inject more money in order to either continue its operations to generate cash flow or to grow the business to a larger scale. It may sometimes need to do both of those together at the same time. There are generally two approaches to this: either the business gets it through additional equity, or secures it through debt.
Financing or securing a loan can be a challenge for start-up businesses faced with cash flow problems and/or capital requirements. Without an established track record on cash flow generation of their business operations, borrowers have difficulty proving their repayment capacity which is one of the 5 C’s of Credit (character, capital, capacity, collateral, and conditions) which lenders typically look into when evaluating a credit relationship with a borrower.
One of the mitigants lenders use to address this risk is to require security from the borrower. The acceptability of the security offered depends on the risk appetite of the lender. More conservative lenders tend to require more liquid instruments such as cash, cash instruments, marketable securities and such.
On the other end of the spectrum, lenders could also provide financing to a borrower even without requiring security at all should the lender’s overall evaluation of the borrower suggest an acceptable credit risk. Somewhere in between that spectrum are loans secured by Real Property, that is, a piece of real estate that the borrower owns.
This means that there are two ways for the lender to secure a real estate property from a borrower: one, through a mortgage loan, and, two, caveat loans. Both are normally short-term business loans which are considered secured business loans because they are bound by an agreement wherein the borrower agrees to offer his/her real estate property as a form of reassurance to the lender that he/she will repay the loan. The difference between a caveat loan and a mortgage loan is their level of agreement as discussed further below.
What is a Caveat?
The word “caveat” is derived from a Latin term that when translated means, to “let him beware”. This entails that a caveat is a warning for third parties that the lodging party, in this case, the Lender, has an interest in the land and that the owner who is encumbering the said property has yet to pay off the debt. A caveat prevents or stops the owner and holder of the title of the property, who in this case is the Borrower, from making encumbrances on the property without the consent of the Lender.
A caveat can be attached to the title of a property without the consent of the owner of it, this stems from their contract therein, but the person lodging the caveat is and can be liable for legal penalties that are usually financial in nature if a Court finds that the caveat is not valid. Therefore, the Caveator or Lender must exercise an extraordinary degree of caution before attaching a caveat to any property. This should also always be lodged by an official Solicitor who confirms that there is an actual caveat interest exists.
A caveat can only be removed by consent of the Lender, or by the registered proprietor of the property if a “lapsing notice” is applied herein which removes the caveat unless the lender appeals to the Supreme Court. A caveat used to protect a loan is generally most frequently removed once the loan has been repaid.
This article serves as an important reminder for the borrower, who is considering to access caveat loans, to also consider the important factors when picking a caveat lender.
How is this different from a Mortgage?
A mortgage is similar to a Caveat. However, it is a degree more secure and enforceable as a type of loan security. This is because a mortgage requires the consent of the registered proprietor, in this case, the Borrower, to take effect.
In most cases, a mortgage provides the lender with the right to sell and repossess the property if the borrower fails to pay their payments on time.
A mortgagee or a Lender, in this case, takes possession of the Deed of Title to the mortgaged property, which means that in order for the registered proprietor, or Borrower in this case, to make any encumbrance of the property mortgaged, the mortgagee must consent and provide the Title Deed.
To remove a mortgage from the Deed of Title, the loan must be repaid and proceedings with the registry should be taken into action.
Therefore, while both caveats and mortgages offer security for a lender against the Real Property of the borrower, a mortgage provides a higher degree of enforcement options if the borrower defaults on their loan.
As a result, a lot of finance facilities require a mortgage as security over the borrower’s property usually for larger loans, while lenders for smaller loans, or a party seeking security for payment of services or supplies, commonly utilize caveats or caveat loans to cater to short term business loan requirements.
When to use a Caveat Loan?
Given above, a caveat loan has fewer restrictions for both the borrower and the lender. While both transactions are covered by legally binding agreements, a caveat effectively bars the borrower, who is the owner of the land in this case, from entering into further transactions including selling, mortgaging or borrowing further against the offered property without the consent of the Caveator, or lender in this case. This is to the advantage of the borrower as this serves as a control or check for the borrower to not get further into debt.
On the other hand, the advantage of this kind of transaction for a lender is an easier, shorter, and quicker internal process as this takes away the need to take a deeper dive into evaluating the borrower’s business. With the reassurance of the legally binding caveat, a caveat lender does not have to spend extra resources, requiring both time and money, looking into the cash flow of the business but instead take comfort in the “security” offered by the effective control of a real estate property covered by a caveat agreement.