13. Loan capital

Question 1

What are the main sources of loan capital?

Answer 1

Loans, overdrafts, debt securities

Question 2

What is a debenture?

Answer 2

A document that provides acknowledgement of debt, written memorandum of a loan. Can be secured and unsecured.

Question 3

What is the difference between possessory and non-possessory security?

Answer 3

Possessory security PLEDGE AND LIEN - creditor has PHYSICAL possession of the secured asset

Non-possessory security (mortgage and equitable charge) - does not involve the creditor taking possession of the secured asset.

Question 4

What is the most common form of security?

Answer 4

CHARGE - there are 2 types of charge

FIXED - taken over a specific asset and restricts the company’s ability to deal with the asset (The borrower cannot deal with the asset in question without either paying back the loan or obtaining the lender’s prior consent).

FLOATING charge is over assets which of their nature, are constantly changing e.g. raw materials, work-in-progress, stock in trade, goodwill etc. The directors are free to deal with these assets until such time as the charge crystallises.

In Re: Yorkshire Woolcombers Association, a floating charge was said to have the following characteristics:-

i) an equitable charge
ii) on a class of assets
iii) which the directors are free to deal with
iv) until crystallisation.  This is what distinguishes a floating charge from a fixed charge.

(i) Floating charge:- Company can deal with asset charged during currency of the charge; On liquidation floating charges rank behind fixed charges in the list of creditors. Proceeds of sale covered by the floating charge are available to pay the expenses of winding up and preferential debts. A statutory part of the proceeds is set aside for unsecured creditors.
(ii) Fixed charge:- The company borrower must obtain the lender’s consent before dealing with the asset.

Question 5

What is crystallisation?

Answer 5

Certain event cause the floating charge to crystallise, at which point it becomes fixed charge (liquidation, business ceasing, appointment of receiver).

Question 6

What are BOOK DEBTS?

Answer 6

BOOK DEBTS are sums of money owed to company for goods supplied or services provided.

Question 7

Why is it important to be able to distinguish between the fixed and floating charge?

Answer 7

It is vital for several reasons:

1. In the event of liquidation, assets secured by fixed charge are not available to the liquidator, s fixed chargeholders rank ahead of other creditors
2. If liquidated, a portion of debt owed to floating chargeholders is set aside to pay off the unsecured creditors. This does not occur in relation to debt owed to fixed chargeholder
3. Certain floating charges are vulnerable to being set aside by the liquidator, whereas fixed charges cannot be set aside by the liquidator.

Question 8

If a charge instrument describes the charge as fixed, does that mean that the charge is a fixed charge?

Answer 8

Classification is relevant, but not conclusive.

(Street v Mountford). This can be up to courts to decide.

Question 9

Can a fixed charge be taken over a company’s book debts?

Answer 9

It is possible to take fixed charge overbook debts. (Spectrum Plus ltd). The following needs to occur:

1. The charge should prevent all dealings with the book debts other than their collection, and to require the proceeds when collected to be paid:
   - to the chargeholder directly
   - into an account with the chargeholder bank that the company cannot access, or
   - into a separate account with a third-party bank, which the chargeholder then takes a fixed charge over.

Question 10

Explain how the post 2013 system of registration differes to the pre-2013 system?

Answer 10

Before 2013, the companies were required to keep a register of charges, (failure to do that - criminal offence).
Post 2013 - no requirement to keep a register of charges, however if a charge is not registered, then it will be a void against a liquidator, administrator or creditor.

Question 11

When must a charge be registered in order to be validly registered?

Answer 11

To register a charge, a statement of particulars must be delivered to the Companies House within 21 day period beginning the day the charge was created.

Question 12

What are the effects of registering a charge?

Answer 12

The registration of charge has following effects:

1. The information will be included in the register of companies
2. The Registrar will provide a certificate of registration to the person who registered a charge and this will provide conclusive evidence that the required docs were delivered within the specified timeframe
3. Provides constructive notice of the charge’s existence but does not provide notice of terms

Question 13

What are the effects of not registering a charge?

Answer 13

If the charge is not registered, then it will be a void against the liquidator, administrator or creditor of the company. (It is the security, not the debt is rendered void). Accordingly, the company will still owe the money to the creditor, but the creditor will lose their secured status. To offset this, if a charge becomes void for non-registration, then the money secured by the charge will become immediately payable.

Question 14

What is the difference between a Debenture and Debenture Trust Deed?

Answer 14

If a company borrows from a single source, the loan will be by way of a single debenture.
If it borrows from a number of sources, eg by way of flotation of debentures, the loan will be by way of debenture trust deed, appointing trustees to look after the interests of the debenture holders.

Question 15

What are the reasons for Debenture Trust Deed?

Answer 15

• More convenient for trustee to represent the interests of many individual debenture holders than for them to have to look after themselves.
• A debenture trust deed will create a legal mortgage of the company’s fixed assets. A legal mortgage is a legal estate estate in land, and in English Law, a legal estate cannot be vested in more than 4 persons. Accordingly, trustees have to be appointed in whom the legal estate can be vested.

Question 16

Contents of a Trust Deed

Answer 16

1. Appointment of trustees
2. Provision for payment of trustees
3. Legal mortgage of company’s fixed assets
4. Floating charge over the company’s undertaking
5. Obligations of company in respect of payment of interest and capital
6. Obligations of company in respect of care and insurance of property
7. Indemnity of trustees
8. Provision for meeting of debenture holders
9. Entitlement of trustees to appoint receiver:
   i. on default in payment of principal or interest
   ii. winding up of a company
   iii. breach of some other undertaking by company

Question 17

Disadvantages of floating charges to Lender

Answer 17

1. Value of security uncertain until crystallisation
2. Ranks after preferential creditors
3. Does not exist over goods subject to retention of the title clauses
4. Can be defeated by execution by judgement creditor
5. Can be defeated by landlord’s distress for rent
6. Can be invalidated for non-registration under s.874
7. Can be invalidated under IA s.239 and 245

Question 18

Invalidation under s.239

Answer 18

Any charge, whether fixed or floating, is invalid if created within 6 months of winding up in circumstances which amount to a preference, i.e. the charge was created by the company with the prime intention of putting hte creditor of the company in a better position that he would have been in but for the creation of the charge.
Once again the period is extended to 2 years if the charge is in favour of a connected person.

Question 19

Invalidation under IA s.245

Answer 19

Any floating charge created within 12 months of hte commencement of the winding up is void unless:

1. Consideration is given after the creation of the charge
2. The company was solvent at the time of the creation of the charge.

This one-year period is extended to 2 years if the charge is in favour of a connected person.

Question 20

Remedies of Debenture holders

Answer 20

The unsecured debenture holder can:

a. Sue for recovery of the money
b. Petition for winding up of the company (if owed £750)

As well as having the above remedies, the secured debenture holder may:

a. as above
b. as above
c. appoint a receiver
d. apply to court for the appointment of receiver.

Question 21

What is the procedure for Voluntary Winding Up?

Answer 21

• Directors enquiry into affairs of company
• Directors make a declaration of solvency
• Member’s meeting called
• Members pass the following resolution:
  i. Special resolution putting company into liquidation
  ii. Ordinary resolution appointing liquidator
• Powers of directors cease - liquidator proceeds with winding up of company

Question 22

What is the process for Creditors’ Voluntary Winding Up

Answer 22

• There is no declaration of solvency
• Members meeting called
• Members pass special resolution putting company into liquidation
• Members pass ordinary resolution appointing liquidator. If different from members, then creditors nominee takes post
• There may be appointed a liquidation committee having representatives of both members and creditors

Question 23

Compulsory Winding Up

Answer 23

Company may be wound up by court:

• if company resolved by special resolution
• no trading certificate (plc)
• the co is unable to pay debts
• resolved by court - just and equitable winding up

Question 24

What are the effects of winding up?

Answer 24

• The powers of the board cease;
• Without court’s permission, no legal action against the co
• ## control of assets passes to liquidator.

Question 25

What is a role of liquidator?

Answer 25

• Collect assets
• Converts them into cash
• Distribute the proceeds in satisfaction of co’s liabilities pari passu

Question 26

What property is not available to liquidator?

Answer 26

• Fixed charges
• Property or assets subject to retention of title
• Property or assets held on trust

Question 27

What is the order of distribution?

Answer 27

Expenses of liquidation
Preferential debts (pari passu)
Debts secured by floating charges to be paid out of proceeds of the property subject to charges
Prescribed part (pre 2013) to be put aside for unsecured creditors
Debts secured by floating charges post 2013 to be paid out of proceeds of the property, subject to charges
Deferred creditors - pari passu
Members (members last principle)

Question 28

What is under Misfeasance Proceedings?

Answer 28

IA 1986
The court can compel the officer to repay, restore or account for the money or property or contribute such sum to the company’s assets by way of compensation as the court thinks just

Question 29

What is wrongful trading?

Answer 29

IA 214
A person knew, or ought to have concluded, that there was no reasonable prospect that the company would avoid going into insolvent liquidation.

Question 30

What is fraudulent trading?

Answer 30

IA 213

A company has been carried on with intent to defraud creditors of the company.

Question 31

What are the book debts?

Answer 31

Book debts are sums receivable, either immediately or at some date in the future, by a company.
Charges over book debts are usually floating charges. It is theoretically possible to have a fixed charge over book debts but the charge holder/bank must control the property charged. In Spectrum Plus Ltd:
1 The company must not be able to sell or use the book debts as security without the consent of the charge holder/bank (so no using the charged book debts for receivables financing).
2 The sum paid to the company by the book debtors must be paid into an account specified by the charge holder/bank.
3 The proceeds in the bank account must be useable by the company only with the consent of the chargee/bank (it must be a ‘blocked account’): essentially, the chargee/bank must control withdrawals from the bank account into which the book debt receipts are paid, both in theory and in practice.

Question 32

Dissolution

Answer 32

Removal from the register is the point of dissolution of the company (IA 1986, ss. 201 and 205).

Removal from the register may take place:

• by the Registrar of Companies striking the company off the register after an advertisement in The Gazette.
• by the Registrar of Companies if the Registrar has reasonable cause to believe that no liquidator is acting or the affairs of the company have been fully wound up and required returns have not been made for six months
• on application by the company two months after publication of the application to remove in The Gazette (CA 2006, s. 1003);
• automatically, three months after the Registrar of Companies has been notified a voluntary winding up procedure is complete (IA 1986, s. 201);
• automatically, three months after the Registrar of Companies has been notified a compulsory winding up procedure is complete (IA 1986, s. 205);
• automatically, three months after application by the Official Receiver (who is the liquidator of the company) for early dissolution because it appears to him or her that: (i) the realizable assets of the company are insufficient to cover the expenses of liquidation; and (ii) no further investigation into the company is necessary (IA 1986, s. 202);
• on completion of administration: three months after notification to the Registrar by an administrator that there is nothing to distribute to creditors (IA 1986, Sch. B1, para. 84(6));
• by order of the court in relation to various circumstances such as reconstructions and amalgamations (CA 2006, s. 900(2)(d));
• pursuant to an Act of Parliament such as an Act providing for the takeover of one bank by another or a merger of banks.

Question 33

Challenging pre-liquidation transactions

Answer 33

Transactions at an Undervalue (IA 1986, s. 238)
‘a company enters into a transaction with a person at an undervalue if–
(a) the company makes a gift to that person or otherwise enters into a transaction with a person on terms that provide for the company to receive no consideration, or
(b) the company enters into a transaction with that person for a consideration the value of which, in money or money’s worth, is significantly less than the value, in money or money’s worth, of the consideration provided by the company.’

By Philips v Brewin Dolphin Bell Lawrie Ltd [2001] the transaction must be:

(i) entered into by the company;
(ii) for a consideration;
(iii) the value of which measured in money or money’s worth;
(iv) is significantly less than the value;
(v) also measured in money or money’s worth;
(vi) of the consideration provided by the company.’

Question 34

What 2 conditions must the liquidator establish to successfully challenge a transaction under s.238
(transaction at an undervalue)?

Answer 34

Even if a transaction is at an undervalue, the liquidator must establish two further conditions to successfully challenge a transaction under s. 238:
the transaction must have been entered into at a relevant time, which means within the two years ending with the commencement of the insolvency (which in most cases means the presentation of the winding-up petition to the court); and
at the time the transaction was entered into the company must have been unable to pay its debts as they fell due or to have become unable to do so as a result of the transaction.
Finally, even if the liquidator can establish these two conditions, no order will be made if the court is satisfied that s. 238(5) applies and the company entered into the transaction:
in good faith;
for the purpose of carrying on its business; and
reasonable grounds existed for believing that the transaction would benefit the company.

Question 35

What qualifies as a preference?

Answer 35

Factual
Person dimension: the preference must have been given to a creditor, surety or guarantor ofthe company.
Effect dimension: the preference must have put that person in a better position in the event of insolvent liquidation.
Relevant time
Temporal dimension: the preference must have been given within two years for a connected person, six months for others, of the commencement of insolvency.
Financial dimension: the company must have been insolvent at the time of the grant or have become insolvent as a result of the grant.
Desire
must have been influenced by a desire to put the preferred person in a better position.

Question 36

What other pre-liquidation transactions are there?

Answer 36

Extortionate credit transactions – within 3 years of winding up:
(a) the terms of it are or were such as to require grossly exorbitant payments to be made (whether unconditionally or in certain contingencies) in respect of the provision of the credit, or
(b) it otherwise grossly contravened ordinary principles of fair dealing and it shall be presumed, unless the contrary is proved, that a transaction with respect to which an application is made, under this section is or, as the case may be, was extortionate.’
burden of proof is reversed, being placed on the party arguing that the transaction is not extortionate.

Swelling company’s assets

• Misfeasance proceedings (Insolvency Act 1986, s. 212) The court can compel the officer to repay, restore or account for the money or property or any part of it or contribute such sum to the company’s assets by way of compensation as the court thinks just (s. 212(3).
• Wrongful trading (Insolvency Act 1986, ss. 214 and 246ZB) – “a person knew, or ought to have concluded, that there was no reasonable prospect that the company would avoid going into insolvent liquidation.”
• Fraudulent trading (Insolvency Act 19986, ss. 213 and 246ZA) - company has been carried on with intent to
  defraud creditors of the company.