13 - Loan Capital Flashcards
Explain the difference between secured and unsecured borrowing.
It is common for creditors to take steps to ensure that repayment is made. The most common way to do this is to obtain a right or interest over an assets or the business of the company. Where such a right or interest over an asset is obtained, the loan is said to have been ‘secured’ as the creditor has sought to secure his chances of being repaid. Where the creditor does not secure the loan, the loan is said to be unsecured.
What are the advantages of taking security over a company’s assets?
- If the company breaches the loan agreement, the lender will have rights over the company’s assets that have been secured (for example, selling the asset and recovering the proceeds);
- if the company is liquidated, secured debts are paid ahead of unsecured debts, meaning that secured creditors have a better chance of being repaid; and
- a secured creditor may be able to negotiate other benefits that unsecured creditors do not have (such as the right to consult with the board in certain cases).
Explain the differences between, and types of, possessory and non-possessory security.
Possessory security involves the creditor taking physical possession of the secured asset. Where security is non-possessory, the borrower will retain possession of the secured asset.
What is a fixed charge and why do they provide such a powerful form of security?
A fixed charge is a charge taken over a specific asset of the company (such as a building or a piece of equipment). Depending upon the terms of the charge, it will provide the charge holder with certain rights and impose upon the chargor certain restrictions. The exact rights contained within a fixed charge will depend on its terms, but typically fixed charges will provide the following advantages.
- Should the company default on the loan or if it enters liquidation, then the chargeholder will typically be able to appropriate the charged asset, and sell it to recover the money owed.
- The company will be unable to sell or deal with the charged asset, unless it first repays the chargeholder or obtains the chargeholder’s consent to sell or deal with the charged asset (AGNEW v INLAND REVENUE COMMISSIONER (2001)).
- The charge instrument usually provides that no subsequent fixed charges can be granted over the charged assets, unless the chargeholder so agrees.
- Assets secured by the fixed charge are not available to the liquidator if the company enters liquidation. This effectively means that debts secured by fixed charge rank ahead of all other debts.
What are the three key characteristics of a floating charge?
In YORKSHIRE WOOLCOMBERS ASSOCIATION LTD (1903), Romer LJ identified the three key characteristics of a floating charge:
- The charge is taken over a class of assets present to future (in practice, it is common for a floating charge to be taken over all the assets and business of the company);
- That class of assets is one which, in the ordinary course of the company’s business, would be changing from time to time (such as stock in trade); and
- Until some future step is taken by the chargeholder, the company is free to use the charged assets.
What does ‘crystallisation’ mean and when will a floating charge crystallise?
A floating charge floats over the charged assets until some specified event occurs, at which point it becomes a fixed charge over the charged assets (although it will not rank as a fixed charge for the purposes of liquidation). The charger is then no longer free to dispose or deal with the charged assets, unless the chargeholder consents. The process by which a floating charge becomes fixed is known as ‘crystallisation’.
The charge instrument may specify which events will cause crystallisation. It is common for the instrument to specify that the charge will crystallise if the company defaults on the loan, or if the chargeholder gives notice of crystallisation. It is implied that crystallisation will occur upon the following events (although the charge instrument can provide that they will not cause the charge to crystallise):
- the company goes into liquidation (PANAMA NEW ZEALAND AND AUSTRALIAN ROYAL MAIL CO (1870));
- the company’s business ceases (WOODROFFES (MUSICAL INSTRUMENTS) LTD (1986)); or
- a receiver is appointed (CARSHALTON PARK ESTATE LTD (1908)).
Why is it important to be able to distinguish between a fixed and floating charge?
- In the event of a company being liquidated, assets secured by fixed charge are not available to the liquidator, meaning that fixed chargeholders effectively rank ahead of other creditors;
- In the event of a liquidation, a portion of the debt owed to floating chargeholders is set aside to pay off the unsecured creditors. This does not cure in relation to a debt owed to a fixed chargeholder.
- Certain floating charges are vulnerable to being set aside by the liquidator, whereas fixed charges cannot be set aside by a liquidator.
If a charge instrument describes the charge as fixed, does that mean that the charge is a fixed charge?
The charge instrument’s classification of the charge is relevant, but not conclusive (STREET v MOUNTFORD (1985)). The court may conclude that a charge that is described as floating is actually a fixed charge, or vice versa.
What are book debts?
The Insolvency Service defines book debts as ‘sums of money owed to a bankrupt, partnership or company… usually for goods or service supplied or work being carried out’.
Can a fixed charge be taken over a company’s book debts?
It is possible to take a fixed charge over book debts. Lord Hope in SPECTRUM PLUS LTD (2005), stated that in order to take a fixed charge over book debts, either of the following would need to occur:
- the charge should prevent the company from dealing with the book debts in any way, so they are preserved for the benefit of the chargeholder’s security; or
- 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 a charge over.
Explain how the post-2013 system of registration differs to the pre-2013 system.
Before 2013, companies were required to keep a register of charges. A failure to do so was a criminal offence. The post-2013 system of registration is different. Companies are no longer required to keep a register of charges, and companies are not required to register charges. However, if a charge is not registered, then it will be void against a liquidator, administrator or creditor.
When must a charge be registered in order to be validly registered?
In order to register a charge, a statement of particulars and a copy of the charge instrument must be delivered to Companies House within a 21-day period beginning after the day the charge was created (s. 859A).
What are the effects of registering a charge?
The registration of a charge has the following effects:
- the information provided will be included in the register of companies (s. 859I(2)), and can be freely accessed online or by visiting Companies House;
- the Registrar will provide a certificate of registration to the person who registered the charge (s. 859I(3)) and this certificate will provide conclusive evidence that the required documents were delivered within the period allowed for delivery (s. 859I(6)); and
- although the CA2006 does not state what notice is provided by registering a charge, the courts have stated that registration provides constructive notice of its terms (WILSON v KELLAND (1910)). It is unclear whether this is still the case under the new system of registration.
What are the effects of not registering a charge?
If a charge is not registered, then it will be void against a liquidator, administrator or creditor of the company (s. 859H(3)). Note that it is the security and not the debt that is rendered void. Accordingly, the company will still owe the money to the creditor concerned, 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 (s. 859H(4)).
