3. Financing a Company- Debt Flashcards
What is debt finance?
Money a company raises by borrowing
Why would a co borrow money?
- Fund start up of operations
- Fund expansion
- Help through temporary cash-flow issues or longer difficulties
2 main types of debt finance
- Loans
- Debt securities
When does a loan arise?
when co borrows money from banks/other lenders (directors/shareholders)
Types of loan
Overdraft
Term loan
Revolving credit facility
What is debt security
IOUs issued by co to investor for cash payment
Have to be redeemed (repaid) by co at an agreed future date
Are there any restrictions on borrowing in the model articles?
No
What is required for the directors to borrow money on behalf of the co
The authority to do so MA 3
When can a private co borrow?
From the moment of incorporation
What governs a loan agreement?
Contract law
What are contractual loan terms usually agreed on
Usual market practice
Purpose/length of loan
Background/finances of co
Relative bargaining power of the parties
Is there a legal requirement to give lender security for a loan
No- if a lender has security, loan can be easily recovered. Without it, co may pay a higher interest rate for unsecured loans.
What is an overdraft facility
Contract between co and bank allowing co to go overdrawn on c/a
Temporary loan for everyday business expenses when there is no other source of money
Terms when a co overdraws on overdraft which has not been agreed in advance
If not agreed, bank is not bound to meet any withdrawal not covered by funds in the a/c
Where co attempts to withdraw money in excess, they are making an offer of which the bank accepts by meeting the drawing -> contract
When is an overdraft repayable
On demand - Borrower is given enough time to effect mechanics of payment, but not to raise requisite sums Bank of Baroda v Panessar
Overdraft interest rate
Charged by reference to bank’s base rate on compound interest. Implied into overdraft
What is a term loan?
Where co borrows a fixed amount for a specified period ‘term’ at the end of which it must be repaid
What is a bilateral loan
A loan between 2 parties
What is a syndicated loan
A loan between a co and a number of different lenders
Different terms for a contract
Loan, credit, or facility agreement
What happens if a co does not borrow the full amount in a term loan agreement
Loan is available to the co for an availability period, after which is unavailable
What is a revolving credit facility?
- Bank agrees to make available a max amount to co throughout agreed period
- Co can borrow and repay amounts during the lifetime of the facility
- Able to borrow amounts that it has already repaid
Contractual terms of a loan agreement
Amount
Currency
Type
Availability period
What happens once an agreement has been signed/
Lender must provide co with loan monies upon request
What happens if lender refuses to lend money upon request
Co may be entitled to damages . Nominal if the co is able to obtain the same loan elsewhere
Robinson v Harman
If loan was at a low rate of interest unobtainable elsewhere, damages could be substantial
Can banks demand repayments for TL/RCF on demand?
No- they cannot. Repayment payable in full in one go at the end of term/in equal instalments/ unequal instalments with the first installment being the largest
What are the 2 types of interest rates
Fixed/floating
What is a floating interest rate?
Co pays interest allowing lender to alter rates at specified intervals
What are express covenants?
Contractual promise to do/not do something
What is the purpose of covenants
Ensures the co conducts business within agreed limits, ensuring lender is repaid in full
Examples of express covenants
Limitation of dividends (not to exceed specified percentage)
Min capital requirements (current assets exceed liabilities)
No disposal of assets or change of business
No further security over assets (negative pledge clause)
Info on co busines (annual accounts, interim financial statements, communications etc)
What is a debt security
Financial instruments issued to investors to raise money
Commercial paper
Short term debt security which has to be repaid ‘mature’ within 12 months of being issued to investors
Bonds
Medium to long-term debt securities maturing over a year after co issues them to investors
EMTN
Allows co to issue IOUS of varying lengths in a series of different issues over time
Short-term trade credit
Payment to suppliers a number of days after invoice delivery (vs goods delivery)
Debt factory
Co sells trade debts to collection agency
Agency pays co a proportion of trade debts (money owed to co)- agency owns debts and seeks to get as must as possible from debtors) + profit
What is a debenture
A doc which either creates a debt/acknowledges it Levy v Abercorris Slate and Steel; s738
What is a secured debt?
Secured lender can claim secured assets of co if co fails to meet its obligations under facility agreement
What is an unsecured debt?
Governed by pari passu
Debts are all reduced pro rata if insufficient funds to pay all debts
Purpose of security
Security increases chances of creditors being repaid, should co’s go into financial difficulties
How does a lender recover debts via security
Defaults -> seizure of assets-> sale for proceeds
Definition of charge
Include any charge or lien on any property (s205(1)(xvii) LPA 1925
Things lenders must consider when granting security
No restrictions on co granting security
Search co records at CH to see if any charges have been registered against co property
Must be sufficient value in that property to act as adequate security for proposed loan
s859I, CA 2006
Registrar of companies must include certified copy of instrument creating charge, open to inspection by anyone
What can a lender discover from the register?
Date of creation of existing charge
Amount secured
Which property is the subject of the charge
Who holds the charge (enforcer)
Types of security
- Mortgages
-Charges - Book debts
Mortgage
Highest form of security
Transfer of legal ownership from mortgagor (co) to mortgagee (lender)
Lender has the reserved right to immediate possession on defaults
Title transferred following repayment of loan
Separate mortgage must be created over each asset
Mortgage over land is ‘a charge by deed expressed to be by way of legal mortgage’ (s87, LPA 1925)
What is a charge?
- Form of security that doesn’t transfer legal ownership from chargor to chargee
- No right to immediate possession
- Important rights over asset should co default
Fixed charges
Can be taken over property such as machinery and shares
Fixed charge over each individual asset
Lender has control of the asset (cannot dispose of asset without charge holders consent)
Upon liquidation, fixed charge holder has the right to sell the asset & be paid from proceeds (repay outstanding amount) before any other claimants (unsecured creditors)
Floating charges
Secures a group of assets which are constantly changing
Possible to create more than one floating charge over the same group of assets
Book debts
Debts owed to the co by debtors
National Westminster Bank v Spectrum Plus LTD
Book debts can be secured by fixed charge where charge holder had control over both debts and proceeds once paid
If co was able to use proceeds from book debts for business purposes, this would indicate a floating charge
Merely calling a charge fixed does not prevent courts from holding it to be floating
Other types of security
Guarantee, Pledge, lien
Pledge
Asset is physically delivered to serve as security until debtor has paid debt
Right to sell asset to settle debt owed, provided creditor gives sufficient notice
Lien
Right to physical possession of debtor’s goods until debt is paid
No right to sell to settle the debt owed
Common law lien arises law, permitted creditor to retain possession of co assets until debt is paid
Retention of title
Buyer does not get title to goods until seller has been paid
Goods are repossessed if buyer defaults
Statutory lien
Unpaid seller of goods which are still in their possession can be kept until they have been paid
Key terms
- Security
- Representation/warranties
- Covenants
- Enforcement and powers
Representation
Borrowing co to make series of contractual statements relating to charged assets
Intention of getting co to reveal relevant info about the assets
Co warrants that property is free from any other charge
If there is, co must disclose this or it will be in breach -> termination of loan agreement
Enforcement and powers
Circumstances in which security becomes enforceable
Sets out lender’s powers
Power to sell assets
Express power to appoint an administrator if a qualifying floating charge holder, lender is empowered to appoint administration without court petition
What happens if a charge is not registered
security becomes void
Documents required
co /interested person will have to deliver
859D statement of particulars to CH
859A(3) Certified copy of charge instrument
Statement of particulars form
MR01
When must form MR01 be submitted
To be submitted within 21 days beginning with the day after the day on which the charge was created (s859A(2) and (4), CA 2006)
Consequence of registering charge
Registrar of companies registers the charge, allocating 12 digit unique reference code to charge and notes it on the register
Charge is fully valid against another creditor/administrator/liquidator of co
Requirement of a fixed charge of land
Registered at LR
What happens if charge is not registered
Charge void against liquidator/administrator of co & against other creditors (s859H(3))
Another creditor who registered the charge takes priority
If 21 day period is missed/inaccurate details provided, same consequences ^
Procedure post loan redemption
Person with interest may complete, sign and send form MR04 to ROC
Ensures co’s file is up to date
Registrar includes statement of satisfaction
Entries at LR to be removed
Remedies for inaccurate details?
s859M allows rectification of any statement/notice delivered to registrar for inaccurate details/order replacement of doc on the register under s 859N if charging doc was defective/wrong doc was sent
Release of charge process
Person with interest of the charge must complete, sign and send form MR05 to Registrar of companies at CH
Includes statement (charge release/that property no longer belongs to co) on file
DS1 removes entry at LR
Priority of charges
Fixed/mortgage over floating even if floating charge was created before the fixed charge
If more than one fixed/mortgage, priority in order of creation date
If there is more than one floating charge, by order of creation date
Subordination
Possible for creditors to agree amongst themselves to alter order of priority of charges
What is a negative pledge?
A clause prohibiting co from creating later charges with priority to floating charge holder
What happens if a lender takes a charge over the same asset where there was a negative pledge
If subsequent lender takes a charge over same asset & has actual knowledge of negative pledge clause, subsequent lender will be subordinate to original charge holder
How to establish negative pledge clause
completing section of MR01 to CH
Clause itself included in copy of charging co, delivered to Registrar
How would a subsequent charge holder have actual knowledge
If subsequent charge holder conducts a search, they will have had the required actual knowledge (liable for inducing breach of contract Swiss Bank Corp v Lloyds)
