5. Debt Finance Flashcards
Priority of fixed and floating charges: General Rule
Fixed charges always rank ahead of floating charges, even if the floating charge was registered first.
Order of fixed charges ranking: General Rules
Fixed charges rank in order of date of creation, as long as they are registered.
Consequences if a fixed / floating charge is not registered
If a charge is not registered, it is still valid and enforceable between the chargor and chargee, but void against the liquidator and third parties.
Highest form of security a bank could seek over an asset
Charge by way of legal mortgage
- this should always be sought in the first instance
Necessary considerations for a company prior to borrowing:
- Company must be allowed to borrow money under the constitution
- Directors must have authority to act on behalf of the company
- Adequate security must be selected for the loan
Are there restrictions in the model articles for private companies on borrowing money?
No BUT
- if company formed prior to 1 October 2009 (and articles not updates) check company memorandum to see if there are restrictions
- if there are - SH must pass SR to change articles
Three main types of loan
- Overdraft
- Term Loan
- Revolving credit facility
DEF: Overdraft Facility
An overdraft facility is a contract between the business and its bank which allows the business to go overdrawn on its current account. They are a type of temporary loan used to cover everyday business expenses when there is no other source of money available.
How is interest charged on an overdraft facility?
- Business has to pay a fee for their overdraft and bank charges interest by reference to its base rate (IR for borrowers with best credit rating)
- Charged on a compound basis: unpaid interest is added to the capital and interest is charged on the whole amount (implied into overdraft contracts unless contrary provision exists)
Downsides of an overdraft facility?
- repayment can be demanded at any time by the bank
- very expensive way to borrow (and unsecured = higher rates)
DEF: Term Loan
In a term loan, the business borrows a fixed amount of money, usually from a bank, for a specified period (ie term), at the end of which it must all be repaid. The borrower must also pay interest at regular intervals. Can be secured or unsecured
Bilateral Term Loan
Between two parties (business and the bank)
Syndicated Term Loan
Between business and a number of different lenders
When are syndicated term loans most commonly used?
If the amount on loan is high, this may be used to share risk between lenders
Terms for contract for a term loan
Loan agreement, credit agreement, facility agreement
Revolving Credit Facilities
In a revolving credit facility, the bank agrees to make available a maximum amount of money to the business throughout the agreed period of the revolving credit facility. During the lifetime of the facility, the business can borrow and repay money
When is interest payable in a revolving credit facility?
At regular intervals
Can revolving credit facilities be secured?
Yes (or unsecured), can also be bilateral or syndicated
Contract for a revolving credit facility: name
Facility Agreement
Benefits and Detriments of a Revolving Credit Facility
Benefits:
1. flexible way to borrow money
2. total amount of interest payable can be reduced by reducing borrowings
Detriments
1. involves time and expense in negotiating terms
2. High Fees charges
How do repayment clauses in contracts differ for revolving credit facilities and term loans?
- RCF: will be towards end of facility period
- TL: spread out evenly throughout the term
DEF: Floating interest rate
‘floating rate’ where interest rate is altered at specified intervals (eg. three or six months), by reference to a formula intended to maintain lender’s profit on the loan
Common Express covenants in loan contracts
- Limitation of dividends to not exceed percentage of net profit
- minimum capital requirements (by a certain percentage)
- no disposal of assets or change of business
- No further security over the assets
- Requiring information on the business
When will the court imply terms into a loan contract?
Rarely - their power is limited to implying terms where it is necessary to make contract effective and must be so obvious it ‘goes without saying’
When can a lender terminate a loan agreement?
If the borrower breaches any of the express contractual terms (eg. insolvent, failure to pay a sum due)
Definition of a Debenture
Generally used to describe a loan agreement in writing between a borrower and a lender that is registered at Companies House - giving the lender security over the borrower’s assets.
Who can enter into a debenture?
Companies and LLPs
Who can grant fixed charges?
Sole traders, partnerships, LLPs, Companies
Can LLPs grant fixed or floating charges (or both)?
Both
Do the Model Articles place restrictions on granting security for companies?
No - restrictions would only be found if articles were amended
What should be checked for a company formed before 1 October 2009 to see if there are restrictions on borrowing?
- If company has not updated articles to incorporate CA 2006, memorandum of association would have restrictions
If an old or new company has restrictions on granting securities in their articles, how must approval be sought?
A special resolution must be passed to amend the company’s articles
How can a lender make sure there are no restrictions on the company granting security / powers of the directors?
Can do this by inspecting articles of the company, searching the company’s records at Companies House + Requesting copies of relevant board resolutions
- Lender should also search company records to see if any charges have been registered
If a prospective lender is investigating the registrar of companies to ascertain any existing charges, what information will they be able to find about charges which do exist?
- date of creation
- amount secured
- which property is subject to the charge
- who holds the charge
In addition to checking the registrar of companies, where else should a lender check if wanting to take a charge over business property
LAND: land registry
IP RIGHTS: company’s title to IP property at IP office
WINDING UP SEARCH: At companies court to check no insolvency proceedings have been commenced
What type of company assets can be secured?
Almost all assets:
a. land
b. tangible property (stock, machinery)
c. intangible property (cash in bank accounts, debts, shares owned in other companies and IP rights)
Types of Security: Mortgages
A mortgage, with the exception of land, involves the transfer of legal ownership from the mortgagor (The company) to the mortgagee (the lender); gives the lender the right to immediate possession of property but this right is ‘held in reserve’ and only exercised if the borrowed money is not repaid (default)
- if it is land charge by deed expressed to be by way of legal mortgage
Difference between mortgage and charge
Charge does not transfer legal ownership from chargor to chargee (no right of immediate possession)
- rights arise if borrower fails to repay money borrowed
Can more than 1 fixed charge be created over the same asset?
Yes, but if the asset is sold by first fixed charge holder, 2nd fixed charge holder only eligible for repayment of the remainder after the 1st charge holder has paid itself
Fixed Charges
Effect: Lender has control over the asset (chargor not permitted to dispose asset eg.) but the chargor retains legal title
- If chargor goes into financial difficulties and enters liquidation, fixed charged holder has right to sell asset and to be paid out of the proceeds of the sale before any other claimants (eg. unsecured creditors)
Floating Charges
Secures a group of assets, such as stock, which is constantly changing. It is possible to create more than one floating charge over the same group of assets
What is crystillisation wrt floating charges? When does it occur?
GR: Company retains right to deal with assets subject to floating charges until the charge crystallises. At this point, the floating charge turns into a fixed charge.
Occurs when
a. chargor goes into receivership
b. chargor goes into liquidation
c. chargor ceases to trade or
d. any other event occurs which is specified in the charge document
Book Debts
Money owed to the company/LLP by its debtors
- book debts may be charged as assets by floating charge (or fixed charge where charge holder had control over both debts and proceeds once they were paid)
Registration process for a charge: first step for creditor / company
Within 21 days of the charge’s creation, company / charge ohlder must file a statement of particulars at CH (usually MR01), a certified copy of the instrument creating the charge, and the fee
When will the registrar of companies register a charge? What will they do after this?
- Once prescribed documents have been delivered
- the certified copy of the charge will appear on the register - Registrar sends certificate of registration to person who delivered documents
- Form MR01 and certified copy of charging document put on public company file
Implications if a company does not keep a copy of the charging document and Form MR01 available for inspection at their registered office or SAIL?
Criminal offence - but will NOT affect validity of the charge
Effect of a failure to register a charge at company’s house
Renders the charge void against a liquidator or an administrator of the company and the company’s other creditors
- lender cannot enforce security but company is required to repay immediately
Can the court extend the deadline for registration of charges at CH?
Yes, limited power if action is due to accident or it would not prejudice position of other shareholders in the company
Effect if the deadline for filing the security documents at CH is missed / details are inaccurate
Then the charge will be void as against a third party
If a company successfully applies to extend the deadline to register a charge at CH, when will the charge ‘take effect’
charge will have priority only from date of actual registration (therefore could lose priority due to delay if other charges registered in meantime)
If there are errors in any documents sent to CH to register a charge - can the company do anything about this?
Court has power under s 859M to allow rectification of any statement or notice delivered to Registrar for inaccurate details and to order replacement of document under s 859N if document is defective or the wrong document is sent
Requirements if a lender wants to release a property from their charge / allow them to sell it?
Person with interest in registration of charge (eg director) must complete sign and send Form MR04 to Registrar of Companies at Companies House
- Registrar will include statement (either release or charge or that property no longer belongs to the company) on its file
Multiple fixed charge holders: Who has priority
Provided all are correctly registered, that which was created first has priority
Multiple floating charge holders: who has priority
Provided all were registered, that which was created first
Fixed and floating charge over the same asset: which has priority
(a) A fixed charge or mortgage will take priority over a floating charge over the same asset, even if the floating charge was created before the fixed charge or mortgage.
Can creditors ever change the order of priority of their own charges?
Yes - via subordination
Creditors can enter into an agreement between themselves to alter the order of priority of their charges (agreement = deed of priority, executed by creditors concerned and sometimes the company)
Negative Pledge
Clause prohibiting the company from creating later charges with priority to the floating charge (ie. fixed or mortgage) with floating charge holder’s permission
Effect of a negative pledge clause when a subsequent lender takes a fixed charge over that same asset
If subsequent lender takes a charge over the same asset and has actual knowledge of this clause, their fixed charge would be subordinate to original floating charge
What if a company grants a subsequent charge on an asset already subject to a floating charge (with negative pledge)
Contract may be terminated immediately if company has covenanted that no earlier charges exist subject to negative pledge clause
How are negative pledge clauses disclosed / how could a lender find out about them?
Disclosed by completing a section of Form MR01 and sending to Companies House (clause will be included in certified copy of charging document delivered to the Registrar)
Two ways a company can execute a deed:
- Affixing its seal (MA: and signed by one authorised person with attesting witness)
OR - Signatures by:
- two authorised signatories (director or company secretary) or
- a director in the presence of a witness who attests the signature
If a company breaches a negative pledge covenant by granting a second security over the same asset - is this security void?
breach of a negative pledge covenant does not render the resultant security void.
What would a company need to do if they wished to sell an asset subject to a fixed charge?
Obtain the lender’s consent
Does a charge over an asset mean the legal title of the asset has been transferred?
No
