7. Debt Finance & Security

Question 1

If a company has Model Articles (MA):
(1) Will it need approval to borrow and grant security?
(2) If so, what resolution must be passed?

Answer 1

(1) Yes
(2) Ordinary Resolution (OR)

Question 2

What are the 3 main types of ‘security’?

Answer 2

(1) Mortgage
(2) Fixed Charge
(3) Floating Charge

Question 3

Rank the following forms of ‘security’ in terms of their strength:
(1) Mortgage
(2) Fixed Charge
(3) Floating Charge

Answer 3

(1) Mortgage
(2) Fixed Charge
(3) Floating Charge

Question 4

What is the effect of a ‘mortgage’ on the legal title of the asset?

Answer 4

Legal title is transferred to the lender until the debt is satisfied and then transferred back to the borrower

Question 5

What is the difference between a ‘mortgage’ and a ‘charge’ in terms of who has the legal title to the asset?

Answer 5

Mortgage - legal title transferred to lender
Charge - legal title remains with borrower

Question 6

What is the difference between a ‘fixed charge’ and ‘floating charge’ in terms of:
(a) Class of assets
(b) Types of assets normally taken over
(c) Lender’s control of what borrower does with asset

Answer 6

(a) Taken over:
Fixed - specific asset(s)
Floating - class of assets

(b)
Fixed - fixed assets e.g. machinery
Floating - floating assets e.g. stock

(c)
Fixed - Lender has control of what borrower does with asset (e.g. dispose of it)
Floating - Lender NOT have control until ‘crystallisation’

Question 7

(a) In a ‘fixed charge’ what are 2 examples of activities the borrower CANNOT do with the asset?
(b) What is the exception to the rule in (a)?
(c) What is an example of what the borrower CAN do with the asset?

Answer 7

(a)
(1) Dispose of the asset
(2) Add new charges to the asset

(b) Consent of the lender

(c) Use asset in ordinary course of business

Question 8

Would a ‘fixed charge’ or ‘floating charge’ be suitable for the following assets?
(a) Machinery
(b) Stock
(c) Vehicles
(d) IP
(e) Goodwill
(f) Cash

Answer 8

(a) Fixed
(b) Floating
(c) Fixed
(d) Fixed
(e) Fixed
(f) Floating

Question 9

What is the effect of ‘crystallisation’ on a ‘floating charge’?

Answer 9

Charge fixes onto the assets in the class so the borrower is unable to ‘deal’ with the assets (e.g. dispose of them)

Question 10

What is the common reason that a ‘floating charge’ ‘crystallises’?

Answer 10

Company becomes ‘Insolvent’

Question 11

Why is a ‘fixed charge’ a more secure form of ‘security’ than a ‘floating charge’?

Answer 11

Fixed charge holders are paid before floating charge holders in the order of priority upon a company’s liquidation

Question 12

What are 3 advantages of a ‘floating charge’ over a ‘fixed charge’?

Answer 12

(1) Can ‘deal’ (e.g. dispose of) assets on a day-to-day basis
(2) Can be taken over entire company - broad coverage
(3) Maximises borrowing - taken over assets (e.g. stock) not suitable for ‘fixed charges’

Question 13

What are the 4 disadvantages of a ‘floating charge’ over a ‘fixed charge’?

Answer 13

(1) Priority winding up - Fixed charge holders are paid before floating charge holders in the order of priority upon a company’s liquidation
(2) Priority same asset - Fixed charge holders take priority over floating charge holders on the same asset
(3) Asset depletion - borrower can sell the asset (e.g. stock) reducing value of the ‘floating charge’
(4) Set-aside - risk ‘floating charge’ could be set aside by application by a liquidator / administrator

Question 14

(1) Must a ‘charge’ be registered at Companies House?
(2) What are the consequences of failing to register the ‘charge’?

Answer 14

(1) No (but recommended)
(2) Charge void against a liquidator, administrator or creditor - holder become an ‘unsecured creditor’

Question 15

When must a ‘charge’ be registered with Companies House?

Answer 15

Within 21 days beginning DAY AFTER charge created

Question 16

To register a ‘charge’ at Companies House:
(a) What 2 documents + fee must be filed?
(b) When must this be done by?

Answer 16

(a)
(1) Form MR01 (details of charge)
(2) Certified copy of charge
(3) Fee

(b) Within 21 days beginning DAY AFTER charge created

Question 17

Following the registering of a ‘charge’ at Companies House. What step must the company also take?

Answer 17

Update its ‘register of members’

Question 18

Following the registering of a ‘charge’ at Companies House. What step must the company also take if it is a FIXED charge over LAND?

Answer 18

Register at Land Registry

Question 19

Who has priority of ‘security’ for two charges of the same type (e.g. 2 ‘floating charges’)?

Answer 19

Registered first (i.e earliest registered)

Question 20

(a) Who has priority of ‘security’ between a ‘floating charge’ and a ‘fixed charge’?
(b) What is the exception to the rule in (a)?

Answer 20

(a) Fixed charge (assuming registered)
(b) Document creating floating charge has a ‘negative pledge clause’ (stops creation of later fixed charges without permission)

Question 21

What ‘security’ has priority between an unregistered fixed charge and a registered floating charge?

Answer 21

Registered floating charge
(unregistered fixed charge = unsecured creditor)

Question 22

If lenders want to create a different order of priority for ‘security’ than the statutory rules (e.g. want floating charge to take priority over a fixed charge), what can they enter into?

Answer 22

Deed of priority

Question 23

What is the difference between ‘debt finance’ and ‘equity finance’ in terms of:

(1) Control over company
(2) Repayment
(3) Tax benefits
(4) Degree of paperwork / procedure
(5) Level of regulation

Answer 23

(1)
Equity - give away control of company (shareholders have voting rights)
Debt - maintain control over company

(2)
Equity - Dividends NOT mandatory
Debt - Interest on loan MANDATORY

(3)
Equity - dividends not tax deducible for Corporation Tax
Debt - interest tax deductible for Corporation Tax

(4) Equity procedurally more onerous

(5)
Equity - highly regulated by CA 2006
Debt - less regulated (contract law)