8) Debt Flashcards
Why is it difficult for private companies to raise money through equity finance?
Private companies are unable to offer shares to the public
s755 CA 2006
Do companies have restrictions on borrowing powers?
- Many companies have unrestricted power to borrow.
- Check company’s articles to ensure no restrictions.
Key method of protection for lender in the event borrowing company cannot repay loan.
- Taking security of assets
Loan Facility
Agreement between a borrower and lender which gives the borrower the right to borrow money on the terms set out in the agreement.
Loan facilities examples
Overdraft; Term loan; Revolving credit facility
Overdraft
- On demand facility
- Bank can call for all the money owed at any point in time to be repaid immediately.
- Makes overdrafts unsuitable as a long term borrowing option.
Term loan
Loan of money for a fixed period of time
Repayable on a certain date
Lender receives interest through period.
Revolving credit facility
Borrower has flexibility to borrow and repay.
Allows a company to draw down money, repay it and re-draw it down again.
* Borrower has flexibility to choose when it borrows and repays against an aggregate.
The main debt finance documents
- Term sheets
- Loan agreement
- Security document
Debt securities
In return for finance
Company issues a security acknowledging the investor’s rights.
Security
A piece of paper acknowledging debt / investors rights.
* Can be sold
* At maturity date, company pays the value.
Classic example of a debt security
Bond
Bond
Issuer promises to pay the value of the bond at maturity.
Interest also paid - usually biannually.
Where can bonds be traded?
Capital market.
Private companies and issuing bonds
- Private companies can only issue bonds to targeted investors
- Not to the public
s755 CA 2006
Term sheet
- Statement of key terms of transactions.
- Equivalent to the HoT
- Not intended to be binding = statement of the understanding
Loan agreement
- Sets out the main commercial terms of the loan
- Interest dates to be paid on dates
- More detail on the term sheet.
- Heavily negotiated.
Security Agreement
If a loan is secured, a separate security document will be negotiated
Debenture Under 738
- Any form of debt security issued by a company
- Debenture stock, bonds, any other assets of the company
- Whether charged or not.
Debenture - security
- Particular doc that creates a security.
- Debenture is a separate document from a loan agreement.
- Debenture sets out the details of security.
Important terms in loan agreement
- Representations
- Undertakings
- Event of default
Representations
- Representations and warranties
- Statement of fact as legal and commercial matters
- Repeated periodically during the life of the loan
Undertakings
Undertakings (or covenants) are promises to do (or not do) something.
Or to procure that something is done.
Event of default
- Breach gives the bank contractual remedies where breach constitutes an event of default.
- Can give the bank the power to call its money early if show a sign of being a credit risk
Forms of security
- Pledge
- Lien
- Mortgage
- Charge
Nature of security
Temporary ownership, possession or other proprietary interest in an asset to ensure a debt owed is repaid
(Collateral for a debt)
Benefit of taking security
Protects the creditor in the event the borrower enters into insolvency
Prove priority of a debt
Enforcing security
- Normally not necessary to enforce security if borrower is able to pay
- Enforcing security may be a simpler way of obtaining repayment rather than suing the borrower.
Pledge
- Security provider gives possession of the asset to the creditor until the debt is repaid
Eg pawning = pledge
Lien
- Creditor retains possession of the asset to the creditor until the debt is paid back.
- Mechanics lien = allows a mechanic to retain possession of a repaired vehicle until invoice is paid.
Mortgage
- Security provider retains possession of asset, but transfers ownership
- Right to require creditor to transfer asset back when debt is repaid = equity of redemption
Mortgage over land
- Charge by way of legal mortgage.
- Unusually ownership remain vested in the security provider usually.
Charge
- Security provider retains possession of the asset.
- Charge creates an equitable propriety interest in favour of the creditor.
- Certain contractual rights over the asset.
Two types of charges
- Fixed charges
- Floating charges
Fixed charge - Define
- Prevents borrower from dealing with the assets subject to the charge
= the strongest form of security. - Lender normally seeks fixed charge.
Floating charge - define
- Floats over a class of assets
- Does not prevent borrower dealing with the assets
- Until the floating charge “crystallises” = when defaults.
Agnew v IRC 2001
Label applied to a charge is not always determinative
* Necessary to look at the terms of the charge itself.
When a fixed charge is granted:
- Lender control borrower’s use of the charge asset
- Company cannot deal with assets without consent of the lender.
When might it not be appropriate to have a fixed charge
- eg stock and raw materials
- Borrower will need to use these assets to generate income to meet liabilities.
Fixed charges can be taken over assets such as
Plant and machinery
If a charge becomes enforceable
- Lender has ability to appoint a receiver
- Exercise power of sale over that asset.
Floating charge is appropriate for
- Over a class of assets - fluctuates
- Does not five the lender control over the assets
Re Yorkshire Woolcombers Association 1904
Defined a floating charge as a charge over:
* Class of assets, present and future
* Which is in the ordinary course of company’s business changes
** Until steps taken to enforce; a company may carry on business in a normal way**
When a floating charge crystallises
- Ceases to float over an asset class
- Fixes onto the assets in the class charged
- Prevents borrower dealing with assets - not treated as fixed charge assets for purposes of winding up
If a company receives more assets of the same class after crystallisation
These assets are automatically subject to the crystilised charge
NW Robbie and Co v Whitnye Warehouse Co Ltd 1963
NW Robbie and Co v Whitnye Warehouse Co Ltd 1963
- If company receives mor assets of the same class after crystallisation
- Assets are automatically subject to the crystallised charge
Crystallisation occurs in the following situations
- Common law - on winding up, appointment of a receiver or cessation of business
- Specified event - as defined in the loan agreement
A book debt
An unpaid invoice
* Sum owed to the company in respect of goods or services
* Book debts are a fluctuating asset
* May be a significant asset of a company.`
Are book debts fixed or floating assets?
- Muh debate
- In earlier cases = fixed charge
- Approach now overuled.
Siebe Gorman and Co Ltd v Barclays Bank Ltd 1979
- Court held that a charge over book debts = a fixed charge
- Degree of control of the bank could stop company withdrawals
- Even when in credit
Re Brightlife Ltd 1987
Clarified a company’s bank balance is not a book debt.
Cannot be subject to a fixed charge
Re Keenan Bros Ltd 1986
- Fixed charge created by the means of requirement that the funds collected. were to be paid into a blocked account.
- Prior consent of bank needed to withdraw funds.
** Fixed charge as the account was blocked**
Re Brumark Investments Ltd 2001
- Company attempted to create a fixed charge over book debts.
- Book debts excluded from fixed charge, unless bank had ordered payment into an account company could not operate freely.
- Who had control of the proceeds = key
Current position on charges over book debts
- Now very difficult to demonstrate the requisite control over book debts for a fixed charge.
- Requires a blocked account.
National Westminster Bank Plc v Spectrum Plust Ltd and Others 2005
National Westminster Bank Plc v Spectrum Plust Ltd and Others 2005
- Charge issued was stated to be fixed
- Company collected book debts, and drew on the account
- HoL held = Floating charge
- Approving Brumark
Following National Westminster Bank Plc v Spectrum Plust Ltd and Others 2005…
It is only possible to have a fixed charge of over book debts if they are paid into blocked account
- Gives the lender the degree of control required.
Are guarantees security
- Not strictly speaking
- Do not give rights in assets
- Similar commercial effect.
Guarantee for a loan
Guarantor will pay the borrower’s debt if the borrower fails to do s.
Why is it important to determine if a charge is fixed or floating>
Order of priority on winding up
* When a company is wound up assets are distributed in a specific order.
On winding up which charges are paid first….
- Fixed chargers are paid first.
Fixed charges on insolvency
- First order of priority on insolvency
- Entitled to whole of their debt.
- If shortfall may receive assets from floating charge fund.
Insolvency rules requirement for floating charge assets.
- Require a proportion of the floating charge assets to be set aside for the unsecured creditors
What are charged out of the floating charge fund before the floating charge holders
- Unsecured creditors.
- Preferential debts
Unsecured creditors are often paid…
- After floating charge holders
What type of charge do most banks require…
- A fixed charge & floating charge
- Greatest chance to recoup money if company goes into liquid`ation
Registration of charges
- All charges
- Created on or after 6th April 2013
- Must be registered on Companies House
Registration formalities for charges
- Charge must be reg within 21 days, beginning day after charge creation
- Usually done by the lender.
Section 859A(4)
Registration of charge within 21 days
Effect of failure to register
- Charge is void
- Debt becomes immediately payable
- Holder of charge reduced to an unsecured creditor
s859H(3)
Records to be kept by the company
Certified copies of all charges must be kept at the company’s office
s859P
Remedial measures in the case of non registration
Court has power to extend period of registration
s 859F
Grounds for extension of the option period for registration
Failure to deliver documents
* Accidental / inadvertence
* Not of nature to prejudice creditors /shareholders
* Just and equitable to grant relief
Barclays Bank plc v Stuart London Ltd 2001
- Court tends to allow register to be rectified
- Provided this does not prejudice any other chargers created between.
Victoria Housing Estates Ltd v Ashpurton Estates Ltd 1982 - summary
- Some cases where court has refused to allow a charge to be registered late
- Where the time has elapsed too long.
Victoria Housing Estates Ltd v Ashpurton Estates Ltd 1982
- Charge was created in 1978, not discovered until 1981 that was not registered
- Notice of winding up the company - chargeee applied to register.
- Charge should have been applied for on realisation
Allowing registration would prejudice other creditors
Debt finance
- Raising money by borrowing from a lender
- Promise to repay the money (usually with interest) at a later date.
Equity finance
- Raising money from shareholders v issue of shares
- Investors may issued preference shares - balanced against no voting rights
Equity - Return on investment
- Dividends.
- Capital growth
Debt - Return on investment
- Interest = contractual right
- Whether or not company is making profit
Equity - When does investor receive amount invested?
- On winding up - if sufficient assets
- On sale of shares (difficult for private companies)
- If company buys back shares
- Successful unfair prejudice claim
Debt - When does the investor receive back the amount invested?
- Agreed between terms or loan agreement
- Usually on maturaity or amortising through installments
- On sale of debt
Amortising
- Gradually write off the initial cost of an asset over a period
Equity - Priority on winding up
- Shareholders paid back after creditors - unlikely to receive full amount
- Arrangements may be made between shareholders as to prioritu
Debt - Priority on winding up
- Creditors paid before shareholders
- Creditors improve priority by taking security
- May contractually agree priority
Debt - Control
- Often require undertakings
- Security may give the lender control over the assets
Equity - Control
- Voting rights
- Existence and extent depends on the rights granted & number of shares
Debt - Other factors
- Banks may not be willing to lend on attractive terms
- Existing loan agreements would need to checked for hindering undertakings
- Interest is a deductible expense for tax purposes
Equity - Other factors
- New shareholders must be found for a share issue to succeed
- Share market conditions
- Dividends = allocation of profit; not deductible
