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SQE2 - Business Law and Practice > Debt Finance > Flashcards

Debt Finance Flashcards

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1
Q

Types of Debt Finance

What are the two main types of debt finance?

A

Loans and debt securities.

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2
Q

What should a company check before borrowing money?

A
  • Constitutional restrictions
  • Ensure the directors have authority to act on behalf of the company.
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3
Q

Types of Debt Finance

What is an overdraft facility?

Provide its key features.

A

A contract between a business and its bank allowing the business to overdraw from its current account.

Features
- Temporary loan for everyday and business expenses.
- Maximum amount agreed in advance.
- Uncommitted facility, i.e. payable on demand.
- Implied term in contract that compound interest is charged on unpaid interest.

Compound interest: unpaid interest is added to the capital and interest charged on the whole amount.

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4
Q

Types of Debt Finance

What are the advantages and disadvantages of an overdraft facility?

A

Advantages

  • Flexible and few formalities

Disadvantages
- Repayment may be demanded at any time.
- High interest rates (as it is usually unsecured)

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5
Q

Types of Debt Finance

What are the features of a term loan?

A
  • Fixed amount borrowed for a specified term.
  • At the end of the term, the money must all be repaid.
  • Interest paid at regular intervals
  • Can be short-term, medium-term, or long-term
  • May be secured or unsecured.
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6
Q

What are the advantages and disadvantages of a term loan?

A

Advantages
- Greater certainty than an overdraft.
- Bank can only request repayment under the terms.

Disadvantages
- Time and expense negotiating terms and legal documentation.
- Once repaid, cannot be reborrowed.

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7
Q

What are the key features of a revolving credit facility?

What are the advantages/disadvantages?

A

The business can borrow, repay and reborrow money up to an agreed limit during the facility period.

Advantages

  • Very flexible
  • Borrower can control amount of interest payable by reducing borrowings.

Disadvantages

  • Time and expense in negotiating and agreeing legal documentation.
  • High fees.
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8
Q

The facility agreement

What are the main clauses in a facility agreement for a loan?

A
  • Payment of money to borrower
  • Repayment and pre-payment terms
  • Interest rates
  • Express covenants
  • Events of default
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9
Q

The facility agreement: Payment to borrower

What do the initial clauses set out?

A
  • Amount of loan
  • Currency
  • Type of loan
  • Availability period during which the loan can be taken

Availability period in a revolving facility will be almost the entire length of the facility.

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10
Q

The facility agreement: repayment and pre-payment

What are the different repayment terms available to the bank?

These will be set out in the agreed repayment schedule.

A
  • Whole loan at end of term (bullet payment)
  • Equal instalments over the term (amortisation)
  • Unequal instalments, with final instalment being largest (balloon repayment)

Repayment of a revolving credit facility is toward the end of the facility period while the term loan is spread out more evenly.

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11
Q

The facility agreement: interest rates

What are the two types of interest rates?

A
  • Fixed
  • Variable

Variable: interest rate alterated at specified intervals (to reflect changes in base rate)

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12
Q

The facility agreement: express covenants

What are some commonly included covenants?

A
  • To limit dividends;
  • Minimum capital requirements (assets exceed liabilities by a specified amount);
  • No disposal of assets or change in business;
  • No further security over assets;
  • To provide information on business.
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13
Q

What is a debenture?

A

A loan agreement in writing, registered at Companies House, giving the lender security over the borrower’s assets.

Note: sole traders/partnerships cannot enter into debentures as debentures are registered at Companies House.

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14
Q

A client wants to know the advantages and disadvantages of financing his company by way of equity finance, compared to debt finance. Advise.

A

Advantages

  • No repayment of capital unless wound up (therefore riskier for investor)
  • Company can restrict investor’s ability to sell shares.

Disadvantages

  • Shareholders have rights in the company
  • If the investor wants dividends (preferential shares), the dividend is not a deductible expense for corporation tax.
  • Value of shares may increase/decrease. Investor is only likely to invest if he expects capital appreciation.
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15
Q

A client wants to know the advantages and disadvantages of debt finance over equity finance. Advise.

A

Advantages
- Lender has no ownership rights, as a creditor.
- More flexible than equity finance, as it is governed by contract law.
- Repayment of interest is deductible for the purpose of corporation tax, as a normal trading expense.

Disadvantages

  • Lender has a contractual right to be repaid.
  • Lender may sell debenture to a third party.
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16
Q

Security

Why should the lender check the articles before lending?

What else should be checked and what does this show?

A

To ensure there are:
- no restrictions on the company granting a security and
- directors have authority to act.

The register (Companies House)
- date of creation of existing charges;
- amount secured;
- property charged; and
- chargeholder.

If taking a charge over property, lender must also conduct a search at Land Registry. If IP rights, check Intellectual Property Office.

17
Q

Security

What assets can be used as security for borrowing?

A
  • land
  • tangible property (e.g. machinery),
  • intangible property (e.g. intellectual property rights).
18
Q

Security

What are the main types of security for LLPs/companies?

A
  • Mortgages
  • Fixed charges
  • Floating charges

A mortgage is a charge by deed expressed as a legal mortgage. It includes the rights to take possession and to sell it. Other than for land, a mortgage transfers legal ownership to the mortgagee.

19
Q

Security: fixed charge

What is a fixed charge?

A

An equitable charge over specific assets (e.g. machinery and shares) giving the lender control over the asset and the right to sell it if the borrower defaults.

Does not transfer legal ownership.

Possible to create more than one over same asset.

20
Q

Security: floating charge

What are the key features of a floating charge?

A
  • Equitable charge over a group of assets such as stock;
  • Assets charged are constantly changing; and
  • The company retains freedom to deal with the assets in the ordinary course of business until the charge crystallises upon specific events.
21
Q

Security: floating charge

What are the events that trigger crystallisation?

A
  • Company enters receivership
  • Company enters liquidation
  • Company ceases to trade
  • Any other specified event.
22
Q

What are book debts?
How can these be charged by the lender?

A

Money owed to the company by debtors.
As a floating charge;
As a fixed charge, if the lender has control over the debts and the proceeds once the debtor pays.

However, if the lender has not prevented the business from using the proceeds for business purposes, a floating charge is appropriate.

23
Q

Security: floating charge

A lender wants to know the disadvantages of a floating charge. Advise.

A
  • The borrower can deal with assets on day-to-day basis.
  • A fixed charge generally takes priority over the same assets.
  • If the company becomes insolvent, preferential creditors can claim from the proceeds of the charged asset before the lender.
  • In certain circumstances, a liquidator/administrator may set aside the floating charge, so that the lender becomes an unsecured creditor.

Lender may consider taking a fixed charge over other assets of the business too.

24
Q

What are the procedural requirements for registering a charge?

A
  • File a statement of particulars and a certified copy of the instrument creating the charge at Companies House within 21 days of creation;
  • Registrar registers the charge and issues a certificate of registration;
  • A certified copy of the charging document and Form MR01 is put on the company’s file available for public inspection.

The copy of the charging doucment and MR01 must be kept at the registered office or SAIL.

Note: a fixed charge over land must also be registered at the Land Registry.

25
Q

What happens if a charge is not registered within 21 days?

A

The charge becomes void against a liquidator, administrator, or other creditors, and the debt becomes immediately repayable without the security.

26
Q

What are some other forms of security?

A
  • Personal guarantees
  • Pledge - asset physically delivered to creditor. Right to sell until repaid.
  • Lien - gives creditor right to physical possession until repaid.
  • Retention of title - buyer does not get full title to goods until seller paid.
27
Q

Charging document

What are the key terms in a charging document?

A
  • Security
  • Representations and warranties
  • Covenants
  • Enforcement and powers

Intention of warranties is to get the borrower to reveal all relevant information about the assets. E.g. of a warranty: property free from other charges.

28
Q

Priority of charges

Provided all charges are registered properly, what is the priority of charges as fixed by law?

A
  • Fixed charge or mortgage takes priority over floating charge over same asset (provided it is properly registered).
  • Where more than one fixed charge/mortgage over same asset, first one created takes priority (not first one registered).
  • Where more than one floating charge over same asset, first one created takes priority.
29
Q

What is subordination?

What is a negative pledge clause? Explain its effects.

A

An agreement among creditors to alter the order of priority of their charges, by deed of priority.

A clause preventing the company from creating later charges with priority to a floating charge without the chargee’s permission.

If the subsequent lender takes a fixed charge over same asset and had actual knowledge of it, the floating charge takes priority.

The subsequent charge holder will have actual knowledge if he conducted a search of the company’s records (as would usually be the case).

Agreements for subsequent charges should contain a covenant by the company that there are no earlier charges subject to a negative pledge clause.

30
Q

What are the formalities for security agreements?

A

They usually require a deed by:
- the company affixing its seal
- two authorised signatories signing (e.g. director + secretary); or
- a director signing in the presence of a witness.

The document must be delivered as a deed, i.e. clear on the face of it.

SQE2 - Business Law and Practice (9 decks)

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