Debt finance Flashcards
Company’s authority to borrow?
Most companies will have unrestricted power to borrow. However, it is necessary to consider when the company was incorporated and to check the company’s articles to ensure that there are no restrictions.
For companies incorporated under CA 2006 (on or after 1 October 2009):
Pursuant to s 31(1) CA 2006:
- Unrestricted objects clause
- Check articles
For companies incorporated under CA 1985:
- Had objects clauses in the memorandum which may restrict the company’s powers to borrow.
- However, many CA 1985 companies had general objects clauses which would allow them to borrow.
- Additionally, s 28(1) CA 2006 states that objects clauses in CA 1985 companies will be treated as part of the articles.
What are the different types of debt finance?
- Loan facilities
2. Debt securities
- Loan facilities?
Agreement between a borrower and a lender which gives the borrower the right to borrow money on the terms set out in the agreement: include:
- Overdraft: bank can call for all of the money owed to it at any point in time and demand that it is repaid immediately - unsuitable as long-term borrowing.
- Term loan: loan of money for a fixed period of time, repayable on a certain date. The lender cannot demand early repayment unless the borrower is in breach of the agreement. The lender will receive interest on the loan throughout the period.
- Revolving credit facility: this is where the borrower has flexibility to borrow and repay. It allows a company to draw down money, repay it and then re-draw it down again, then repay it. Unlike a term loan, with an RCF, the borrower has flexibility to choose when it borrows and repays as against a maximum aggregate amount of capital provided by the lender.
- Debt securities?
Debt securities have similarities to equity securities as they are a means by which the company receives money from external sources.
Piece of paper acknowledging the debt: can be kept or sold onto another investor. At the maturity date of the security, the company pays the value of the security back to the holder.
Classic example is a bond. Here the issuer (the company) promises to pay the value of the bond to the holder of that bond at maturity. The company also pays interest at particular periods, usually biannually.
Bonds are issued with a view to being traded. The market on which bonds may be traded is known as the capital market.
What’s a ‘debenture’?
2 separate meanings:
- Under s738: covers any form of debt security issued by a company, including debenture stock, bonds and any other securities of a company.
- Also the name of the particular document which creates a security. It is in this context that the term is generally used. Separate document from the loan agreement. The loan agreement sets out the terms of the loan, and the debenture sets out the details of the security.
Fixed and floating charges, guarantees?
- Fixed charge - prevents borrower from dealing with the assets subject to the charge and is the STRONGEST form of security.
- A lender will normally seek a fixed charge where possible. - Floating charge “floats” over a class of assets.
- Does not prevent the borrower from dealing with these assets unless and until the floating charge “crystallises”, which usually happens when the borrower defaults on the loan repayments. - Guarantee:
- Not strictly speaking a form of security but has a similar commercial effect in that a guarantor (usually a director, or a parent company) provides a guarantee to pay the company’s debts in the event of a default event.
More about fixed charges?
Lender will control the borrower’s use of the charged asset. The company cannot deal with (dispose of or create further charges over) the assets subject to the charge without the consent of the lender.
Lender will normally want fixed - not always appropriate, i.e. over stock or raw material. Usually taken over assets such as plant and machinery.
If becomes enforceable - lender has ability to appoint a receiver and exercise power of sale of that assets.
label applied to a charge is not always determinative – it is necessary to look at the terms of the charge itself (Agnew v IRC).
Ashborder BV v Green Gas Power Ltd: The court said that the prevention of the chargor from freely disposing of the asset is crucial to the creation of a fixed charge.
More about floating charges?
Many companies are unable to grant fixed charges over the majority of their assets (if the stock was subject to a fixed charge, the company would be unable to dispose of it).
A floating charge floats over a class of asset which fluctuates eg stock, raw materials. Whatever assets in that class the borrower owns at any point in time are subject to the floating charge.
A floating charge does not give the lender control over the assets. The borrower may freely dispose of such assets unless and until the floating charge “crystallises”.
Key case for floating charges?
Re Yorkshire Woolcombers Association: defined floating charge as a charge over:
- A class of assets, present and future; and
- Which in the ordinary course of the company’s business changes from time to time; and
- It is contemplated that until the holders of the charge take steps to enforce it, the company may carry on business in the ordinary way as far as concerns the assets charged.
What’s meant by the ‘crystallisation’ of floating charges?
When a floating charge crystallises, it ceases to float over all of the assets in a class and instead fixes onto the assets in the class charged at the time of the crystallisation. The lender then has control of those assets and the borrower is unable to deal with these assets, as if the assets were subject to a fixed charge
!! Whilst the effect of crystallisation on preventing the borrower dealing with assets subject to a floating charge is the same as for a fixed charge, the assets subject to crystallisation of the floating charge are not treated as fixed charge assets for distribution purposes on a winding up.
If the company receives more assets of the same class after crystallisation, these assets are automatically subject to the crystallised charge (NW Robbie and Co v Whitney Warehouse Co Ltd).
When does crystallisation occur?
- Common law – on a winding up, appointment of a receiver or cessation of business.
- Specified event – as defined in the loan agreement. This usually occurs where a borrower defaults on the loan repayments or interest payments, or where another lender enforces their security.
Charges over book debts – fixed or floating?
Book debt? - is an unpaid invoice - they are fluctuating, and may be significant asset of company.
Whether they are fixed or floating has been subject of much debate in courts - earlier cases, the courts took the approach that a charge granted over book debts was a fixed charge, however, this approach has now been overruled..
Key case law for fixed/floating charges over book debts?
Key cases:
Siebe Gorman and Co Ltd v Barclays Bank Ltd (1979): court held charge over book debts was a fixed charge because of the degree of control of the bank which could stop the company making withdrawals, even when the account was in credit..
Re Brightlife Ltd (1987): court in this case clarified that a company’s bank balance is not a book debt and therefore cannot be subject to a fixed charge.
Re Keenan Bros Ltd (1986): prior written consent of the bank was required before any
funds were allowed to be withdrawn from this account. Here the court said that the charge was a fixed charge due to the fact that the account was blocked.
Re Brumark Investments Ltd [2001]: key issue was who had control of the proceeds and the answer determined the type of charge. Here the company’s freedom to collect and use the proceeds of the book debts as it wished without requiring the lender’s consent was inconsistent with the nature of a fixed charge. This was a Privy Council case, which means that it is persuasive but not binding.
CURRENT POSITION:
National Westminster Bank plc v Spectrum Plus Limited and others [2005]:
only possible to have a fixed charge over book debts if they are paid into a blocked account which gives the lender the degree of control required!!
Why’s it so important to determine whether a charge is a fixed or a floating charge?
In liquidation, when a company is wound up, the assets are distributed in a specific order. On a liquidation, a company’s assets fall into two groups:
- Those subject to a fixed charge
- Those subject to a floating charge
Who’s paid first on winding up?
Fixed charge holders are paid first in the order of priority on insolvency and are entitled to the whole of their debt from the fixed charge fund.
If there is a shortfall, they may receive assets from the floating charge fund. The insolvency rules require a proportion of the floating charge assets to be set aside for the unsecured creditors. In addition, preferential debts (those payable to employees) are also paid out of the floating charge fund before the floating charge holders are paid. The unsecured creditors are paid after the floating charge holders, and any remaining assets are paid to the shareholders.
Most banks therefore require a fixed charge and a floating charge, giving themselves the greatest chance to recoup their money if the company goes into liquidation. A summary of the order of priority on a winding up is set out below.
