Debt Finance and Insolvency Flashcards
- Which one of the following is a form of possessory security?
- A fixed charge.
- A charge by way of legal mortgage.
- A pledge.
- A floating charge.
- An overdraft.
Option C is correct. A pledge is a form of possessory security, which involves the lender having physical possession of the charged asset. An example is pawnbroking where you hand an asset over to the pawnbroker, who holds on to it until the debt is repaid – or after a certain period of time, if the debt is not repaid, has the right to sell it.
Options A, B and D are wrong. These types of security are non-possessory securities, which involve the lender taking security over an asset. The borrower retains possession of the asset and can continue to use it. These all give the lender proprietary rights – i.e. rights against the property. They only have the right to take possession of the asset in certain circumstances (usually in the event of default by the borrower).
Option E is wrong. An overdraft is not a form of security. It is an unsecured loan (and the most common form of unsecured borrowing).
Which one of the following statements best describes the characteristics of fixed and floating charges?
1. Both incorporated and unincorporated bodies can create a floating charge.
2. A floating charge will only crystallise when the chargor enters into an insolvency process.
3. A fixed charge allows the chargor to deal freely with the charged assets, unless the chargor defaults.
4. More than one fixed charge can be taken over the same asset.
5. A fixed charge will most usually be taken over the company’s whole undertaking.
Option D is correct. More than one fixed (or floating) charge can be taken over the same asset, but (provided that the first charge is properly registered) the second charge will rank behind the first in order of priority. [Commercially, the debenture creating a fixed charge will usually provide that no further fixed charges can be created over the same asset and, in any event, lenders tend not to like second charges, so this would be rare.]
Option A is wrong. Only an incorporated body can create a floating charge – they are not available for partnerships or sole traders.
Option B is wrong. The debenture document creating the charge will normally set out a number of factors which will cause the charge to crystallise. Insolvency of the chargor (the borrower) will be one but not the only one. Usually any default will trigger this, e.g., default on payment of interest instalments.
Option C is wrong. Fixed charges restrict the ability of the chargor to deal with the charged asset until the loan is repaid or it obtains the consent of the chargee.
Option E is wrong. Fixed charges are normally taken over a specific, identifiable, asset, e.g. premises or machinery. The statement best reflects the position with floating charges.
An insolvency practitioner has been appointed as the administrator of an insolvent company
What is the insolvency practitioner’s principal objective as the administrator of the company?
1. To rescue the company as a going concern.
2. To realise the assets to get the best result for the chargeholder(s) who appointed him.
3. To realise the company’s assets, and distribute them to those entitled and wind up the company.
4. To achieve a better result for the company’s creditors than would have been achieved if the company had not been put into administration.
5. To perform his functions in the interests of the company as a whole, however long this takes.
Option A is correct. There is a “three tier” purpose for administration. The administrator must start with the objective of aiming to rescue the company as a going concern – only if this is not possible move down the next objective.
Option B is wrong as this is the objective of a receiver appointed by a chargeholder, whose sole function is to take possession of the charged asset and sell it for the benefit of the chargeholder (or chargeholders – a group of chargeholders can appoint a receiver) who appointed him.
Option C is wrong as this is the duty of a liquidator: to collect in the assets, distribute them in accordance with the statutory order and, once this is done, to wind up the company.
Option D is wrong, as achieving a better result for the creditors as a whole is not the principal objective of the administrator.
Option E is wrong, as although an administrator must perform his functions in the interests of the company as a whole, they must do so as quickly and efficiently as reasonably practicable.
A bank makes a term loan of £250,000 to a company. The loan agreement provides for payment of the loan by instalments with interest over a five-year period. The loan is secured by way of a fixed charge on the company’s premises. The debenture creating the charge is executed as a deed on 1 April.
Which one of the following statements best reflects the position in relation to the bank’s security?
1. The latest date that particulars of the charge should be delivered to Companies House is 21 April.
2. The latest date that particulars of the charge should be delivered to Companies House is 29 April.
3. The company must register the charge at Companies House within the statutory time period or it will commit a criminal offence.
4. If the charge is never registered, it will still be valid as between the bank and the company, but not against a liquidator or administrator and any creditor of the company.
5. Even if the charge is never registered, provided that the company does not default on any of the terms of the loan facility agreement, the bank will not be entitled to be repaid until the end of the five year period.
Option D is correct. The effect of failure to register is that the charge will be void against a liquidator, administrator or creditor of the company, and will lose its priority in the event of insolvency (s.859H(3)), but until then, it remains valid as between the bank and the company (and third parties who are not creditors).
Options A and B are wrong. The particulars set out in s.859D CA 2006 must be delivered within 21 days (not 28 days, so B is wrong) beginning with the day after the day on which the charge was created (here 1 April) so this would be 22 April (s.859A(4)).
Option C is wrong as registration is voluntary and, in any event, any person interested in the charge may deliver the particulars to Companies House (s.859A(2)) – and as it is in the interests of the bank to ensure that the charge is validly registered so it is often the bank that will register the charge.
Option E is wrong. The amount secured by the loan becomes immediately due (s.859H(4)).
A creditor has successfully petitioned for a company to be put into liquidation.
The company’s accounts show that it has the following assets:
o Premises worth £200,000.
o Stock worth £50,000.
o £5,000 in cash.
A bank has a fixed charge over the premises to secure a loan of £195,000 plus outstanding interest of £15,000 (which is also secured by the loan). The liquidation costs are estimated at £50,000 and it owes £35,000 to its unsecured trade creditors. There are no preferential creditors.
How much will the unsecured creditors receive in the liquidation (rounded to the nearest pence in the £)?
- 11 pence in the £.
- 14 pence in the £.
- 22 pence in the £.
- 28 pence in the £.
- The full amount owing to them
Option A is correct. The bank as a fixed charge holder will be paid first. It is owed £210,000 in total and the premises are worth £200,000. This leaves a shortfall of £10,000 for which the bank must prove as an unsecured creditor, making a total of £45,000 owed to the unsecured creditors. After payment of the liquidation costs, there are assets of £5,000 to pay £45,000 of debt = 11 pence in the £1.
This makes Options B - D wrong. They either fail to take into account the interest or add the shortfall to the amount owed to the unsecured creditors.
Option E is wrong as it fails to take into account the liquidation costs which would be paid next after the bank but before the unsecured creditors.
Which of the following statements best describes actions for wrongful and fraudulent trading?
0. Only a liquidator can bring an action for wrongful trading.
1. A liquidator can bring an action for wrongful trading against a director or any officer of a company.
2. An award against a director for wrongful trading will be assessed on a compensatory basis.
3. A creditor can bring an action for fraudulent trading against a director or any officer of a company.
4. An award against a director for fraudulent trading will be assessed on a punitive basis.
Option C is correct. The court may order a director who has been found guilty of wrongful trading to make a contribution to the assets of the company. The courts have held that this will be assessed on a compensatory basis.
Option A is wrong. Both liquidators and administrators can bring an action for wrongful trading.
Option B is wrong. An action for wrongful trading can only be brought against directors (unlike fraudulent trading where an action can be brought against any person involved in the management of the company).
Option D is wrong. Creditors cannot bring an action for fraudulent (or wrongful) trading.
Option E is wrong. For fraudulent trading, the award will also be assessed on a compensatory basis.
A company has two executive directors, a Managing Director and a Finance Director, who is an accountant, and one non-executive director who is the wife of the Managing Director. She has not played an active role in the company’s management for several years.
The company’s accounts show that the company has been in financial difficulties for the last three years, but the directors have struggled to keep the company afloat in the hope that trading conditions would improve and have held regular, well documented meetings to discuss how to do so.
An administrator was appointed two weeks ago with a view to rescuing the company as a going concern. He has established that although the company was insolvent on the cash flow test for the last three years, it was not balance sheet insolvent until shortly before it went into administration.
The directors are concerned that the administrator may bring an action against them for wrongful trading.
Which one of the following statements best reflects whether the directors may be liable for wrongful trading?
- The directors will not be liable for wrongful trading as the company was not balance sheet insolvent until shortly before it went into administration.
- All the directors will be liable for wrongful trading as they carried on trading after the company became insolvent.
- Only the Finance Director, as an accountant, can be liable for wrongful trading.
- The non-executive director will not be liable for wrongful trading as she played no part in the management of the company.
- The directors may be able defend an action for wrongful trading.
Option E is correct. The directors will not be liable if they took ‘every step’ to minimise the loss to the company’s creditors. Here it appears that they struggled to keep the company afloat, and their efforts appear to be well documented.
Option A is wrong. The company must have gone into insolvent administration, i.e., it must be balance sheet insolvent at the time it was put into administration, but it need not be balance sheet insolvent during entire the period leading up to this.
Option B is wrong. Carrying on trading whilst insolvent is not in itself enough to prove wrongful trading.
Option C is wrong. There is an objective and subjective test. The Finance Director as an accountant will have more specialist skill and knowledge than the others, but the other directors may be liable if on an objective test, they knew or ought to have known that there was no reasonable prospect of avoiding insolvent liquidation and did not take ‘every step’ to minimise the loss.
Option D is wrong. A director cannot avoid liability by claiming that they took no part in the management of the company.
