Loan Capital Flashcards
What is Capital?
The long-term financing of the company
Long-term sources of external finance
What is share capital?
- Funds are raised by selling shares in the company
- The shareholders are the owners of the company
There are different classes of shares and rights relating to those shares.
Long-term sources of external finance
What is loan capital?
These are loans obtained by the company.
- Funds are raised by obtaining a loan
- Lenders are not owners but creditors of the company
Power to borrow
Non trading companies
These are companies providing services and goods.
A non-trading company has no implied borrowing powers and must take express power to borrow in its constitution (of the company)
Power to borrow
Trading companies
A trading company has implied power to borrow (General Auction Estate and Monetary Co v Smith (1891))
Power to borrow
Public companies
A public company should not borrow until it has received its trading certificate.
Without the trading certificate they are not aloud to start any trading activities.
Power to borrow
The board
The board is given all powers to manage and there is no need for a specific power to borrow.
Power to borrow
The boards additional powers
A power to borrow (express or implied) has further implication → power to give a security for the loan and to pay interest upon it
BUT … the directors must obtain member approval before allotting convertible debentures (debentures which carry rights of conversion into share capital)
What are convertible debentures?
Convertible debentures can be converted into equity shares. This means that it will result in a dilution of existing shareholding.
Must get members approval before allotting convertible debentures.
What is a debenture (means owing)
Textbook Definition
“… is a document executed by the company as a deed in favour of a creditor, providing the creditor with security over the whole or substantially the whole of the company’s assets and undertaking, normally creating a fixed charge over fixed assets such as land and buildings and a floating charge over the rest of the company’s assets such as stock and giving the creditor power to appoint and administrative receiver with extensive authority to collect in the assets, run the company’s business and dispose of the assets either one at a time or as part of a sale of the business as a going concern.”
Debenture Definition
This is the written acknowledgement of a debt of the company
- usually a formal legal document
- this document normally contains provisions as to repayment of capital and interest
Debentures may be..
- redeemable,
- irredeemable (the debenture is issued with no fixed date of redemption; but … they are redeemable on a winding-up) or
- perpetual (a debenture with no fixed date for redemption; but … the company has the right to repay it at its option)
Debenture Definiton
Further details
- May be secured on some or all of the assets of the company (by the creation of a charge over the companies assets) … BUT …. it also could be unsecured (creditors)
- Registered debentures are transferable security (usually long-term investment in the company)
- Can be issued individually (e.g bank loan) or in series (e.g. public offer)
Debentures may be allotted….
- at par (face/nominal value)
- at a discount
- at a premium (above face/nominal value)
Debentures are usually
- Secured
- Registered
- Redeemable
Debentures may be…
- Unsecured
- Unregistered
- Irredeemable
Difference between shareholders and debenture holders
Role
Shareholders - are a member or owner of the company
Debenture holders - is a creditor of the company
Difference between shareholders and debenture holders
Voting Rights
Shareholder - May vote at general meeting
Debenture holder- No voting rights
Difference between shareholders and debenture holders
Cost of investment
Shareholders- Share many not be issued at a discount
Debenture holders- Debentures may be offered at a discount
Difference between shareholders and debenture holders
Return
Shareholders- Dividends are only paid out of distributable profits and when directors declare them
Debenture holders- Interest must be paid when it is due
Difference between shareholders and debenture holders
Redemption
Shareholders- Statutory restrictions on redeeming shares
Debenture holders- No restriction of redeeming debentures
Difference between shareholders and debenture holders
Liquidation
Shareholders- Are the last people to be paid in a winding up
Debenture holders- Debentures must be paid back before shareholders are paid
What is a charge?
It is common for debentures to be secured.
A charge is a right and is granted over the assets of a company and to the one who provided the loan (the charger)
A charge is an encumbrance upon real or personal property granted by one party (the charger) that gives another party (the chargee) certain rights over that property, usually as security for a debt owed by the charge holder. (e.g. by way of legal mortgage)
Charge in the case of companies?
- Charges over assets frequently granted to persons who provide loan capital to the business
- The charge is secured over a company’s assets gives the creditor a prior claim over unsecured creditors
Charges can be
- fixed and
- floating
Fixed Charges
Fixed charges are always attached to an asset or certain assets (usually NCA eg land, property)
The company is not permitted to deal with, or dispose of, assets that are subject to fixed charge without the consent of the charge holder.
Fixed charges
Company disposal of assets
IF the company dispose of the asset
- repay the secured debt out of the proceeds of sales (charge is discharged) or
- transfer the asset to the purchaser still subject to the charge
Fixed charges
If the company is unable to repay the debts then…
The charge holder has the right of enforcement against the identified asset in the event of default in repayment
Fixed charges
In case of liquidation
Fix charges rank first in order of priority in liquidation. Fixed charge holders are in the best position.
IF a fixed charge is created to secure debt within six moths before a company become insolvent, it may be invalid as a preference.
Fixed charges
Sale of asset
IF the value of the asset does not fully discharge the debt → in a liquidation the unpaid balance falls to be an unsecured debt
The excess amount is an unsecured debt
Fixed Charges
Important things to note
Fixed charges are always over an asset or certain assets of the company and the company is not aloud to deal with that asset or dispose of it.
Fixed charge holders will always be ranked first in the case of liquidation.
Floating charges
These permit the company to deal with the charged assets without the permission of the charge holder.
Floating Charges
These will float over the assets of the company
It is over the undertaking and assets of a company (future & current) → it is not possible to identify the assets to which a floating charge relates until the charge attaches by crystallisation (at which point the floating charge is converted into a fixed charge).
They are not linked to any particular assets of the company. For example cash, debtors, inventories.
Floating charges
Events causing crystallisation (floating charges will then be linked to particular assets of the company)
The liquidation of the company
Cessation of the company’s business (may occur on the crystallisation of another floating charge)
Active intervention by the chargee (generally by way of appointing a receiver)
Any event specified in the charge (e.g. non-payment of interest on the due date or notice
What is crystallisation?
This is the process of which the floating charge becomes a fixed security.
When this occurs the company is no longer free to dispose the assets.
Floating charges
Liquidation
In case of liquidation floating charge, if created within 12 months before liquidation, may become void automatically on liquidation
How to know whether the charge is Fixed or Floating?
It is not always immediately apparent (whatever label is given to it)
General rule: a charge over assets will not be registered as fixed if it envisages that the company will still be able to deal with the charged assets without the reference to the chargee
If the company is still able to deal with charged assets then it is going to be linked to a floating charge.
If the company is not aloud to deal with an asset without the previous permission of the charge holder then it will be fixed.
Floating Charge
If the company is still able to deal with charged assets then it is going to be linked to a floating charge.
Fixed Charge
If the company is not aloud to deal with an asset without the previous permission of the charge holder then it will be fixed.
Fixed or Floating Case Law
National Westminster Bank plc v Spectrum Plus Limited (2005)
House of Lords: although a fixed charge over book debts is conceptually possible, if the charger retains the right to deal with the book debts in the ordinary course of business in any way …, then the charge (whatever it is called) will be a floating charge
Fixed Charges
Standard Security (relevant in Scotland)
Standard security: is the form of security that is used in relation to lands & buildings in Scotland (heritable property) [→ fix charge]
-in writing
Needs to be registered
- in the Land Register in Edinburgh
- with the Registrar of Companies
In Scotland instead of using charges we use security.
In the case of lands & buildings standard security is used
Registration of charges
Registrar of Companies
(must be registered within 21 days after date of creation)
The Registrar (Companies House)
- enters details of the charge in the register (date, name of the chargee, amount secured)
- issues a certificate of registration of the charge
Registration of charges
Registrar of Companies
Failure to register
-Affects the validity of the charge
- Non-compliance renders the charge void against any
- liquidator
- administrator
- creditor of the company
The holder of the charge becomes an unsecured creditor on winding-up
An unregistered charge may become immediately payable
Priority of Charges
Where different charges over the same property are given to different creditors, their priority must be determined.
Fixed charges rank first then floating
Priority of Charges
Fixed (rank first in the case of winding up or liquidation of a company)
Fixed charges rank first (it has immediate effect from the moment is was created)
… except …
If the charge holder has an agreement with the company
“Negative pledge clause”: a floating charge holder protects himself by prohibiting the company from creating a subsequent fixed charge over the same assets
Priority of Charges
Floating
Floating charges generally rank among themselves in order of priority of registration with the Registrar of Companies
Once a floating charge has crystallised it becomes a fixed charge → a fixed charge created subsequently ranks after it
