Capital

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Capital Financing of Companies (Part 2)

• Loan Capital
• Rosemary Craig BA LLB LLM PGCHEP

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Learning Objectives

• Understand how debentures differ from shares.
• Describe in detail and differentiate between the
  fixed charge and the floating charge.
• Understand how the system of registration of
  charges not only affects the validity of a charge
  but also enables later creditors to discover the
  extent to which the companys assets are already
  charged.
• State the order of priority of charges where more
  than one is secured on the same asset.
• Recognise the situations in which a charge is
  invalid thereby depriving a creditor of his
  status as secured.
• Describe the actions a debenture holder can take
  where a company defaults, concentrating in
  particular on his contractual right to appoint a
  receiver.

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Debentures

• Debentures are defined by S 744 Companies
  Act 1985.
• A debenture is a document that creates or
  acknowledges a debt due from a company, such as a
  loan from a Bank.
• It is usually, but not always, given with a
  charge over the companys assets by way of
  security.
• A mortgage debenture is one which is secured by a
  charge on fixed assets.
• Convertible debenture is one which carries a
  right at the option of the holder to convert into
  shares.
• Single debenture, or a series of debentures
  equal ranking.
• Debenture stock a loan raised from a large
  number of lenders.
• Bearer debentures.
• Recognised debentures.
• S. 193 CA 1985 a company can create a perpetual
  mortgage.
• Knightsbridge Estates Trust v Byrne 1940.

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Differences between a debenture and a share

• Debentures
• Debenture holders are creditors of the company
• As creditors, debenture holders receive interest
  o their loans
• Debenture holders are entitled to receive
  interest whether the company is profitable or not
  and payment can be made out of capital
• Debentures may be issued at a discount, that is,
  less than their nominal value

• Shares
• Shareholders are members of the company
• Shareholders receive dividends
• Dividends must not be paid out of capital
• Shares cannot be issued at a discount and the
  company must receive the equivalent to the
  nominal value of the shares

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Issue of Debentures

• Similar rules to those governing the issue of
  shares same general prospectus requirements.
• Only a public company can offer debentures to the
  public. It is an offence for a private company
  to do so. S.170 Financial Services Act 1986.
• S. 195 CA 1985 contract to subscribe for
  debentures can be enforced by order of specific
  performance.
• Debentures may be issued at a discount. Moseley v
  Koffyfontein Mines 1904.
• If issued at a premium, no restriction on use of
  premium when received but it is normally
  transferred to capital reserve.
• S. 130 Companies Act 1985 Discount/ premium may
  be charged to share premium account.

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• Identical debentures issued as a series to
  different lenders, on different dates, can be
  deemed to rank pari passu (on like footing).
• Restrictions on convertible debentures
• S. 80 CA 1985 Directors must have permission from
  company in general meeting, or within the
  articles to issue such debentures
• S. 89 CA 1985 Such securities must be offered
  first to members/ debenture holders on equal/
  better terms.

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Redemption of Debentures

• Company is bound to repay debentures by specified
  final date for redemption, unless debenture is
  perpetual.
• Company may be required to make an annual payment
  into a sinking fund for eventual redemption.
• May have to redeem a proportion of outstanding
  debentures each year.
• Company is free to purchase its own debentures.
• Debentures can be re-issued once redeemed unless
  prohibited by the articles, terms of the
  debenture or a resolution passed at a general
  meeting.

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Debenture Trust Deeds

• A trustee will be appointed for debenture
  stockholders to protect their interest and
  rights.
• Nominal amount of debenture stock will be
  defined.
• Various covenants will be entered into by the
  company.
• Creation of fixed charge over fixed assets as
  security floating charge over some or all of
  companies assets.
• Trust deeds will deal with appointment of
  trustee holding meetings to give necessary
  authority to trustee powers duties of trustee
  provision for payment of trustee for work
  conducted.
• Advantages include prompt intervention by
  trustee, representation, periodic information
  supplied, power to appoint receiver is a
  safeguard. Security for debenture can be give to
  single trustee.

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Fixed Charges

• Legal/ equitable mortgage.
• Attaches to the property charged as from the
  moment of creation of the charge.
• In practice, a company cannot create a fixed
  charge over current assets.
• Fixed charges are confined to fixed assets such
  as property, land, plant etc which the company
  will retain.
• A fixed charge has the right to resort to company
  assets in priority to preferential unsecured
  debts. A floating charge does not have this
  priority.

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Floating Charges

• There is no statutory definition of a floating
  charge. We need to look to case law.
• In Illingworth v Houldsworth (1904) a floating
  charge was described as a charge over a class of
  assets, both present and future, which, in the
  ordinary course of business, changes from time to
  time and which leaves the company free to deal
  with the charged asset in the ordinary course of
  its business.
• Assets therefore that are typically the subject
  matter of a floating charges are stock in trade
  and goods in production.
• Also secure a debenture. Unique to company law.
  It is created over the whole of the companys
  assets and undertakings.

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• A floating charge was defined by Romer LJ in
  Re Yorkshire Woolcombers Association Ltd 1904.
  He said that a charge would be a floating charge
  if it had the following three characteristics
• (1) If it is a charge on a class of assets of a
  company present and future
• (2) if that class is one which, in the ordinary
  course of business of a company, would be
  changing from time to time and
• (3) if you find that by the charge it is
  contemplated that, until some further step is
  taken by or on behalf of those interested in the
  charge, the company may carry on in its business
  in the ordinary way

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• Not effective until something happens to cause
  the charge to crystallise. It floats over the
  property and does not immediately attach to the
  property.
• Pending crystallisation, a floating charge leaves
  the company free to deal with the assets subject
  to the charge, without encumbrance by it.
• Advantage of taking in the current assets which
  may be the companys most valuable assets.
• Disadvantages uncertainty, no priority.

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Crystallisation

• Assets over which a floating charge has been
  created can be sold by the company up until
  crystallisation.
• Automatically occurs when
• 1. Company goes into liquidation
• 2. A receiver is appointed
• 3. Company ceases to carry on business
• 4. An event stipulated in the contract would
  lead to automatic crystallisation
• 5. Another floating charge crystallises which
  ceases company to cease business
• Crystallisation can also occur where the
  debenture holder gives notice that he is
  converting the floating charge into a fixed
  charge.

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Registration of Charges

• Registering a charge is constructive notice
  to the world of its existence.
• Registration must be completed within 21 days of
  creation of charge S. 395 (1) and S. 399 (1) CA
  1985.
• S. 396 CA 1985 provides a list of registerable
  charges.
• Particulars of the charge must be sent to the
  Registrar.
• S. 401 CA 1985 indicates that details such as
  date of creation, sum secured, chargees names,
  short details of the property subject to the
  charge must be registered.
• Registrar will issue a certificate that is
  evidence that requirements have been complied
  with.
• Failure to register results in the charge
  becoming void.
• S. 411 CA 1985 A company must maintain register
  of charges.

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Priority of Charges

• Two basic principles
• 1. Priority of time.
• 2. Notice by registration.
• General rule is that fixed charges, effective
  from the time of creation, have priority over
  floating charges which only come into effect at
  the time of crystallisation.
• Only exception to this rule is that a floating
  charge containing a negative pledge provision may
  have priority over a later fixed charge.
• Note that an administrative receiver/ liquidator
  will be paid first, then preferential creditors
  before those with fixed/ floating charges.

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Debenture Holders Remedies

• Any debenture holder is a creditor of the company
  with the normal remedies of an unsecured
  creditor, and as such could
• (a) sue the company for debt, and seize its
  property if his judgement for the debt is
  unsatisfied
• (b) present a petition to the court for the
  compulsory liquidation of the company
• (c) present a petition to the court for an
  administration order.
• Secured debenture holder may enforce the
  security, and may
• (a) take possession of the asset subject to the
  charge
• (b) sell it
• (c) apply to the court for its transfer by
  foreclosure order
• (d) appoint a receiver of it.

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Receivership

• An alternative to liquidation where a company is
  in financial difficulty, is the right of a
  secured creditor to appoint a receiver or
  administrative receiver to manage the companys
  assets that are the subject matter of the
  creditors security. A receiver is a financial
  agent and manager. The task is to control and
  obtain money from property for which he accounts
  to those whom he represents.
• S. 390 (1) IA 1986 A receiver must be an
  individual and not a body corporate.
• Receiver must be an insolvency practitioner S.
  390 (2) IA 1986 in some situations, must not be
  disqualified by court order under Directors
  Disqualification Act 1986.

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• A receiver appointed under a floating charge is
  an administrative receiver IA 1986 s. 29 (2).
• Must be a qualified insolvency practitioner. The
  Court may appoint a receiver/ administrative
  receiver.
• NB with effect from 15 September 2003 the changes
  introduced by the Enterprise Act 2002 diminish
  the right of floating charge holders,
  particularly those creditors providing finance to
  companies, such as banks, to appoint an
  administrative receiver

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Role of Receiver

• Powers of a receiver are usually contained in
  full in the debenture. S. 42 Sch 1 IA 1986
  provide a statutory list of powers subject to any
  inconsistencies with the debenture.
• Directors powers of management are suspended
  during receivership, but formal powers and duties
  are not be affected.
• Receiver has no liability on existing contracts.
• Note position of receiver in relation to
  employment contracts, may be liable if he adopts
  contract.
• Receiver may make new contracts to carry on
  business of company.
• Statement of affairs.
• Administrative receivers report.
• Power to dispose of charged property.
• Payments.

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• Appointment of a receiver or administrative
  receiver often leads to the company proceedings
  into liquidation, as the company is likely to
  have few assets left to trade with, but this is
  not always the case and it may be possible to
  sell the company as a going concern.
• In the late 1990s Leyland Daf Trucks Ltd was
  able to come out of receivership and to continue
  to trade without going into liquidation. This
  meant that the company's business of
  manufacturing commercial vehicles remained intact
  along with the protection of hundreds of jobs in
  the Midlands where the company was based.

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• Care should be taken not to confuse the term
  receiver with the office of the official receiver
  who is a court appointed official with the
  function of protecting all the companys assets
  during the time between a petition for winding up
  and the granting of a winding-up order.

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• Prior to the 1A 1985, a company becoming
  insolvent was likely to be wound up. There was
  no formal system in the Uk for endeavouring to
  restore a company in financial difficulty and
  little protection afforded to unsecured
  creditors.
• Contrast this with the USA where companies in
  financial difficulty can file for Chapter 11
  bankruptcy which results in a moratorium on
  creditor claims against the company. A number of
  American Airlines have filed for Chapter 11
  protection in recent years.

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• To address this issue the 1A 1985 later became
  the 1A 1986 which introduced a procedure where an
  administrator could be appointed to manage a
  companys affairs with the purpose of salvaging
  the company as a going concern or at least to
  consider whether a winding up could be done more
  efficiently by considering the needs of all
  creditors both secured and unsecured.

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• The End
• I hope you have enjoyed this lecture
• Any questions?