Debt Finance

Question 1

What are the two main types of debt finance?

Answer 1

Loans and debt securities.

Question 2

Do the model articles contain any restrictions on borrowing money?

Answer 2

No.

Although were incorporated before 1st October 2009, memorandum must be checked in order to it contains no restrictions on company borrowing money.

Question 3

For a company incorporated prior to 1st October 2009, if the memorandum contains restrictions on borrowing how is this removed?

Answer 3

Shareholders must pass a special resolution to change the articles to remove the restrictions.

Question 4

What is a secured loan?

Answer 4

A loan where the lender takes security over a certain asset or assets of a company.

In the event of default, the lender can therefore easily recover their funds by obtaining interests in the assets (ie appointing receiver to sell them).

Question 5

What are the three main types of loans?

Answer 5

• Revolving credit facility;
• A term loan; and
• An overdraft.

Question 6

What is an unsecured loan?

Answer 6

A loan where no security over assets of the company is given.

More risky for lenders so they often insist on higher interest payable on the instalments.

Question 7

Explain the premise of an overdraft facility.

Answer 7

Contract between the business and its bank which allows the business to go overdrawn on its current account.

Good for medium and small sized companies and businesses.

They are a temporary type of loan used to cover daily expenses in the event of cash flow issues.

The bank can demand payment of the entirety of the overdrawn amount at any time (usually not exercised unless business is in severe financial difficulties).

Business pays fee for overdraft facility. Bank also charges interest (generally on a compound basis).

Question 8

Defined compound interest.

Answer 8

Any interest which is unpaid will be added to the capital (amount borrowed) and interest is charged on that whole amount.

Question 9

What is a term loan?

Answer 9

A specific amount of money, repayable at the end of a specified term.

Interest is payable at regular intervals.

Term loans may be secured or unsecured.

It may allow the company to take the funds in one go, or in instalments.

Question 10

What is the main advantage of taking a term loan in instalments?

Answer 10

This will reduce the amount of interest payable.

Question 11

What is the main advantage of taking a term loan?

Answer 11

It gives greater certainty than an overdraft (which his repayable on demand) and borrower has greater control as lender can only ask for repayments in accordance with the contract.

Question 12

Give the disadvantages of a term loan.

Answer 12

Time and expense negotiating and agreeing legal documentation.

Once repaid, money can’t be re-borrowed (ie its a one time only loan).

Question 13

What is a revolving credit facility?

Answer 13

Bank agrees to make available a maximum amount of money to the business throughout the agreed period of the revolving credit facility.

During the lifetime of the facility the business can borrow and repay the money.

Interest is payable at regular intervals.

The business can re borrow amounts that it has already repaid (as long as it does not exceed the maximum amount which has been agreed).

Useful for businesses that have income which is not evenly distributed throughout the year.

RCFs can be secured or unsecured (but they are usually secured).

Question 14

What is a syndicated loan?

Answer 14

Usually applies to high value loans (where risk is too great to be taken by one lender).

Multiple banks lend to the borrower under the agreement.

Question 15

What is the advantage of a RCF?

Answer 15

Flexible means of borrowing money where it is possible to reduce the interest payable by reducing borrowings.

Question 16

What is a bilateral loan?

Answer 16

A loan which is made between the borrower and the lender only.

Question 17

Explain the terms in a loan agreement which sets out the payment of money to the borrower.

Answer 17

Initial clauses of the facility agreement will set out:

1) amount of the loan;
2) the currency;
3) the type of loan (eg term loan or RCF);
4) availability periods during which loan can be taken out (for an RCF this will usually be the entire length of the RCF).

Question 18

Explain the terms in a loan agreement which sets out the repayments and prepayments of the loan.

Answer 18

Sets out when and how the lender can demand repayment.

It will set out the agreed repayment schedule for the loan, and may provide for:
- repayment of the whole loan in one go at the end of the term (bullet payment);or
- repayment in equal instalments over the term of the loan (amortisation); or
- repayment in unequal instalments, with final instalment being the largest (balloon repayment).

Question 19

Explain the terms in a loan agreement which sets out the interest rates.

Answer 19

Rate payable for the loan is to be agreed between the parties (ie there is no statutory control).

Rate will therefore be expressly stated in the agreement.

It may be fixed for the period of the loan, or could be variable (ie a floating interest rate) altered at specific intervals in the term, by reference to a formula which is intended to maintain the lender’s profit on the loan.

Question 20

Explain events of default clauses.

Answer 20

They set out circumstances where, if breached, the borrower will be in default and the lender may terminate the agreement.

Common default events include:
- non payment;
- commencement of insolvency procedures;
- or breaches of other various obligations under the agreement which the parties agree would default the loan.

Question 21

Can sole traders or partnerships grant both fixed and floating charges?

Answer 21

No. They can only grant fixed charges.

Question 22

Can LLPs grant both fixed and floating charges?

Answer 22

Yes.

Question 23

What should a lender do when considering taking security in respect of a loan they are going to grant?

Answer 23

They should check on companies house to see if there are any other charges. If there are, it will be important to establish where their security would rank in the order of priority.

If they are taking security over IP rights (eg a trademark) they should check the company’s title to the intellectual property at the IPO.

Lender should also conduct a winding up search by telephone at the Companies Court to check no insolvency proceedings have been commenced against the company

Question 24

List the assets which a company can grant security over?

Answer 24

1) Land (whether freehold or leasehold) fixtures and fittings;
2) Tangible property (eg machinery, stock etc);
3) Intangible property (eg money in bank accounts, debts owed, IP rights etc).

Question 25

Explain mortgages as a type of security.

Answer 25

- Highest form of security; - Lender would seek a mortgage over high quality assets owned (eg land, buildings, machinery, aircraft etc); - Mortgage (with the exception of land) involves transferring legal ownership from the borrower to the lender. Mortgage gives the lender right to immediate possession of the asset, but this will only happen on default. - Title to the property is transferred back to the borrower once the loan has been repaid. - Separate mortgage must be created over each asset. - A mortgage taken over land is a charge by deed expressed to be by way of legal mortgage. Rights of the mortgage over land include right to take possession and sell it.

Question 26

What is a fixed charge?

Answer 26

- May be taken over property such as machinery and shares owned in another company. - Chargor must create separate fixed charge over each asset being given as security. - If chargor gets into financial difficulties and goes into receivership/ liquidation, fixed charge holder will have the right to sell the asset and be paid out of the proceeds of sale before other claimants such as unsecured creditors.

Question 27

Is it possible to have more than one fixed charge over an asset?

Answer 27

Yes however the lender which had their security granted and registered first will be the priority creditor out of the proceeds.

Question 28

What does crystallisation of a floating charge mean?

Answer 28

A specified event where it turns the charge into a fixed charge over the assets which were subject to the initial floating charge.

Question 29

List the common situations where a floating charge would crystallise.

Answer 29

1) borrower goes into liquidation; 2) borrower goes into receivership; 3) borrower ceases to trade; or 4) any other events specified in the charge document.

Question 30

Explain charges over book debts.

Answer 30

Book debts are money owed to the company by its debtors. Book debts may be charged by a floating charge. They can be charged by a fixed charge provided the charge holder obtains control over both the book debts and their proceeds once paid. This may arise where charge holder allowed company to collect book debts, but then the company had to pay over the money to the charge holder to settle part of the debt owed to the charge holder. If the company could use the proceeds from book debts for its business purposes, this would indicate a floating charge.

Question 31

Give the main advantages of a floating charge.

Answer 31

Allows borrower to deal with secured assets on daily basis. Suitable form of security which can be granted over assets not capable for a fixed charge/ mortgage. Floating charge may also be taken over the whole business.

Question 32

How long does the charge holder have to register the charge at CH?

Answer 32

Within 21 days of the charge being created. A certified copy of the instrument creating the charge, CH statement of particulars (usually an MR01) and the fee must be filed.

Question 33

What is the effect of failing to register a charge at CH?

Answer 33

Charge is void against a liquidator or administrator of the company (and also void against the company's creditors). Company still obliged to pay the debt and it is repayable immediately, but the lender cannot enforce the security.

Question 34

Explain the priority of charges.

Answer 34

1) Fixed charge or mortgage will take priority over a floating charge over the same asset (even if floating charge is registered first). 2) If there is more than one registered fixed charge or mortgage over the same asset, they have priority in order of their date of creation, not date of registration. 3) If there is more than one registered floating charge over the same asset, they have priority in order of date of creation not date of registration.

Question 35

What is a negative pledge?

Answer 35

Prevents a later fixed charge taking priority over a floating charge created and registered first. It prohibits the company from creating a later charge with priority over a floating charge (without the floating charge holder's permission). Actual knowledge of the negative pledge is required on the part of the lender taking the later security. this is satisfied where they have searched CH and seen the charge which has been registered (as it will be presumed they have read the document). The agreement for the subsequent charge should therefore include a clause whereby the company contractually promises there are no earlier charges subject to a negative pledge.

Question 36

Can the court extend the registration period for a charge at CH?

Answer 36

Yes but only in very limited circumstances (and the court will ensure it does not do so if it will prejudice other shareholders or creditors).

Question 37

Explain the shareholder resolutions needed to effect a share buyback.

Answer 37

Only an ordinary resolution is required if the company has sufficient distributable profits to complete the buyback. If the company need to use capital reserves (ie they do not have enough distributable profits) a special resolution is required.

Question 38

Is a shareholder resolution required to approve a share buyback contract by the company?

Answer 38

Yes an ordinary resolution is required to prove the buyback.

Question 39

Which form is used to notify CH the charge has been satisfied?

Answer 39

MR04.

Question 40

What is a floating charge?

Answer 40

It secures a group of assets such as stock which is constantly changing. It is possible to create more than one floating charge over the same group of assets. Charge consists of an equitable charge over the whole or a class of the company/LLP's assets (such as stock) meaning the company retains freedom to deal with assets in the ordinary course of business until the charge crystallises.

Question 41

List the common express covenants contained within a loan agreement and briefly explain what they do/ restrict.

Answer 41

1) Limitation of dividends - companies must ensure dividends and other distributions to shareholders do not exceed specified percentage of net profits. 2) Minimum capital requirements - business must ensure current assets exceed current liabilities by a specified amount of money or percentage. 3) No disposals of assets, or change of business - business must not dispose of assets without the lender's consent, or change the scope/ nature of the business. 4) No further security over assets - business must not create any further security over whole, or any part, of the undertaking without the lender's consent (ie negative pledge clause). 5) Provision of information on the business - eg annual accounts.

Question 42

What is the main disadvantage of an RCF?

Answer 42

Time + expense negotiating and agreeing all the legal documentation for the loan and the high fees which are charged.

Question 43

Do directors have the authority to act on behalf of the company in relation to borrowing?

Answer 43

Yes if they have model articles as MA 3 allows them to make decision on the day to da running of the company. If company has bespoke articles, they must be checked to ensure there are no restrictions on directors' powers/ any requirements that shareholders must give prior approval before a company borrows a certain amount. For partnerships, partners should check the partnership agreement doesn't contain any restrictions.