MOCK Q - shares & debentures Flashcards
(8 cards)
“With respect to corporate finance, outline the nature and purpose of charges and the requirements for their effective operation, and explain what debentures are and the role they play in the management of a company’s finances.” (100)
Intro
- Debentures
A debenture is a written loan agreement between a borrower & lender. It provides lenders security over borrowers’ assets.
commonly used by banks, directors, private lenders, typically registered at companies house.
they dont give lenders ownership rights but grant them priority if company defaults or insolvent.
attractive because they reduce lenders risk and enable company to raise finance without issuing new shares & diluting control.
- Role of Debentures
offer secured finance, encouraging lending by reducing risk.
give priorty in insolvency, ahead of unsecured creditors.
flexible and unlike equity they dont dilute shareholder control.
Lender has right to appoint administrator to take control of companys assets (to enforce secuirty to recover debt and sell assets for them for a fee AKA charge)
- Charges (fixed & floating)
A charge is a legal mechanism where a company gives security to a lender to secure debt repayment.
- FIXED charge = attached to identifiable specific assets (land, plant, machinery). The company cant sell/deal with these assets without lender consent. strongest form of security for a creditor.
- FLOATING charge = attaches to a class of moveable/changeable assets (stocks, receivables, equipment, furniture, etc.). company can use/dispose of these until the charge crystalizes (into fixed charge upon events like insolvnecy/default).
useful for companies as they allow flexibility in day-to-day operations while still offering security to lenders.
- legal requirements for effective charges
charge needs to be registered with Companies House within 14 days under section 859a CA 2006.
must include :
name of charge holder, details for the charge & secured assets, date of creation.
if not registered on time, the charge is void against liquidators & administrators, and the debt becomes unsecured.
Priority of charges is determined by date of registration unless altered by a deed of priority between creditors.
- Enforcement & insolvency & consequences for creditors.
debenture holders can enforce their rights upon company default,
fixed charges - asset is immediatry enforceable.
floating charges – assets caught at the point of crystallisation. They rank behind fixed but ahead of unsecured creditors.
Floating charges are subject to “prescribed part” under the Insolvency Act 1968 - a portion of assets must be set aside for unsecured creditors to ensure they receive something.
Preferential creditors like emoloyees take priority against floating charge holders.
The charge holder may also appoint an administrator to recover the loan through asset realisation. This is often a faster and more cost-effective alternative to liquidation.
- policy considerations & criticisms
conclusion
charge & debenturs promote finaical stability by protecting lenders.
however
floating charges can allow large lenders to sweep up all assets, leaving little for unsecured creditors.
complex arrangements lack transparecny.
reforms such as prescribed part. attempt to strike a balanc between ensuring unsecured creditors recieve somethin in insolvency.
an optimal capital stucruee includes both share issuance (dilution of cotrol) and debemture finance.
conclusion:
Debentures and charges are fundamental tools in corporate finance. Debentures provide companies with access to secured loans without sacrificing control, while charges ensure creditors can recover debts effectively. The Companies Act 2006 establishes clear rules for registration and enforcement to protect the interests of both lenders and third parties. While not without criticisms, these mechanisms remain vital in balancing flexibility for companies with security for creditors, ensuring robust financial management and credit availability in the corporate sector.
