2.

Loan capital
a) Define companies borrowing powers. (a) b) Explain the meaning of debentures. (a) c) Distinguish loan capital from share capital. (a) d) Explain the concept of a company charge and distinguish between fixed and floating charges. (a) e) Describe the need and the procedure for registering company charges. (a)

BORROWING POWERS Trading companies i.e. objects are to carry on a trade or business has an implied power to borrow for purposes incidental to the trade or business. A non-trading one must have express powers to borrow not implied. !f directors are delegated this power the delegation should set the maximum limit on the borrowing arranged by directors. A contract to repay borrowed money may be unenforceable if" The money was borrowed for an ultra-vires purpose and its #nown to the lender. The directors either exceeded or did not have borrowing powers. $owever in both cases the lender will probably be able to enforce the contract by virtue of sections %&'() or %&'A). if the loan is within the capacity of the company but directors have exceeded borrowing powers the company may ratify the loan contract. *ase law has determined that a companys power to borrow is bac#ed up by power to create a charge over the companys assets as security for the loan. DEBENTURES Loan capital is issued by issuing debentures. Def; a debenture is a written ac#nowledgement by the company with or without its seal ac#nowledging how much money the company has borrowed from whom with a promise to repay with interest agreed at the time of entering the contract. (

ACCA Class notes compiled by Njihia Kaburu A debenture may ta#e any of the following forms Single Debenture: the company may borrow money from a particular ban# under an overdraft facility. !n such instances most ban#s insist on the company issuing a standard debenture form and further secure the debentures 'give security) in form of a charge on the companys assets. Debenture issued as a series: the company may borrow different sums of money from different people at different times but the companies intention is to give all the lenders a +pari passo right 'e,ual right) concerning the return of the money borrowed and the interest to be paid. -uch debentures are normally registered with the registrar of companies. Global Loan Stock: used by listed public company which borrows from the general public by ma#ing an offer through its prospectus. The money borrowed is considered as a single loan stoc# in which the lender holds a fraction of the money which can be transferred to any person at any time. -uch stoc#s are issued in multiples of ( & (. and so on. The advantage is that one can transfer any amount from the stoc# he holds which is not possible in case of single debentures. !n the later he can only transfer the whole amount not part of it/ !t may ta#e the form of an instrument ac#nowledging the debt and charging the companys property with repayment" or !t may ta#e the form of an instrument ac#nowledging the debt charging the companys property with repayment and further restricting the company from creating any other charge in priority over the charge created by the debenture. Debenture Trust Deed This is re,uired mandatorily for global loan stoc# debentures though the others may often incorporate one. This is formed on appointment usually of a trustee for prospective debenture stoc#holders. The trustee is usually a ban# insurance company or other institution but may be an individual.

The nominal amount of the debenture is defined which is the maximum amount which may be raised then or later. The date or period of repayment is specified as is the rate of interest and halfyearly interest payments. !f secured the deed creates a charge or charges over the assets of the company. The trustee is authori0ed to enforce security in case of default and in particular appoint a receiver with suitable powers of management. !n return the company enters in various covenants for instance to #eep its assets fully insured or to limit its total borrowings" breach is a default by the company. Advantages of the trust deed The company can contact a representative of the debenture holders with whom it can negotiate. -ecurity for the debenture stoc# in the form of charges over property can be given a single trustee. A trustee with appropriate powers can intervene promptly incase of default. The trustee can call a meeting of the debenture holders and consult them to obtain a decision binding on them all. 1ebenture holders enjoy the benefit of a legal mortgage over the companys land. This would not be possible without trustees since under 2nglish law a legal estate in land cannot be vested in more than four persons. d!antages o" debentures o -ince debenture holders carry no votes they do not dilute or affect the control of the company. o 1ebentures may be cheaper to service than shares. o There is no restriction to issuing debentures at discount or on redemption. o !nterest is chargeable against the profit before tax. o The board does not 'usually) need authority of a general meeting to issue debentures. 2

ACCA Class notes compiled by Njihia Kaburu Disad!antages o" debentures o $igh gearing will affect the share price. o !nterest must be paid out of pre-tax profits regardless of the companys profit. o 1efault may precipitate li,uidation and3or administration if the debentures are secured. o *rystalli0ation of floating charge can cause trading difficulties for the company. Si#ilarities bet$een s%ares and debentures 4oth are long-term investments in the company. The rules concerning the issue of share s and debentures are similar. The rules concerning their transfer are similar. Di""erences bet$een s%ares and debentures A shareholder becomes a member of the company while a debenture holder becomes a creditor of the company. 1ividend 'which may be fixed or unfixed) is paid on the shares while interest 'which is always fixed) is paid on debentures. 5ayment of dividend depends on the discretion of the directors while payment of interest is mandatory. -hareholders have voting and other rights while debenture holders do not have such rights they only attend the meeting to appoint li,uidator if the company goes into li,uidation. -hares redeemed are cancelled and cannot be re-issued while debentures can be re-issued. 1ebenture holders have priority with respect to re-payment while shareholders receive payment after creditors but can participate in surplus assets. 1ebenture is a document ac#nowledging indebtness of the company while a share is the interest of the holder in the company measured in money terms. Re#edies a!ailable "or an unsecured debenture %older $e can sue the company to recover his money.

 $e can apply to court for compulsory li,uidation3 winding up of the company. $e can petition the court for an administration order.

ACCA Class notes compiled by Njihia Kaburu event occurs or some act is done which causes it to settle and fasten on the subject of the charge within its reach or grasp.: Fixed charge This is a legal or e,uitable mortgage on a specific asset 'e.g. land) which prevents the company from dealing with the asset without the consent of the mortgagee. !t grants the holder rights of enforcement against the identified assets so that incase of default of repayment the creditor may reali0e the asset to meet the debt owned. They ran# first in order of priority upon li,uidation. !t has three main characteristics" o !t is on an identified asset. o The asset is intended to be retained permanently in the business. o The company has no general freedom to deal with 'e.g. sell) the asset. Floating Charge The judge in #e $or%shire &ool'o()ers Asso'iation *1903+ stated that a floating charge has % basic characteristics. o !t must be a charge on a class of a companys assets both present and future" o That class must be one which in the ordinary cause of business of the company #eeps changing from time to time" o 4y the charge it must be contemplated that until future step is ta#en by or on behalf of those interested the company may carry on its business in the ordinary way as far as concerns the particular class of the assets charged i.e. deal with assets in ordinary course of business. A floating charge cannot be created by an ordinary partnership. Cr,stalli-ation A floating charge does not attach to any particular asset until it crystalli0es. This means that the company can no longer deal freely with the assets. !t will crystalli0e under the following circumstances" ;here the company defaults in the payment of any portion of the principal or interest thereon when such portion or interest is due and %

Re#edies a!ailable "or t%e secured debenture %older A secured debenture holder or his trustee can ta#e possession of the asset under charge. $e may sell the asset to recover his money. $e may apply to court for transfer of the ownership of the asset. $e may appoint a receiver provided an administration order is not in effect. 6eceivers are usually appointed by the secured debenture holders. 7nce appointed they are given the power to either run3manage the company or to dispose of the assets under charge. 6eceivers become agents of the company and not of the debenture holders who appointed them. A receiver is normally appointed under the floating charge. &' RGES A charge over the companies assets gives a creditor a prior claim over the creditors to payment of his debt out of these assets. The indebtedness ac#nowledged by a debenture is normally but not necessarily secured by charge over the companys property. -uch charge could either be a specific3fixed charge or a floating charge. (i)ed !ersus "loating c%arge 4oth were defined by Lord 8cnaghten in the case of" Illingsworth v. Houlsworth [1904] A.C. 3 A! 3 " 9A specific3fixed charge is one that without more fastens on ascertained and definite property or property capable of being ascertained and defined. A floating charge on the other hand is ambulatory and shifting in its nature hovering over and so to spea# floating with the property which it is intended to affect until some

payable. !n that event however the debenture holders rights will not crystalli0e automatically. After the expiry of the agreed period for repayment the debenture still remained a floating security until the holders ta#e some step to enforce that security and thereby prevent the company from dealing with its property" <pon the appointment of a receiver in the course of a companys winding up3 li,uidation. <pon commencement of recovery proceedings against the company !f an event occurs upon which by the terms for the debenture 'e.g. company unable to pay its debts fails to loo# after property fails to #eep stoc# levels sufficiently high etc) the lenders security is to attach specifically to the companys assets. !f the company ceases to carry on business. The crystalli0ation of another floating charge if it causes the company to cease business. Advantages of floating 'harge !t has the following advantages to the company" o The company can deal freely with the assets under charge. o A wider class of company assets can be charged. .isadvantages !t portends the following disadvantages to the chargee o The value of the security is uncertain until it crystalli0es. o !t has lower priority than the fixed charge. o A li,uidator may ignore it if it was created within (2 months of winding up. Priorit* and registration o" c%arges The *ompanies Act re,uires every *harge created by a company and conferring security on the companys property to be registered. Priority !f more than one charge exists over the same class of property legal rules must be applied to see which ta#es priority. The priority of a charge depends on the type of the charge and whether or not it has ?

ACCA Class notes compiled by Njihia Kaburu been registered. 2,uitable charges first created have top most priority. Two e,uitable charges ta#e priority according to the time of their creation. A fixed charge has priority over floating charge. An unregistered registrable charge has no priority over a registered charge. Legal charges ran# according to their order of creation. =urther a charge holder 'floating) can prohibit the creation of a later charge 'fixed) with priority but the prohibition is only effective if a subse,uent chargee has notice of the prohibition as well as the charge. Registration The company must notify the registrar within 2( days of the creation of certain types of charges. -uch charges include charges on" Those securing a debenture issue. =loating charges. <ncalled share capital or called but unpaid. Trade receivables 'boo# debts). -hips or aircraft or any share in a ship. >oodwill or any intellectual property. Land or any interest in land but not rent or other periodic sums from the land. 6egistration can be underta#en by either the company or the charge holder. 6egistrar must be sent copies of the instrument by which the charge is created 3evidenced. The registrar then files it in the companies charges register and issues a certificate which is conclusive evidence that the charge has been duly registered. =ailure to register the charge has threefold effects" 6enders the charge void against the administrator li,uidator or any creditor of the company. 6enders the money secured immediately repayable. 6esults in fine on the company and every officer in default. The company must also include the charge in its own register of charges. $owever failure to do this does not invalidate the charge.

ACCA Class notes compiled by Njihia Kaburu Again not all charges are registered some remain unregistered. &O+PILED B,: (rancis N-i%ia .aburu/ I+IS 0Di1/23 LL/B 0'ons/23 LL/+ 0cont2/ Lecturer3 Os%$al &ollege/

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