ACCA Class notes compiled by Njihia Kaburu2. Loan capitala) 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 POWERSTrading 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.

If 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 it’s known

to the lender. The directors either exceeded or did not have borrowing powers.

However, in both cases, the lender will probably be able to enforce the contract by virtue of sections 35(1) or 35(A). if the loan is within the capacity of the company but directors have exceeded borrowing powers, the company may ratify the loan contract.

Case law has determined that a company’s power to borrow is backed up by power to create a charge over the company’s assets as security for the loan.

DEBENTURESLoan capital is issued by issuing debentures. Def; a debenture is a written acknowledgement by the company with or without its seal acknowledging how much money the company has borrowed from whom with a promise to repay with interest agreed at the time of entering the contract.

A debenture may take any of the following forms

Single Debenture: the company may borrow money from a particular bank under an overdraft facility. In such instances, most banks insist on the company issuing a standard debenture form and further secure the debentures (give security) in form of a charge on the company’s 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 (equal right) concerning the return of the money borrowed and the interest to be paid. Such debentures are normally registered with the registrar of companies.

Global Loan Stock: used by listed public company, which borrows from the general public by making an offer through its prospectus. The money borrowed is considered as a single loan stock in which the lender holds a fraction of the money which can be transferred to any person at any time. Such stocks are issued in multiples of 1,5,10 and so on. The advantage is that one can transfer any amount from the stock he holds which is not possible in case of single debentures. In the later, he can only transfer the whole amount, not part of it!

It may take the form of an instrument acknowledging the debt and charging the company’s property with repayment; or

It may take the form of an instrument acknowledging the debt charging the company’s property with repayment and further restricting the company from creating any other charge in priority over the charge created by the debenture.

Debenture Trust DeedThis is required mandatorily for global loan stock debentures, though the others may often incorporate one. This is formed on appointment usually of a trustee for prospective debenture stockholders. The trustee is usually a bank, 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 half-

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ACCA Class notes compiled by Njihia Kaburuyearly interest payments. If secured, the deed creates a charge or charges over the assets of the company.

The trustee is authorized to enforce security in case of default and in particular appoint a receiver with suitable powers of management. In return, the company enters in various covenants for instance to keep 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. Security for the debenture stock 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. Debenture holders enjoy the benefit of a legal mortgage over the

company’s land. This would not be possible without trustees since under English law, a legal estate in land cannot be vested in more than four persons.

Advantages of debentureso Since debenture holders carry no votes, they do not dilute or affect

the control of the company.o Debentures may be cheaper to service than shares.o There is no restriction to issuing debentures at discount or on

redemption.o Interest is chargeable against the profit before tax.o The board does not (usually) need authority of a general meeting to

issue debentures.

Disadvantages of debentureso High gearing will affect the share price.

o Interest must be paid out of pre-tax profits regardless of the company’s profit.

o Default may precipitate liquidation and/or administration if the debentures are secured.

o Crystallization of floating charge can cause trading difficulties for the company.

Similarities between shares and debentures Both 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.

Differences between shares and debentures A shareholder becomes a member of the company while a

debenture holder becomes a creditor of the company. Dividend (which may be fixed or unfixed) is paid on the shares

while interest (which is always fixed) is paid on debentures. Payment of dividend depends on the discretion of the directors,

while payment of interest is mandatory. Shareholders have voting and other rights while debenture holders

do not have such rights, they only attend the meeting to appoint liquidator if the company goes into liquidation.

Shares redeemed are cancelled and cannot be re-issued, while debentures can be re-issued.

Debenture holders have priority with respect to re-payment while shareholders receive payment after creditors, but can participate in surplus assets.

Debenture is a document acknowledging indebtness of the company, while a share is the interest of the holder in the company measured in money terms.

Remedies available for an unsecured debenture holder He can sue the company to recover his money. He can apply to court for compulsory liquidation/ winding up of the

company. He can petition the court for an administration order.

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ACCA Class notes compiled by Njihia Kaburu

Remedies available for the secured debenture holder A secured debenture holder or his trustee can take possession of the

asset under charge. He may sell the asset to recover his money. He may apply to court for transfer of the ownership of the asset. He may appoint a receiver provided an administration order is not

in effect.

Receivers are usually appointed by the secured debenture holders. Once appointed, they are given the power to either run/manage the company or to dispose of the assets under charge. Receivers become agents of the company and not of the debenture holders who appointed them. A receiver is normally appointed under the floating charge.

CHARGESA 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 acknowledged by a debenture is normally but not necessarily secured by charge over the company’s property. Such charge could either be a specific/fixed charge or a floating charge.

Fixed versus floating chargeBoth were defined by Lord Mcnaghten in the case of;Illingsworth v. Houlsworth [1904] A.C. 355 AT 358 “A specific/fixed 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 speak floating with the property which it is intended to affect until some 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 equitable mortgage on a specific asset (e.g. land), which prevents the company from dealing with the asset without the consent of the mortgagee. It grants the holder rights of enforcement against the identified assets so that incase of default of repayment, the creditor may realize the asset to meet the debt owned. They rank first in order of priority upon liquidation. It has three main characteristics;o It 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 ChargeThe judge in Re Yorkshire Woolcombers’ Association (1903) stated that a floating charge has 3 basic characteristics.o It must be a charge on a class of a company’s assets both present

and future;o That class must be one which in the ordinary cause of business of

the company keeps changing from time to time;o By the charge it must be contemplated that until future step is taken

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.

CrystallizationA floating charge does not attach to any particular asset until it crystallizes. This means that the company can no longer deal freely with the assets. It will crystallize under the following circumstances; Where the company defaults in the payment of any portion of the

principal or interest thereon, when such portion or interest is due and payable. In that event however, the debenture holder’s rights will not crystallize automatically. After the expiry of the agreed period for repayment, the debenture still remained a floating security until the

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ACCA Class notes compiled by Njihia Kaburuholders take some step to enforce that security and thereby prevent the company from dealing with its property;

Upon the appointment of a receiver in the course of a company’s winding up/ liquidation.

Upon commencement of recovery proceedings against the company If an event occurs upon which by the terms for the debenture (e.g.

company unable to pay its debts, fails to look after property, fails to keep stock levels sufficiently high etc) the lender’s security is to attach specifically to the company’s assets.

If the company ceases to carry on business. The crystallization of another floating charge if it causes the

company to cease business.

Advantages of floating chargeIt 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.

DisadvantagesIt portends the following disadvantages to the chargeeo The value of the security is uncertain until it crystallizes.o It has lower priority than the fixed charge.o A liquidator may ignore it if it was created within 12 months of

winding up.

Priority and registration of chargesThe Companies Act requires every Charge created by a company and conferring security on the company’s property to be registered.

PriorityIf more than one charge exists over the same class of property, legal rules must be applied to see which takes priority. The priority of a charge depends on the type of the charge and whether or not it has been registered. Equitable charges first created have top most priority. Two equitable charges take 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 rank according to their order of creation. Further, a charge holder (floating) can prohibit the creation of a later charge (fixed) with priority, but the prohibition is only effective if a subsequent chargee has notice of the prohibition as well as the charge.

RegistrationThe company must notify the registrar within 21 days of the creation of certain types of charges. Such charges include charges on; Those securing a debenture issue. Floating charges. Uncalled share capital or called but unpaid. Trade receivables (book debts). Ships or aircraft or any share in a ship. Goodwill or any intellectual property. Land or any interest in land, but not rent or other periodic sums

from the land.

Registration can be undertaken by either the company or the charge holder. Registrar must be sent copies of the instrument by which the charge is created /evidenced. 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. Failure to register the charge has threefold effects; Renders the charge void against the administrator, liquidator or any

creditor of the company. Renders the money secured immediately repayable. Results in fine on the company and every officer in default.

The company must also include the charge in its own register of charges. However, failure to do this does not invalidate the charge. Again, not all charges are registered, some remain unregistered.

COMPILED BY:Francis Njihia Kaburu. IMIS (Dip.), LL.B (Hons.), LL.M (cont).

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ACCA Class notes compiled by Njihia KaburuLecturer, Oshwal College.

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