Loan capital

Introduction

All companies have the implied power to borrow for the purpose of business. Loan capital comprises all the longer term borrowing of a company such as:

• permanent overdrafts at the bank
• unsecured loans either from a bank or other party
• loans secured on assets either from a bank or other party.

Companies often issue long-term loans in the form of debentures.

Debentures

A debenture is a document issued by a company containing an acknowledgment of its indebtedness whether charged on the company's assets or not.

There are three main types of debentures:

• a single debenture e.g. a company obtains a secured loan or overdraft facility.
• debentures issued as a series and usually registered
• debenture stock subscribed to by a large number of lenders.

Advantages of debentures:

• The board does not (usually) need the authority of a general meeting to issue debentures.
• As debentures carry no votes they do not dilute or affect the control of the company.
• Interest is chargeable against the profit before tax.
• Debentures may be cheaper to service than shares.
• There are no restrictions on issuing debentures at a discount or on redemption.

Disadvantages of debentures:

• Interest must be paid out of pre-tax profits, irrespective of the profits of the company. If necessary must be paid out of capital.
• Default may precipitate liquidation and/or administration if the debentures are secured.
• High gearing will affect the share price.

Fixed versus floating charges

Fixed charge

A fixed charge is a legal or equitable mortgage on a specific asset (e.g. land), which prevents the company dealing with the asset without the consent of the mortgagee.

A fixed charge has three main characteristics:

• It is on an identified asset.
• The asset is intended to be retained permanently in the business.
• The company has no general freedom to deal with (e.g. sell) the asset.

Floating charge

The judge in Re Yorkshire Woolcombers' Association (1903) stated that a floating charge has three main characteristics:

• It is on a class of assets, present and future.
• The assets within the class will change from time to time.
• The company has freedom to deal with the charged assets in the ordinary course of its business.

A floating charge cannot be created by a partnership.

Crystallisation

A floating charge does not attach to any particular asset until crystallisation. This means the company can no longer deal freely with the assets. It occurs in the following cases:

• liquidation
• the company ceases to carry on business
• any event specified (e.g. the company is unable to pay its debts; the company fails to look after its property; the company fails to keep stock levels sufficiently high).

Advantages of a floating charge:

A floating charge has the following advantages for the company:

• The company can deal freely with the assets.
• A wider class of assets can be charged.

Disadvantages of a floating charge:

A floating charge has a number of disadvantages for the chargee:

• The value of the security is uncertain until it crystallises.
• It has a lower priority in order of repayment than a fixed charge.
• It may be challenged by a liquidator if it was created within 12 months preceding a winding up. This is to prevent a company from giving preference to one of its unsecured creditors by giving a floating charge over its assets.

Priority and registration of charges

Priority

The priority of a charge depends on the type of charge and whether or not it has been registered:

• Equal charges - first created has priority.
• Fixed charge - has priority over a floating charge.
• An unregistered registerable charge has no priority over a registered charge.
• A chargeholder can prohibit the creation of a later charge with priority, but the prohibition is only effective if a subsequent chargee has notice of the prohibition as well as the charge.

Registration

The company must also notify the registrar within 21 days of the creation of the charge.

Registration can be undertaken by:

• the company
• the chargeholder.

Failure to register:

• renders the charge void against the liquidator
• results in a fine on the company and every officer in default
• renders the money secured immediately repayable.

If the charge relates to land it must also be registered with the Land Registry.

The company must also include all charges in its own register of charges. However, failure to include the charge in the company's own register does not invalidate the charge.

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Tags:	debentures;fixed charges;floating charges;crystallisation