Corporate financing: Debt Financing

Concept of security

A ‘security’ is a charge over, e.g. a specific asset. A mortgage is the highest form of security over an asset From a company perspective, ‘securities’ are instruments used to RAISE CAPITAL.

What is debt financing ?

Borrowing money ; allows SHs to maintain current control however lenders charge interest - repayments need to be met

Debentures/Bonds

In quoted companies, bond and shares are often side by side

Can be traded in the same way as shares

In bond, the company undertakes to repay the loan according to a schedule and with an interest ( known as the ‘coupon’)

In terms of investment, in a portfolio you want to include equity and debt, shares and bonds

What is a debenture

A debenture (a bond) is a document, a written acknowledgement - Fons Hf v Corporal Ltd and another

Under S.738: : ‘debenture’ includes debenture stock, bonds and any other securities of a company, whether or not constituting a charge on the assets of the company.

Debenture Holders

If company borrows for many holders, the coroporate trustee provides a system for:

Registration of debenture holders

Transfer of debentures

Ensuring that the interest of the debenture holders are properly taken into account

Secured Borrowing

Secured, different forms; most commonly charges

Fixed or floating charge

Fixed charge

One which “fastens on ascertained and definite property” or property that is “capable of being ascertained and defined”

Floating charges

“ambulatory and shifting in nature, hovering over and so to speak floating with the property which it is intended to affect” until it crystallise

Characteristics of a Floating Charge

that the asset subject to the charge is not finally appropriated as a security for the payment of the debt until the occurrence of some future event.

In the meantime, the chargor is left free to use the charged asset and to remove it from the security. Where the chargor remains free to remove the charged assets from the security, the charge should, in principle, be categorized as a floating charge

Classic description of a floating charge

(1) If it is a charge on class assets of a company present and future

(2) If that class is one which in ordinary course of business of the company would be changing from time to time

(3) The company may carry on business the ordinary in relation to that class od assets some future step is taken

Floating charge effect

Until a floating charge crystallises, the chargor is at liberty to use the assets charged in the ordinary course of business.

The crystallisation of a floating charge converts it into a “fixed” charge over whatever assets are within the class at the time of crystallization

Event of Crystallisation

(1) the making of winding-up order

(2) the appointment of an administrative receiver

(3) The companies ceasing to carry on business

(4) automatic crystallisation clauses:

Floating charge in Scotland

 floating charges have a statutory basis → Part 2 of the Bankruptcy and Diligence etc. (Scotland) Act 2007: crystallisation happens only on statutory triggers

Scots floating charges only attach to specific assets upon the appointment of a receiver or administrator, or upon the commencement of winding-up proceedings. In Scotland, there is NO ability for a floating charge over Scottish assets to convert into a fixed charge contractually (by notice)

Registration of charges

All charges may be registered - 21 day time limit to register

Failure to register within time limit =  will render it void against the administrator, liquidator or any secured creditor of the
company

Priority Issue

Fixed normally come first even when created after floating

Two or more floating - by date of registration

Register > unregistered

Priority Ranking

Fixed charge holders

Liquidation expenses

Preferential debts

Floating charges

Unsecured creditors

*that floating charges created 12 months in the run-up to the insolvency of the chargor are set aside on insolvency