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LPC Law Notes Business Law and Practice Notes

Introduction To Debt Finance Notes

Updated Introduction To Debt Finance Notes

Business Law and Practice Notes

Business Law and Practice

Approximately 649 pages

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Company Law – Private Limited Companies

Introduction to Debt Finance

Definition Lending / borrowing of money on the understanding that is will be repaid on a specific date or contingency, and on the winding up in priority to shareholders.
Capacity to borrow: Implied power / Express powers

IMPLIED:

  • S.31 CA 2006: company has unrestricted objects

  • Borrowing is a POWER rather than object implies the necessary powers for a company to pursue its objects.

  • Re David Payne: Implied power to raise funds by borrowing for the purposes of the company’s business.

  • Re Patent File: A company who has power to borrow also has implied power to give security for a loan.

EXPRESS:

  • Power is within the company Articles – making it part of the company constitution. [NB. This power is NOT in the Model Articles]
Director’s authority to exercise power

  • Art. 3 Model Articles: gives Director’s wide powers [e.g. act in the best interests of the company – therefore borrow money to pursue business]

  • Always consider any Special Articles – do they impose restrictions on borrowing over a certain amount?

  • Rolled Steel Products v British Steel Corporation (1985): directors had implied power to enter into a guarantee and debenture – BUT they had exceeded their powers because it was NOT for the best interest of the company.

  • If the Director’s exceed their powers breach of Fiduciary Duty.
Protection for persons dealing with the company [i.e. the bank]

  1. S.39 The validity of an act done by the company shall not be called into question on the ground of lack of capacity by reason of anything in the company’s constitution.

  2. S.40 S.40(2)(b) good faith issue! “In favor of a person dealing with a company in good faith, the power of the directors to bind the company, or authorise others to do so, is deemed to be free of any limitations under the company’s constitution”.

  • If lender knows that there is no benefit to company (or ought to have known) then there is a risk of no good faith and lender cannot rely on S.40. Therefore guarantee may be voidable by the shareholders (or liquidator) of the company.

Therefore, lenders ask for BOARD MINUTES that state

  1. Board approval of guarantee

  2. Who is authorised to sign for the company

  3. Why board considers the guarantee to be in best interest of company

This will support the contention of good faith!

OR

  • Lender can request unanimous consent of shareholders to the granting of the guarantee – to show good faith and get protection of S.40.
Restrictions on borrowing

  • Restriction on borrowing can exist in the Articles!

E.g. a maximum sum otherwise need SH approval.

If breached = lender may be able to rely on S.40 – to enforce the borrower’s obligations.

  • Contractual restriction e.g. 2 loans. Loan 1 contains a contractual restriction on further borrowing by the borrower. Loan 2 is entered into in breach of Loan 1. Lender 1 can get contractual remedies for breach of contract.

If Lender 2 had notice of the restriction they may also be liable to lender 1 on the basis of procuring breach of contract.
Other issues affecting validity of borrowing

  1. Is the borrowing illegal?

  2. Company giving loans to Directors – must comply with S.197 CA 2006. [Re. Loan to Directors]

Forms of debt finance

Loan facilities
Overdraft

  • Uncommitted facility bank not obliged to lend money.

  • Repayable on demand usually bank can ask for money back any time

  • Interest at fixed percentage above bank base rate

  • Usually subject to an upper limit company pay penalty if they go beyond overdraft.
Term Loan

  • Money lent over a set period (a term) with an agreed schedule of repayment

  • Committed facility bank cannot demand repayment of money at any time. Must comply with the schedule of repayment set out in the terms of the loan agreement.

  • Necessary for the loan agreement to include an ‘event of default ‘ – which triggers bank to recall money back early if company cannot pay.

Security

Security interest

[i.e. guarantees]

  • A right given to one party [i.e. the lender / the bank] in the asset of another party [I.E the borrower / the company] to secure payment or performance by that other party or by a third party [i.e. the company]

  • Security gives rights over assets – not merely a personal rights

How is security given?

  • Agreement between the parties “consensual security” – Debenture!!

  • Operation of law – automatically
Why do lenders take security?

  1. To avoid the disadvantages of unsecured debt.

  • Unsecured debt = where no security is given!

  • Without security, the lender’s remedies are limited if company goes into default /...

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