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Corporate Finance: SGS 10: Security: Assets & Priorities INDEX OF ABBREVIATIONS
- RIE - Recognised Investment Exchange
- IPO - Initial Public Offering
- PR - Prospectus Rules
- LR - Listing Rules
- DTR - Disclosure Guidance and Transparency Rules
- LP - Listing Principles
- PLP - Premium Listing Principles
- FSMA 2000 - Financial Services and Markets Act 2000
- RAO - Financial Services and Markets Act 2000 Regulated Activities Order 2001
- FPO - Financial Services and Markets Act 2000 Financial Promotions Order 2005
- MAR - Market Abuse Regulations
- CJA - Criminal Justice Act 2002
- FSA - Financial Services Act 2012
- UK CGC - UK Corporate Governance Code
- RCF - Revolving Credit Facility
- LSE - London Stock Exchange
- AIM - Alternative Investment Market
- FCA - Financial Conduct Authority
- MAC - Material Adverse Change
- EoD - Event of Default SECURITY: OVERVIEW
- Security - Protects lender against insolvency of borrower by enabling lender to sell assets over which it has been granted security (subject to prior competing securities over those assets) and use sale proceeds to repay the amount outstanding under the loan in the event of borrower's default under terms of that loan.
- Exercising security rights usually quicker/easier means of recovery for the lender than bringing debt action against borrower in the courts.
- Proceeds of Sale - Proceeds of sale of a secured asset can ONLY be used to repay the secured debt + any amount obtained in excess of value of outstanding secured debt must be returned to borrower.
- Extent of Security - Lender may take security over specified assets held by the borrower (e.g. security over borrower's property where loan used to finance acquisition of property) OR may take security over all the borrower's assets (e.g. bank lending to new business venture may take security over all the business' assets).
- Effect of Security for Lender - Security increases lender's protection against borrower's default/insolvency because: (a) lender has direct recourse to asset over which security granted; (b) lender can avoid costs/delays/administrative burden of litigation by simply enforcing security rather than bringing a debt claim against the borrower; (c) lender obtains priority over unsecured creditors in relation to priority of distribution of borrower's assets on liquidation; and (d) lender's recourse to specified assets and priority over unsecured creditors in event of borrower's insolvency means that the secured lender is more likely to be able to wholly/partially recover the debt owed to them.
- Reasons for Providing Security - Borrowers provide security to lenders for 2 main reasons: (1) Obtain Loan - Borrowers with weak credit status often unable to obtain loan finance unless they are willing to offer security due to lender's need to obtain greater protection offered by secured lending in light of greater risk of borrower's default. (2) Decrease Cost of Borrowing - Borrower who is able/willing to offer security provides greater protection to lender + reduces credit risk for lender - lower the risk for the lender, the lower the interest rate payable.
- Negative Pledge Clause - Clause in loan agreements which forbids the creation of any future security over the assets over which lender granted security in relation to that loan agreement.
- Companies Act 2006 ss.677-683: Unlawful Financial Assistance - Borrowing company and its subsidiaries will not be able to provide security where this amounts to unlawful financial assistance - covers: (a) security provided by public company to secure loan made to purchaser of shares in that company where the loan is used to fund the share purchase; (b) security provided by private company to secure loan made to purchaser of shares in the private company's public holding company, where the loan is used to fund the share purchase; and (c) security provided by public company to secure loan made to purchase of shares in the public company's public/private parent company, where the loan is used to fund the share purchase. MAIN TYPES OF SECURITY (1) Fixed Charge
- Charge - Equitable/statutory right over an asset which gives the charge-holder the right to appropriate that asset, sell it and use proceeds of sale to discharge debts due to the charge-holder. 1
- Fixed Charge - Equitable proprietary right over a particular specified asset which attaches to that asset as soon as charge created and provides charge-holder with right to appropriate that asset, sell it and used proceeds of sale to discharge outstanding debt owed to the charge-holder.
- 'Control'- Valid/effective fixed charge requires the charge-holder to show a sufficient degree of CONTROL over the charged asset - usually done by use of clause in security document preventing borrower dealing with charged asset without prior consent of charge-holder
- Control clause allows borrower granting security to possess/use charged asset throughout term of loan BUT prohibits the borrower from disposing of/granting further securities over the charged asset without first obtaining the consent of the charge-holder in the prescribed form.
- Sale of Asset Subject to a Fixed Charge - Purchaser of asset subject to a fixed charge will take that asset SUBJECT TO that fixed charge PROVIDED that purchaser has NOTICE of that charge - notice usually given by registration of the charge at Companies House. (2) Floating Charge
- Floating Charge - Charge which 'floats' over a defined class of charged assets until occurrence of specified event (i.e. event of default) at which time the charge will crystallise into fixed charge over whatever assets are within the class of assets over which the floating charge granted.
- Crystallisation results in floating charge becoming a fixed charge over the assets within the class of assets over which the floating charge granted at the time when the event triggering crystallisation occurs BUT still treated as a floating charge for insolvency purposes and when determining order of priority of distribution on insolvency.
- Freedom for Borrower - Borrower able to possess/use/deal with (i.e. sell/hire/charge/lease) assets within class of assets subject to floating charge because charge only crystallises into a fixed charge over assets within prescribed class of assets at time of occurrence of specified event.
- Once floating charge has crystallised into fixed charge over assets within specified class of assets, borrower no longer able to dispose of/deal with such assets without the prior consent of the floating charge holder (same as for standard fixed charge).
- Allows borrower to use/deal with valuable/tradeable class of assets AND grant security over that class of assets despite fact that nature/composition/value of that class of assets (and thus of lender's security interest) is liable to change over the loan term, as lender agrees to take security over whatever is within the specified class of assets at time of crystallisation BUT does not restrict how borrower deals with assets within that class prior to crystallisation.
- Crystallisation of Floating Charge - Crystallisation as a matter of LAW where borrower placed into LIQUIDATION or a RECEIVER is appointed in respect of borrower's business or if borrower CEASES TO CARRY ON BUSINESS.
- Crystallisation occurs under terms of SECURITY DOCUMENT whenever any of the events specified as triggering crystallisation in that document occur (e.g. event of default under terms of loan agreement relating to loan secured by the floating charge).
- Re Yorkshire Woolcomber's Association Ltd (1903): Floating Charges - Charge deemed to be a 'floating charge' if: (a) it is a charge over a CLASS OF ASSETS held by a company from time-to-time; (b) the assets within that class of assets are, in ordinary course of the borrowing company's business, liable to CHANGE from time-to-time; and (c) parties contemplate that, until occurrence of some future event, the borrowing company granting the charge will be free to CARRY ON BUSINESS IN ORDINARY WAY in relation to the assets within the class of assets over which the charge takes effect.
- National Westminster Bank Plc v Spectrum Plus Ltd (2005): House of Lords: Lord Scott - Key characteristic of floating charge is the 3rd limb of test in Re Yorkshire Woolcomber's Association Ltd (1903) - assets subject to the charge and over which the charge takes effect are not definitively identifiable until the occurrence of the specified event which results in the crystallisation of the charge - until that event occurs, charger (borrower) is free to use/dispose of/deal with the assets within the class of assets over which the charge takes effect.
- Contrast with essential feature of fixed charges being the borrower's inability to deal with/dispose of the charged asset without the prior approval of the charge-holder/lender.
- Substance Not Form - Level of control which charge-holder possesses over the charged assets will determine whether the charge is a fixed or floating charge - name allocated to the charge by the parties will NOT be conclusive.
- Weaknesses of Floating Charges - 7 main issues with floating charges: (1) Vulnerability to Future Fixed Charges - Subsequently created fixed charges over assets subject to floating charges will take priority over the pre-existing floating charge in relation to order of priority on insolvency UNLESS the charging document creating the floating charge contained a NEGATIVE PLEDGE CLAUSE of which the charge-holder of the fixed charge had NOTICE. (2) Lesser Priority - Claims of fixed charge creditors + preferential creditors + liquidator's fees/expenses rank above claims of floating charge creditors in order of distribution of borrower's assets on insolvency. (3) Prescribed Part Fund - Proportion of proceeds of sale of assets subject to floating charge (up to maximum of
PS600,000) is ring-fenced for distribution amongst the insolvent borrower's unsecured creditors by way of the Prescribed Part Fund - reduces the proportion of the sale proceeds of charged assets to which the floating charge 2
holder may have recourse and thus decreases the likelihood that the floating charge-holder will be able to recover in full. (4) Administrator's Costs - Paid out of proceeds of sale of assets subject to floating charge - decreases proportion of proceeds of sale of assets subject to the floating charge available to the floating charge-holder, thus decreasing likelihood that it will be able to recover in full. (5) Avoidance Rules - More stringent avoidance rules apply to floating charges + floating charges may be set aside in some circumstances where borrower has become insolvent (s.245 Insolvency Act 1986). (6) Non-Recognition - Legal systems in some foreign jurisdictions do not recognise floating charges. (7) Retention of Title Clause - Even if floating charge crystallises over assets within specified class, assets may be subject to a valid RETENTION OF TITLE CLAUSE meaning that assets within that legal title to those assets is NOT vested in borrower and so cannot be charged to the lender - prevents the lender appropriating/selling those assets and using proceeds to discharge outstanding debt.
- Advantages of Floating Charges - Principal advantage is that the lender acquires security (i.e. reduced risk/greater protection for lender) whilst the borrower retains possession of/ability to deal with assets within the class over which the floating charge takes effect.
- Administrative Receivership - Holder of GRANDFATHER FLOATING CHARGE over the whole/substantially the whole of the company's assets which was created BEFORE 13 September 2003 is NOT subject to the Prescribed Part Fund + can appoint an administrative receiver as a means of preventing the appointment of an administrator +
administrative receiver owes primary duty to appointing charge-holder and will appropriate/sell assets over which the charge takes effect and use proceeds to discharge debts owed to charge-holder.
- Qualifying Floating Charge - Floating charge over the whole/substantially the whole of the company's assets created ON/AFTER 13th September 2003 which states that Insolvency Act 1986 Sched B1 Para 14 applies OR purports to allocate the powers granted by Para 14 to the Qualifying Floating Charge Holder (QFCH) - entitled the QFCH to appoint an administrator using the out-of-court procedure BUT administrator will owe duties to borrower's creditors as a whole and NOT to the appointing QFCH individually. (3) Mortgages
- Legal Mortgage - Transfer of OWNERSHIP of an asset from borrower to lender subject to: (a) implied obligation on part of lender to return ownership of that asset to the borrower on repayment of loan - EQUITY OF REDEMPTION; and (b) a right vested in the lender to sell the asset and retain the proceeds of sale (up to value of outstanding debt owed to the lender) in the event of the borrower's default.
- LPA 1925 s.101: Power of Sale - Legal mortgage created by deed grants the mortgagee a power of sale in respect of the mortgaged property/asset.
- LPA 1925 s.87: Charge by Way of Legal Mortgage - Standard for of security over land BUT NOT a 'true' mortgage because ownership of land does NOT pass to lender - requires registration at Land Registry.
- Grants charge the same powers/protections/remedies as a 'true mortgage' WITHOUT transfer of legal title to the property to the mortgagee.
- Equitable Mortgage - Transfer of beneficial interest in an asset BUT no transfer of legal title to that asset - can be created by written agreement which is not a deed + agreement to create a legal mortgage in future + mortgage over an equitable interest + mortgage over property, legal title to which is not yet vested in the mortgagor + agreement to create a legal mortgage which has not been properly executed (e.g. not executed as a deed as required by s.52(1) LPA 1925).
- Bona fide 3rd party who purchases asset subject to an equitable mortgage for value without notice will acquire the asset free from the equitable mortgage - means that equitable mortgages over corporate assets must be registered at Companies House under ss.859A-Q Companies Act 2006 in order to ensure that any purchasers of that asset deemed to have notice of the equitable mortgage and will therefore acquire the asset subject to the equitable mortgage interest. (4) Security by Way of Physical Possession
- Pledge - Lender takes actual/constructive delivery of asset until repayment of debt by borrower pursuant to a letter of pledge/memorandum of deposit - requires the lender to acquired control of the pledged asset + lender acquires implied power to sell the pledged asset and use proceeds to discharge the outstanding debt if the borrower defaults.
- Weaknesses - Pledgor (borrower) surrenders physical possession/ability to use the pledged asset and so cannot pledge assets which it requires in order to generate income in ordinary course of business + pledgee (lender) owes duties/faces liability as a bailee of pledged asset.
- Lien - Right, arising by operation of law, to retain possession of property belonging to another until that other discharges an obligation (contrast with a pledge where property is retained until payment of a debt) - no automatic power of sale for the party with the benefit of the lien (i.e. cannot sell the retained assets in order to cover losses suffered as a result of other party's non-performance of relevant obligation). (5) Assignment by Way of Security
- Choses in Action - Borrower's contractual rights against 3rd parties (e.g. borrower's insurance policy/rights under loan agreements with its debtors) are CHOSES IN ACTION because they are rights which the borrower may enforce by bringing an action in contract, rather than by appropriating an asset - choses in action can be granted as security. 3
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