Company Borrowing and Security

A company is a separate legal entity but is an artificial one to some extent so the ability of the company engage in commercial borrowing depends on

1.       The company still being in existence i.e. not having been struck off

2.       Not being in receivership, liquidation or under the protection of the court.

It is interesting to note that if a company adopts the standard Table A articles of association and section 79 has not been excluded from it, then the powers of the directors to borrow on behalf of the company is ineffective.

Section 79 says that a company can only borrow an amount equal to the nominal value of the issued share capital unless the company in a general meeting authorises a higher amount. This can be of enormous significance if the legal team advising the bank overlook this point when granting loans to companies.

A bank will usually take either a fixed charge (on a property) or a floating charge (on stock or debtors or assets that change).

A fixed charge has preference over a floating charge and preferential creditors such as employees and the Revenue Commissioners. But the latter have preference over a floating charge in a wind up situation.

The person wishing to borrow for the company must have the capacity to do so. This means they cannot be acting ultra vires, as seen in AG v Great Eastern Railway.

In corporate finance, a debenture is a medium- to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. The legal term "debenture" originally referred to a document that either creates a debt or acknowledges it, but in some countries the term is now used interchangeably with bond, loan stock or note. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital. Senior debentures get paid before subordinate debentures, and there are varying rates of risk and payoff for these categories.

Debentures are generally freely transferable by the debenture holder. Debenture holders have no rights to vote in the company's general meetings of shareholders, but they may have separate meetings or votes e.g. on changes to the rights attached to the debentures. The interest paid to them is a charge against profit in the company's financial statements. They are a debt before equity and if secured, the holder has a direct interest in the company’s assets.

If they are of the same series, then they all rank pari Passau. This means that if debentures are issued with the same terms and conditions to different lenders at different times for different amounts, they all rank equally. They provide for immediate repayment were an order for the winding up of a company is made, the company ceases business, a receiver is appointed or the company defaults in payment for six months.

Debentures may be transferred, as per their terms and conditions. Once transferred, the company’s register of the debentures must be amended. In the event of an Event of the default of the company, the holder of the Debenture can sue for debt or petition for a winding up. If the Debenture is secured by a fixed or floating charge, the Debenture holder may appoint a receiver in relation to their asset.

A floating charge is a security interest over a fund of changing assets of a company or a limited liability partnership (LLP), which 'floats' or 'hovers' until the point at which it is converted into a fixed charge, at which point the charge attaches to specific assets of the company or LLP. This conversion into a fixed charge (called "crystallisation") can be triggered by a number of events; inter alia, it has become an implied term (under English law) in debentures that a cessation of the company's right to deal with the assets in the ordinary course of business leads to automatic crystallisation. Additionally, according to express terms of a typical loan agreement, default by the chargor is a trigger for crystallisation. Such defaults typically include non-payment, invalidity of any of the lending or security documents or the launch of insolvency proceedings

Although the nature of a floating charge has been widely considered by the courts, historically no full definition has ever been given, and the nature of the chargee's interest in the charged assets (or fund of assets) remains doctrinally uncertain. The earliest descriptions were given by Lord MacNaghten in two cases.

In Government Stocks and Other Securities Investment Co Ltd v Manila Rly Co he said:

"A floating security is an equitable charge on the assets for the time being of a going concern. It attaches to the subject charged in the varying condition in which it happens to be from time to time. It is the essence of such a charge that it remains dormant until the undertaking ceases to be a going concern, or until the person in whose favour the charge is created intervenes. His right to intervene may of course be suspended by agreement. But if there is no agreement for suspension, he may exercise his right whenever he pleases after default."

Later in Illingworth v Houldsworth he stated:

"...a floating is ambulatory and shifting in 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 and grasp."

A description was subsequently given in Re Yorkshire Woolcombers Association, and despite Lord Justice Romer clearly stating in that case that he did not intend to give a definition of the term floating charge, his description is generally cited as the most authoritative definition of what a floating charge is:

·         it is a charge over a class of assets present and future;

·         that class will be changing from time to time; and

·         Until the charge crystallises and attaches to the assets, the chargor may carry on its business in the ordinary way.

When conducting a recent review of the authorities, in keeping with that tradition, in National Westminster bank plc v Spectrum Plus Ltd, the House of Lords elected instead to describe the essential characteristic of a floating charge rather than define it, and they described it thus:

"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“.

Fixed and floating charges are used to secure borrowing by a company. Such borrowing is often done under the terms of a debenture issued by the company. Charges on a company's assets must be registered at Companies House and may also need to be registered in some other way, e.g. a charge on land and buildings must also be registered at the Land Registry.

A fixed charge is a charge or mortgage secured on particular property, e.g. land and buildings, a ship, piece of machinery, shares, intellectual property such as copyrights, patents, trademarks, etc. A floating charge is a particular type of security, available only to companies. It is an equitable charge on (usually) all the company's assets both present and future, on terms that the company may deal with the assets in the ordinary course of business. Very occasionally the charge is over just a class of the company's assets, such as its stock.

The floating charge is useful for many companies, allowing them to borrow even though they have no specific assets, such as freehold premises, which they can use as security. A floating charge allows all the company's assets, such as stock in trade, plant and machinery, vehicles, etc., to be charged.

The special nature of the floating charge is that the company can continue to use the assets and can buy and sell them in the ordinary course of business. It can thus trade with its stock and sell and replace plant and machinery, etc. without needing fresh consent from the mortgagee. The charge is said to float over the assets charged, rather than fixing on any of them specifically. This continues until the charge 'crystallizes', which occurs when the debenture specifies. This will include any failure to meet the terms of the loan (non-payment, etc.), or if the company goes into liquidation, ceases to trade, etc.

The case of Welch v Bowmaker is one of the leading Irish cases in regard floating charges. In this case, the Plaintiff issued a debenture to the defendant, creating a floating charge and a specific charge over the lands in the schedule. The debenture said that the charge was “a specific charge as regards the company’s lands for the time being” and a floating charge in regards the other property. They later made an equitable mortgage to a tract of the land to Bank of Ireland. The defendant claimed that their fixed charge included the land given to Bank of Ireland and that their charge took priority. The Supreme Court held that the plot of land was only governed by a floating charge.

Book debts are a current asset and whether or not there can be a valid fixed charge on book debts has been the subject of much legal discussion. For 25 years banks and other charge holders have used a standard form of debenture which had been approved as creating a fixed charge over present and future book debts by Mr. Justice Slade in the matter of Siebe Gorman & Co Limited v Barclays Bank Ltd. In June 2001 the Privy council heard an appeal from the Court of Appeal of New Zealand in the matter of Richard Dale Agnew and Kevin James Bearsley v Brumark. Following this decision it appears that in the majority of cases encountered by the official receiver where a fixed charge over book debts leaves the company free to collect the debts and to use the proceeds in the ordinary course of business, the charge should instead be treated as though it were a floating charge and realised accordingly.

This decision which is not binding in English law was challenged by the bank in the High Court in the Spectrum case. The Vice Chancellor 'very reluctantly' followed the position of the Privy Council in Brumark concluding that the Siebe Gorman judgment was wrong. While this was overturned in the Court of Appeal, it was subsequently upheld in the House of Lords.