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Advantages and Disadvantages of Raising Loan Capital

Info: 1878 words (8 pages) Essay
Published: 2nd Aug 2019

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Jurisdiction / Tag(s): UK Law

The power to borrow is of great importance to the company, and corporate borrowing enjoys some unique characteristics. Loan capital and share capital are two types of borrowing money for a company. Types of borrowing by loan capital are debentures, mortgage of corporate property and assets, unsecured loans, overdrafts and bills of exchange. The share capital represents how much the company is worth. Share capital is that part of the company’s capital that is made available by the members who have subscribed for shares in the company, which in truth is usually worth far less than the company’s total assets and should be differentiated from loan capital. In this case, Black Books plc is considering methods of raising or securing loan capital.

There are some advantages for Black Books plc of raising loan capital rather than share capital. First of all, loan capital allows them to maintain the ownership of their property and at the same time assists them in reaching financial aid too therefore the land which is mortgage is owned by them. Loan capital unlike share capital, does not share ownership so Black Books plc has the entire ownership. The debenture holder is very much more of an outsider. Also, there is no necessary for someone to sell or leave his property in order to deposit some money. An important point is that interest payments on the mortgage are tax free. Repayments should be predefined and determined it allows them to plan their budget. Furthermore, lender will monitor the performance of business but will have no control over the business. In addition, once loan capital is repaid, it will benefit to gain profit. On the other hand, shareholder will still expect a share of profit. Finally, debenture holder has to release the ownership once loan repaid.

On the other hand there some disadvantages of raising loan capital too. Firstly, repayments have to be made separately from of making profit or not. On the other hand shareholder will not receive dividends until business makes a profit. Interest to be paid, will impact profit. In addition, the company will not be able to sell the land to third party until loan is repaid. Also, the risk of them ending up or losing their property increases drastically. Finally, register security charge.

An issue of debenture document which implies to acknowledge a credit arrangement between a company and a creditor. A debenture holder is entitled to obtain payment of the sums due to him, whether they are principal or interest; the set holder irrespective of whether or not the debtor company is in profit. When a company wishes to raise finance, especially long-term finance, it will almost predictably be obliged to give security for the amount it wishes to borrow. An action by a secured creditor to realize a security interest will normally be impossible until the debtor company fails to meet its obligations under the terms of the debenture contract. Nevertheless, where a company borrows money by way of an overdraft facility, the overdraft may be expressed to be repayable on demand.

For a mortgage, you borrow money to buy a land, you cannot own the land complete until the debt is repaid, nor can you sell it without the lenders authorization. The mortgage is a form of fixed charge.The fundamental characteristic of any mortgage is that it is a conveyance of an interest in property with a provision for redemption. A legal mortgage may be created over personal or real property. In the case of a legal mortgage taken over land, the mortgage may only be created in one of two ways. First, it may be created by a transfer of the property for a period of years complete. Secondly, and in this case, by company act 2006 s 738 allows a legal mortgage of the company’s land in favour of Lender as security for a simultaneous loan of £500,000.With the second method, the mortgagee obtains no estate in the land secured by the mortgage, but, by s 87(1) of the Law of Property Act 1925, should the mortgagor be unsuccessful to make the repayment of sums due under the mortgage, the charge may take control of the mortgaged property.

The floating charge is a mechanism which can only be given as security for a debt incurred by a limited company. The character of a floating charge is such that the charge does not fix itself to an exact corporate asset until an event, ‘crystallization’, arises. The floating charge is formed over a class of assets which by their very nature are supposed to not have a degree of stability, thus preventing them being readily identified (i.e. the assets are all the time changing nature). Black books plc has a first floating charge over the company’s assets to the extent of £100,000. In Illingworth v Houldsworth (Re Yorkshire Woolcombers Association Ltd) [1903] 2 ch. 284, Romer LJ tentatively identified the floating charge as possessing some qualities. Firstly it can be a charge on all of a class of assets of the company present and future. Also a floating charge can include a class of assets which in the ordinary course of a company’s business would be change during time and would allow the company to run its business in the regular way.

At the floating charge of Supplier was included a negative pledge clause. Negative clause prevents from creating further charge. The “negative pledge” clause is where a floating charge over “all the assets and responsibility” of the company is spoken to take priority over all later charges over the same property. Such a clause will in reality only affect later fixed charge, with actual notice of the earlier floating charge and the restriction contained within it (Earle v Hemsworth RDC [1928]. According to CA 2006 s741 charges should be registered to secure the charge. Black Books plc according to Palmer must register an allotment of debentures as soon as practicable and in any event within two months after the date of the allotment. If a company fails to comply with this section, an offence is committed by the company. If Black Books plc does not registered charges under CA 2006 s874 become unsecure. If a company creates a charge to which section 860 applies, the charge is void against a creditor (Supplier) of the company unless that section is complied with.

Automatic crystallization is a clause in a debenture contract that provides for a floating charge to crystallize into an equitable fixed charge on the happening of a specified event without the need for the creditor to make claim to the assets subject to the charge. The legal effectiveness of such a clause was once doubted but the judicial acceptance of the automatic crystallization clause is now well established on the premise that the court should seek to give effect to the contractual intention of the parties subject to the charge. Hoffman J stated ‘ it seems to me fallacious to argue that once the parties have agreed on some terms which are thought sufficient to identify the transaction as a floating charge, they are then precluded from agreeing to any other terms which are not present in the standard case.’ (At p 427) The approval of the authority of an automatic crystallization clause was again confirmed by Hoffmann J in Re Permanent Housing Holdings Ltd [1988] BCLC 563.

Black Books plc can not continue to deal with assets which are the subject of a floating charge because the charge crystallises: see e.g. Re Borax [1901] Ch 326. A floating charge over the company’s assets to the extent of £50,000 in favour of Pressing automatic crystallised into a fixed charge in the event of the England Cricket Team which loosed the One Day test series in Australia in January 2011. The fixed (registered) charge takes priority over a (registered) uncrystallised floating charge. (Once the floating charge

has crystallised then it will take priority over any later fixed equitable charge). But it is not certain that Pressing has priority over Supplier. As there was a risk for Supplier of a later fixed charge obtaining priority, he commonly inserts negative pledge clauses in his agreement with Black Books plc. A negative pledge clause is an express term of the contract which precludes the company from creating a second charge with priority. Supplier will retain priority only if Pressing has notice of the first charge and of the clause. If Pressing searches the register of charges and obtains actual knowledge of the charge and of any restriction registered with the charge, then Supplier claim will take priority over Pressing claim.

The debenture holder, who wishes to realise his security and get his money back, may either exercise remedies given by the debenture trust deed without recourse to the court or take proceedings to enforce his rights. As Lender (debenture holder) is a creditor of Black Books plc he has the normal remedies of an unsecured creditor, due on March 1st 2011 including the right to sue the company for the realisation of the amount due on debenture held by him and appeal for a decree against the company’s property. Also Lender has the right to present a petition to the court for the compulsory liquidation of the company and the right to present a petition to the court for an administration order.

Lender as a secured debenture holder has the additional right to enforce his security. May take possession of the asset charged and sell it. Lender, the debenture holder, is the holder of a single debenture giving a charge on the assets of the company; he will have an express or implied power of sale. If there is a trust deed, the trustees have power to sell the property of the company. Any surplus of the proceeds of sale after payment of debts due to debenture-holders is payable to the company.

Furthermore, Lender, debenture-holder, may request to the court for distrait, the effect of which is that the borrowers’ interest in the assets charged is completely extinguished and the lenders become the owner of them. However, for its proper exercise it is necessary for all the debenture-holders of every class to be parties to the action. Lender, the debenture holder, may bring action (called a debenture holder action) on behalf of him and other debenture holders of the same class asking for a declaration that the debenture have a charge on the assets; an account of what is owned to the debenture holders; an order of foreclosure or sale and the appointment of a receiver.

In addition, Lender, debenture-holder, may appoint a receiver or manager to take on his property in this, which is compulsory to do he is so empowered. If Lender lacks the power, he may apply to the court for an appointment. In either case the fact of appointment must be brought to the notice of the registrar within 30 days.

Finally, Lender asks for an administration order. If the company is being wound up and his security is insufficient, Lender, the debenture holder, may value his security and prove for the balance of his debt or give up his security and prove for the whole debt. In case a debenture-holder owes a debt to the company, he cannot set off his debt against the debenture.

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