Week 3 Law

Cards (62)

  • Capital Structure
    How a firm finances its overall operations and growth by using different sources of funds
  • Sources of funds
    • Debt (bond issues or long-term loans payable)
    • Equity (common stock, preferred stock, retained earnings)
  • Debt and equity
    Have different costs, specific to each company and how risky it is perceived to be, although based on economic factors
  • Loan capital

    Comprises all longer term borrowings for the purpose of the business. E.g.:
    • Permanent bank overdraft
    • Unsecured loans from a bank or third party
    • Loans secured on assets either from a bank or third party
  • Debentures
    Long-term loans issued by a company to raise significant amounts of capital
  • Types of debentures
    • Single debentures
    • Multiple debentures
    • Debentures issued as a series
  • Secured debentures
    Debentures with security over a specific asset
  • Unsecured debentures
    Debentures with no security, also called "bare" or "naked" debentures
  • Redeemable debentures

    Debentures that can be repaid
  • Irredeemable debentures

    Debentures that cannot be repaid, also called "perpetual debentures"
  • Advantages of debentures (for the borrower)
    • Debentures carry no voting rights, so do not dilute or affect the control of the company
    • Interest should be tax deductible for the borrower, thus reducing the effective cost of servicing the debt
  • Disadvantages of debentures (for the borrower)
    • Interest must be paid out of pre-tax profits, irrespective of the profits of the company
    • Default may lead to liquidation and/or administration
    • High gearing may lead to adversely affect the company's share price
  • Advantages of debentures (for the lender)
    • Debentures will rank higher in the event of liquidation – therefore a lower risk option than shares
    • Debentures holders have a contractual right to interest every year
    • Lender has the option to agree security for the debt, which may reduce their risk even further
  • Disadvantages of debentures (for the lender)
    • Return is limited to interest payments – lender is only entitled to receive the nominal value of the debenture at redemption
    • Debentures carry no voting rights, so lenders are unable to directly influence the actions of directors
  • Remedies for unsecured creditors in the event of default

    • Right to sue the company for debt
    • Right to petition the court for the compulsory liquidation of the company (if sum owed is >£750)
    • Right to petition the court for an administration order
  • Remedies for secured creditors in the event of default

    • Take possession of the asset charged and sell it
    • Seek a foreclosure order from the court whereby ownership of the property will be transferred to him
    • Appoint a receiver over the assets
    • Seek an administration order (without court order)
  • Fixed charge
    Security over a specific asset, which prevents the company from selling the asset without the consent of the creditor (charge holder)
    Company has no general freedom to sell the asset
  • Advantages of fixed charges
    • The charge provides immediate and greater security for a loan
    • The asset cannot be disposed of without the lender's consent
    • The charge ranks higher priority than floating charges – i.e. it is the lowest risk/highest security
    • Interest rate likely to be lower for the borrowing company due to lower risk for the lender
    • Company may find it easier to borrow under a fixed charge due to feeling of greater security
  • Disadvantages of fixed charges
    • Less freedom to deal with assets for the borrowing company
    • Lender at risk if the asset deflates in value or is destroyed
  • Floating charge
    Security over a class of assets (e.g. inventory, receivables) where the company has freedom to buy/sell the charged assets in the ordinary course of its business
    the charged assets will therefore be subject to change from time to time
  • Crystallisation
    The process by which a floating charge will attach to a specific asset, meaning the company can no longer deal freely with the assets. Turns floating charge into fixed charge
  • Triggers for crystallisation
    • Liquidation
    • The company ceases to trade
    • Any specified event (e.g. devaluation)
  • Advantages of floating charges
    • The borrowing company has freedom to buy and sell the charged assets – so are not tied down
    • The borrowing company has greater flexibility over the class of assets that can be charged
    • Assets generally more "liquid" than fixed charge assets
  • Disadvantages of floating charges
    • The value of the security is unknown until is crystalises, the borrowing company cannot be made up any loss of value
    • Rank lower in order of repayment than fixed charges on liquidation
    • Due to higher risk, interest charged is usually higher than fixed charges
  • Order of distribution on liquidation
    • Liquidators' costs
    • Fixed charge holders
    • Ordinary (employees) and Secondary (HMRC. For VAT, PAYE, Employer NICs) preferential creditors
    • Floating charge holders
    • Unsecured creditors
    • Shareholders
  • Factors determining priority of charges
    • Equal charges rank in order of creation
    • Fixed charges rank above floating charges
    • Negative pledge clauses can prohibit future fixed charges from taking priority
    • Unregistered registrable charge has no priority over a registered charge
  • Registration of charges

    • All charges must be registered under s741 CA06
    • Within 21 days of creation
    • Duty of the company to register the charge with the registrar of companies, but lender usually undertakes the register
  • Failure to register the charge will result in the charge being void on liquidation and the company/directors being fined
  • Veil of incorporation
    A company is a separate legal entity from its shareholders
    • Single legal entity - Sole trader, partnerships
    • Separate legal entity - Companies
  • Articles of Association
    Bind the company and its shareholders, and the shareholders to each other
  • Share capital
    The interest of a shareholder in the company measured by a sum of money, for the purpose of liability and interest
  • Types of shares
    • Ordinary shares
    • Preference shares
  • Ordinary shares
    Have full voting rights, not fixed dividend rights, and are entitled to surplus assets after repayment of preference shares
  • Preference shares

    Usually have no voting rights, have fixed dividend rights paid in priority to other dividends, and are entitled to repayment of initial capital but cannot participate in surplus
  • Ordinary shares (investor perspective)
    • Riskier as they are last to be paid out on a winding up
    • Can appreciate in value if the company is successful.
  • Preference shares (investor perspective)
    • Provide a guaranteed income, and are less risky as they are repaid before ordinary shares
    • Downside is the shareholder will not benefit from capital appreciation and cannot vote on company business
  • Ordinary shares (company perspective)
    • Carry voting rights, so majority might give away control
  • Advantages of preference shares (company perspective)
    • Do not dilute control, but dividends must be paid and reduce discretion over use of profits
  • Varying class rights
    1. Is the procedure contained in the articles?
    2. Yes - Must follow the procedure set out in the articles
    3. No - Variation requires a special resolution or written consent (i.e. 75% majority) of shareholders in that class
  • Cumbrian Newspapers Group Ltd v Cumberland & Westmorland Herald (1986)
    • Claimant acquired a 10.67% stake in the Defendant company, with special rights attaching to those shares, including pre-emption rights and the right to appoint a director to the board. Defendant company passed a special resolution to remove these rights, but the courts held this was unlawful as they had effectively created a new class of share, with one shareholder, and alteration requires the shareholder's consent, which they refused.