Insolvency WS2 Final Notes PDF

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Insolvency; Options for a Secured Creditor, Different types of Security, Challenging Earlier Transactions OUTCOMES 1. Advise on the options available to a secured creditor of a company which is in financial difficulty (PT) 2. Explain the nature, validity and priority of particular types of security for a company’s borrowings (PT,T1) 3. Identify the ways in which a liquidator or an administrator can challenge earlier company transactions in order to increase the funds available to creditors (T2) 4. Explain the way in which a trustee in bankruptcy can challenge earlier transactions of a bankrupt individual in order to increase the funds available to his creditors (PREP – Not covered in class) READING -

Chp 10 – On secured debt p227 Chp 11 – Taking Security (in full) Chp 19 – On preserving and increasing a company’s assets Chp 20 – On preserving and increasing the bankrupt’s assets PLC practice note “Perfection and Priority of Security” (below)

INSOLVENCY ACT 1986 ss238-241

s245

s249

s435

EXAM http://www.out-law.com/en/topics/financial-services/banking/loan-agreements---key-terms/ -

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Why do companies borrow? o Expand o Temp CF problems o Purchase assets Why would you borrow from 1+ lender? o To swell the funds o To protect themselves (all monies clause) – not putting all eggs in one basket o Sharing the risk From Lenders o Security a good idea, more likely to get ££ back at the end of the day Do not forget that receivers costs are paid first! Also remember that you need to look at the assets as two separate pools i.e. land/undertaking! AND always apply to the facts are you work through the question!

SECURED DEBT -

Debt finance is a matter of contract law between the lender and borrower With a secured debt, the borrower receives money (or other credit) and gives the lender rights over the borrower’s property. Terms on which granted determined by agmt btwn the parties after negotiations

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Lenders ask for ‘security’ in return for the loan to increase their chances of being repaid if the company should get into financial difficulty (i.e. borrower fails to meet obligations) • B/C can then seize the secured asset, sell it and pay itself out of the proceeds (priority) • NB: does not entirely eliminate risk of being repaid These rights will not come into play unless the borrower defaults. At that point, the secured property will be sold to repay the debt. Secured creditors are in a much stronger than unsecured creditors who are governed by the pari passu principle (equity) • Pari passu –unsecured debts reduced pro rata if insufficient funds to pay all company’s debts (insolvent) Usually in return for the secured loan the borrower will borrow at a lower rate albeit with restrictions on the use of the asset

Security for the loan: There are fixed charges and floating charges (see detail below). They have certain features in common: (a) most charges need to be registered with CH (CA 2006, s860(1)) and are void against a liquidator, an administrator or a creditor w/an interest in the secured assets if not so registered (s874), though the contract between the lender and the company is still valid (b) the charge holder’s rights prevail over other creditors on insolvency; and (c) the charge holder can take possession and sell the assets subject of the charge. TERMINIOLOGY -

‘CHARGE’ – CA 2006, s859(7) ‘includes mortgage’ ‘MORTGAGE’ – LRA 1925, s205(1)(xvi) ‘includes any charge or lien on the property’ ‘SECURITY’ - IA 1986 ‘any mortgage, charge, lien or other security’ ‘DEBENTURE’ - an agmt pursuant to which a company gives security to a lender Be careful when reading legislation (precise meaning) and particularly when examining contractual documentation (ensure you have correctly identified the type of security it covers) TAKING SECURITY Pre-Contract Considerations

Pre-contract considerations for LENDER: -

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Must make sure the Ds have the authority to act on behalf of the company and that the people dealing with have been properly appointed Ds of the company. • This can be done by inspecting the Company’s AoA at CH, and • Requesting copies of relevant Board Resolutions If the loan is to be secured by a charge - search at CH should be made to see if there are any other charges currently registered against the company’s property, and sufficient value to the property to provide adequate security for the loan

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Even if the loan is to be unsecured, the lender should search CH to determine the extent of the company’s current secured borrowing. The following can be discovered from the charges register at CH: 1. The date of creation of any existing charge 2. The amount secured 3. Which property is the subject of the charge 4. Who holds that charge If lender takes charge over land held by Co - conduct search at Land Reg checking Company’s title to land & whether any pre-existing charges registered If charge over IP (™) - Check Intellectual Property Office AND should check no insolvency proceedings are being commenced against the Company – Winding-Up Search (by telephone) at Companies CT

1. Consider: DOES THE COMPANY HAVE THE REQUISITE CAPACITY TO ENTER INTO THE LOAN? s31: Unless the Article specifically restrict the company’s objects, then its objects are unrestricted S 28(1): The company’s objects clause is now treated as a provision of the company’s AoA if 1985 co. So: -

Check the company’s objects clause in its Memo of Association if 1985 Co If states unrestricted/no clause = company has capacity as its objects are unrestricted If states objects = objects clause is now in the AoA. Company should: 1. Adopt new AoA (e.g. MAs) or amend existing – s21(1) by SR + admin requirements s26(1) and s30(1) 2. Include a bespoke article stating “For the avoidance of doubt, the Company’s objects are unrestricted” 3. NB s39: The validity of an act done by a company shall not be called into question on the ground of the lack of capacity by reason of anything in the constitution --so the lender can still enforce the loan against the co. (still internal liability!) 2. Consider: DOES THE DIRECTOR HAVE THE REQUISITE AUTHORITY TO ENTER INTO THE LOAN? - Check the AoA o Must have authority – MA 3/TA 70 o Check any amended AoA for restrictions on the Ds acting in this situation o Is SH approval needed for the loan? (i.e. under s21 to change the AoA) - s40: If a 3P deals with the co. in good faith, they are entitled to assume D’s power to bind the co. or to authorise a 3P to bind it is unlimited by the constitution - BUT Ds may still be in breach of fiduciary duty etc. – s171 & breach of warranty - Lender therefore can enforce against co. but will not want to rely on s39 & 40 due to requirement of good faith in s40 (difficult to prove) and will not want to lend to a co with internal issues - Therefore should ask for evidence (or find) that the D has power 3. CHECK CH: (i) Has the company already granted security over any of its assets? (ii) How much is secured and what is the value of those assets? (iii) What conclusions should the lender draw from charges that are already in the register? Co’s assets already charged -- 2 options to achieve secured lending: 1. obtain security over any other assets (BUT security interest likely rank behind that of existing charge holders); or 2. require removal of existing charges in order to replace w/own charges - lender could require the 3

loan to be used to pay off existing debts in order to secure the removal of the existing charges (by condition precedent in agreement) Note: - Re Option 2: need to obtain a deed of release from any existing charge holders + send Form MR04 to CH in return for a statement of satisfaction. The uncharged property could then be charged to the lender. - existing charge may have covenants preventing subsequent charges etc (though won’t be bound by negative pledge if not in registered – query if pre 6 Apr 2013) - may also need to have regard to any term relating to prepayment of the existing loan - The bank should also: o Obtain a letter of non-crystallisation for the floating charge -

If any existing charges, the following must all happen simultaneously: o Co pays off existing loan o Get deed of release/statement of satisfaction from Registrar of CH o Register new charges within 21 days

4. WHAT ADDITIONAL SECURITY COULD THE LENDER REQUEST? Personal guarantees from Ds Personal guarantee from SHs – or perhaps a majority SH Usually will only get a personal guarantee from a D-SH 5. REGISTERING fixed and floating charges (imp post 6 Apr 2013) TYPE OF SECURITY MORTGAGE

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Highest form of security L seeks to take out over high quality assets – e.g. land, buildings, machinery, aircraft (even shares in other companies) - Transfer legal ownership from Mortgagor (Co) to mortgagee (Lender) - Gives L immediate right to possession but this is held in reserve and exercised only if the borrowed money is not repaid (i.e. co defaults) - Title transferred back to mortgagor when loan repaid - Separate mortgage must be created over each asset - Possible to have 1+ mortgage on the same asset CHARGES Does not transfer legal ownership or right to immediate possession but gives important rights FIXED CHARGE - Gives lender control of the asset - i.e. cannot sell w/o permission and must keep in good condition - Takes priority over a floating charge on the same assets – right to sell asset and be paid first out of the proceeds - Most attractive security for a lender is land, buildings and major items of machinery and a company can create a number of fixed charges over such assets - The company cannot deal with the asset, e.g. sell it, keep it in bad repair, w/o the charge holder’s consent - The purchaser of a charged property can only take it subject to the charge, as long as it has been registered. FLOATING CHARGE - Only a Co or LLP can create a floating charge (ability to borrow against a floating (p236) charge = adv of incorporation) – see T&F - Security over a group of assets which is constantly changing (NZ&A Royal Mail) - The three basic features of a floating charge are (Re Yorkshire Woolcombers): • It is an equitable charge over the whole or a class of the assets • The assets subject to the charge are constantly changing 4

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The company retains the freedom to deal with the assets in the ordinary course of business until the charge crystallizes It is the company’s freedom to deal with the assets which is the primary characteristic of a floating charge A floating charge will crystallize on the company: (in effect turn into a fixed charge) • Going into receivership • Going into liquidation • Ceasing to trade • Any other event specified in the charges document On crystallisation the company can no longer deal w/ the assets covered by the charge (effectively turns into a fixed charge)

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DISADVANTAGES Fixed charge takes priority over floating charge over the same assets - For lender its disadv. that co is allowed to deal with assets - For lender some preferential creditors (e.g. EEs) take priority over holder of floating charge & some money may be ring-fenced for unsecured creditors of co. (ie deducted before floating ch holder is paid) - Liquidator/Administrator may apply to have floating charge set aside-- float. (s245 IA 86) Ch holder is then unsecured creditor Note: security over book debts (company’s debtors) can take the form of a fixed charge where the charge holder had control over both the debts and the proceeds once they were paid(Natwest v Spectrum) – merely calling it ‘fixed’ charge will not satisfy the CT – they will look at the substance of the charge and its commercial effect - Personal guarantees from Ds-SHs - Pledge – asset physically delivered to serve as security - Lien – right to possession until debt paid (CL, Equity or Statute) - Retention of title – where sale of goods: BYR doesn’t get title to goods until pays full price to SLR (interest retained by creditor, not registrable clause) -

OTHER FORMS OF PROTECTION (p238-239)

ADVANTAGES allows co. to deal with secured assets on day-to-day basis can maximize amount that co. is able to borrow may be taken over whole of co’s business

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ISSUING A DEBENTURE -

It is the Ds decision whether to borrow money in the company name and a resolution of the board of directors is sufficient to authorize borrowing by the company Ds must ensure that they have been given the power to borrow on behalf of the company by the articles The lender may require the Ds to guarantee personally a loan to the company

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Note: where Ds guarantee the loan in this way they have a personal interest and must declare that interest at first BM at which the loan is discussed (s182 – 187 CA 2006). o May also have quorum and voting issues--check AoA (e.g. MA 14 can disapply) Once Ds have resolved to enter in to the loan, the debenture will be executed by either 2 Ds or a D and a witness. (Use company seal also if have one) o

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Typical terms of debentures: -

Form of the security and specific assets charged Fixed repayment date or on demand Interest rate Representations and warranties about the assets Covenants to ensure maintain value of the assets Enforcements and powers: o Events of default o Power to appoint administrator – this power must be contained in the debenture; it will not be implied o Power of sale free from restrictions under LPA 1925– this power must include as won’t be implied REGISTRATION

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Charge post 6 April 2013 - VOLUNTARY system of Registration; charge created by a co. may be registered o B/C of the consequence of failing to register there is a huge incentive in practice to register the charge

What do you register? -

s859A CA 06: a charge includes mortgages; limited guidance as to what this means o unsure over new regime given wide range of possible security

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Registrable: o mortgages, o fixed & floating charges over land, o ships, aircraft, machinery, o book debts, o shares, o IP NO need to register: Guarantees

How do you register it?

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When do you register it?

Must submit Form MR01 + fee + copy of charge instrument to CH

Agreement containing charge entered into (w/loan agmt for debenture), then co or any person interested in the charge (incl charge holder) will have to deliver: s859D statement of particulars to CH (ie Form • MR01 + fee) (s859A(2)), and • Certified copy of the instrument creating the charge (s859A(3))

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w/in 21 days (weekends and bank hols included) beginning with day after the day on which charge created (s859A(2) and (4)) What happens once submitted to CH?

Registrar of CH must then: - register charge (s859A(2)) - allocate 12-digit unique reference code to charge, - make note on the register, - include the certified copy of the charge on the register (s859I(2)) - give person who delivered docs a certificate of registration (s859I(3))

What do you do after its been reg’d?

Company MUST keep copy of charging doc and Form MR01 for inspection (s859P) at Registered office or SAIL (s859Q)

Failure to register

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CT power

Is the charge over LAND?

charge void against a liquidator/administrator and against co’s other creditors (s859H(3)) Security remains valid against co itself - money secured by charge becomes payable immediately (s859H(4)) The charge will be enforceable against the company, however, the company will not be able to sell the asset (Fixed) w/o the permission of the chargee. IF the liquidator etc selling the asset, they do not have to give the benefit to the chargee (i.e. they lose their priority)

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Limited power under s859F for CT to extend 21 day period if failure to deliver required docs was accidental / due to inadvertence - but charge will have priority only from date of actual registration Under s859M to allow rectification of any statement or notice delivered to the Registrar for any inaccurate details, and to order the replacement of a document on the register under s859N if, eg, the charging document was defective/wrong document sent

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Must also reg w/ the Land Registry

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Redemption of the Loan/ Release of Charge -

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When the loan is repaid to the lender, a D or the CoSec may ( usually will) make a statutory declaration that the debt has been paid and will send Form MR04 (even where charge registered before 6 April 2013) to the Registrar of Companies Registrar will include statement of satisfaction on company’s file If instead the charge is released or property sold, must send Form MR04 Registrar will include a statement either of release or that ppty no longer belongs to co. in company’s file If any entries were made at Land Registry, these need to be removed 7

Priority of Charges -

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Usually, later fixed charges take priority over earlier floating charges over same asset (unless the floating charge holder sought to prevent including a negative pledge clause in the charge document preventing the company from creating subsequent fixed charges ranking in priority to or equal with the floating charge) Fixed Charges and mortgage over same asset have priority in order of their date of creation (NOT registration) Floating charges over same asset have priority in order of their date of creation (NOT registration) NB: Lenders may enter agreements between themselves to alter order of priority (subordination (deed of priority))

Floating charges: Negative Pledge Clause (in the loan agreement) -

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See WS2 Task 2 – likely question: the effect of an NPC on the priority order A NPC prohibits the company from creating later charges (w/priority over the floating charge) w/o permission o Also includes quasi security such as finance leases, sale and leasebacks, factoring arrangements If a subsequent lender takes a charge over the same asset and has actual knoelwege of the NPC then the subsequent lender will be subordinate to the orig charge holder (English and Scottish Mercantile v Brunton) In practice existence of NPC identified by completing Form MR01 (to CH) and include the clause itself the certificated copy of the charging doc delivered to the Registrar Constructive knowledge is not enough Actual knowledge is necessary As Lender will likely conduct search at CH, will have actual knowledge and will not have propriety over the floating charge It is also possible that the subsequent charge holder will be liable for the tort of inducing BoC (Swiss Bank v Lloyds Bank) To protect itself, subseq charge should contain a covenant by the company to the effect that there are no earlier charges which are subject to a NPC (if not true, company in breach and can terminate agmt immediately)

PRESERVING AND INCREASING THE COMPANY’S ASSETS p306 IA 1986 S238 S239 S240

Transactions at undervalue Preferences ‘Relevant Time’

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S241 S245 S249 S435

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Orders under s238 and s239 Avoidance of floating charge ‘Connected’ with company ‘Associate’ – see subsections (6) and (10) partic.

Common for Ds (and others) to consider dispersing assets away from the company’s ownership when they think that liquidation is on the horizon, to keep the assets out of company’s hands As liquidators and administrators have a duty to > funds available to the creditors, if possible, and not do anything which would < them…. IA 1986 provides various powers allowing them to investigate the Company’s affairs AND actions of the Ds prior to liquidation and/or administration: o Transact...