CHAP 6- Raising capital: equity and loans

MG + DIGNAM AND LOWRY

Raising equity capital

MG
What is equity capital?
Refers to the money a company raises by selling shares in itself.

Whose interests may be affected where a company raises capital by selling

shares?
The (2) groups of possible affected persons are;

1. Existing shareholders in the company- selling news shares can reduce the proportion
they own and thereby reduce their influence in the company.

2. Buyers of shares- might be misled about the value of the company and therefore of
the shares they are buying.

Protecting existing shareholders: rights of pre-emption

Where a company sells more shares in itself, this can result in ‘share dilution’ (a change in
the proportion of shares owned by each existing shareholders) (MG).
Regulation/protection
To regulate this, shareholders are offered new shares, in proportion to their existing
shareholding (‘rights issue’), usually because of shareholders’ pre-emption rights (right existing
to purchase shares before it is issued to others) (Choo).

Notwithstanding, the s.561 right can be waived by the existing shareholders AND same can
be excluded by the articles of a private company.

Protecting buyers
It must be remembered that, the law protects those buying shares in a company.
Protecting process
It does this by preventing private companies from being used to raise share capital from the
public at large.

In so doing, private companies are not permitted to make general offers to the public, to buy
shares (s.775 CA).
Rather, they will have to raise the share capital they want from existing shareholders OR
from new members who are identified privately by the company, for e.g., relatives or
business contacts of existing shareholders).
 Public and Private Companies
Dignam
Capital raising: distinction between public and private companies?

 Private Companies- can be either limited (by shares or guarantee) OR unlimited

as per Companies Act 2006 “CA”.
The law presumes that their investment is largely provided
provided by the founding members (i.e., through their personal savings or from bank
loans).

NB- They are prohibited from raising capital from the general public (s.755 CA).
Furthermore, the London Stock Exchange (LSE) require that a company be a public
company.

HOWEVER
Some private companies are very large to the point that they obtain their capital through
lending or private investment firms (venture capital firms such OR more recently hedge
funds rather than from the general public.
However, very large private companies are unusual, as most business ventures in need of
capital fulfil it through the formation of a public company in order to access the public
funding market.

 Public Companies- the intention is to raise large amounts of money from the general
public.
But where they extremely large amounts of capital is needed, a public company will choose
to raise capital through listing on the stock exchange.
Therefore, unlike private companies, public companies are not prohibited from raising
capital.

NB- the application for registration of a public company must state it is public and as with
private companies the liability of the members is limited, thus pursuant to s.58(1) CA, the
words public limited company (PLC or plc) must come at the end of its name.

What is the minimum share capital for public companies?

Unlike private companies which can have a purely nominal share capital, a public company
can only be formed as a company limited by shares (s.4(2) CA).
Pursuant to s.763 CA, the minimum share capital for public companies is £50,000.

HOWEVER
The company need not have £50,000 up front. All that is needed is merely ¼ of the £50,000
AND an ability to call on the members for the remaining amount (s.586 CA).
How can public companies secure investment from the general public?
Through advertisement that they are offering shares to the public.
In so doing, the company must issue a prospectus giving a detailed and accurate description
of the company’s plans.
Are there any restrictions on the transfer of shares of public company?
Albeit there is no formal limitation where this is concerned, any restriction would be
highly unusual, given that the aim is to raise money from the general public as it would
discourage them.
Nonetheless, once a public company is listed on the LSE such restrictions on transfer will
be prohibited.

Public Company: Methods of raising money from the public

Dignam
What is the process where a public company wishes to raise a large amount
of capital?
The process of gaining a listing on the London Stock Exchange ‘LSE’ is complex, costly
and extremely time consuming, as it involves a large number of financial and legal advisers.

MG
What is the LSE?
Operates as a secondary market. In so doing, it allows for shares to be traded after they have
been issued to shareholders.
Further, it also functions as a capital market for companies to sell new shares to the general
public who can then trade them on the stock exchange.
What is the effect joining the LSE?
The public company, once it gains access to the stock market, is then generally known as a
listed company and its shares are known as listed shares or securities, as it has fulfilled a
very strict set of criteria to ensure that the business is a sound one.
Advantage of being listed under LSE?
A company that seeks a listing on the LSE must comply with the Listing Rules, which are
extensive and onerous.
Investors will have greater confidence in the business just by the fact that it is within the
regulatory ambit of the LSE, thereby allowing for investors to sell their shares easily.
What are the shareholders of the listed companies called?
Usually referred to as, institutional investors.
Institutional investors usually comprise;
- pension funds
- insurance companies
- professional management funds who are investing funds on behalf of individuals
AND
- investment vehicles of foreign states aka ‘sovereign wealth funds’.
What is a listing on the LSE?
Essentially a private contractual arrangement between a public company and the LSE (itself a
listed public company) to gain access to a very sophisticated market for its shares.
Who regulates the LSE?
These rules are issued, and enforced, by the UK’s Financial Conduct Authority ‘FCA’.
The FCA is designated as the UK Listing Authority and therefore is the main regulatory
body for the LSE’s capital markets.
Important of the listing rules
The Listing Rules are designed to ensure that companies that are admitted for listing already
have a solid financial track record and disclose to investors enough information about the
company’s financial performance, to enable investors or their advisors to make informed
investment decisions.
What is the effect of achieving a listing?
Once a company has achieved a listing, it continues to be subject to a number of continuing
obligations, also found in the Listing Rules, to disclose information necessary to maintain an
orderly market and to protect investors.
Requirement of the continuing obligations
The continuing obligations requires that listed companies must;
- publish ½ yearly reports on their activities, together with profits and losses made
during the first 6mths of each financial year, also
- publish a preliminary statement of its annual results.

Require that Directors of listed companies must;

- produce a ‘strategic report’ covering the development and performance of the
business, which identifies the principal risks and uncertainties ahead.
ALSO
The continuing obligations also operate as, a means of preventing insider dealing: when
those with information about a company, which has not been made publicly available,
seek to use that information in dealing in the company’s shares.

NB- The Listing Rules require a listed company to publish price-sensitive information-
(information that may result in substantial movement in the price of its securities) as
quickly as possible.
Failure to comply with the listing regime
Carries the possibility that the FCA will sanction the company or individuals responsible for
the failure.
Insider dealing is also controlled through both criminal provisions (in the Criminal Justice
Act 1993) and a regime of civil sanctions.

How does the company prepare to sell its shares to the general public?
To do this, it must employ a merchant bank (the issuing house) as well as a stockbroker, to
decide the best way to do same.

What are the (4) methods that can be used to sell shares?
The company can;
1. itself, simply offer its shares for subscription, by issuing a prospectus and advertising
in the trade or general press

2. offer for sale (most common method).

This involves an agreement between the company and the issuing house, that the latter will
accept an allotment of the company’s entire issue of shares and try to sell them to its clients
and the general public.
The advantage of this type of sale
The company transfer the risk (the shares will not see) to the issuing house and the issuing
house accepts this risk, but of course, in return for a large fee.
 3. shares are ‘placed’ with the clients of a merchant bank or a group of merchant bank,
rather than offered to the general public at all.

4. company can raise money through a rights issue.

This is where shareholders are offered new shares, in proportion to their existing
shareholding (‘rights issue’), usually because of shareholders’ pre-emption rights (right existing
to purchase shares before it is issued to others) (Choo).
Where does this pre-emption right emanate?
Under s.561 CA 2006.
HOWEVER,
There are exceptions AND some listed companies may not want to exercise or have pre-
emption rights. But this is likely to make such company unpopular with investors.

Raising capital through loans

CHOO
For most small to medium-sized companies, the most accessible form of external finance,
will be to borrow capital from creditors. In so doing, they may borrow from;
- trade credit.
This is where a company pays later for the goods or services it receives.

- shareholders

- loans (i.e., high street banks, or other more specialised financial institutions).

What is loan capital?

According to Choo, an extremely flexible way of raising capital as it can be listed (i.e.,
issued via a stock market like LSE), OR unlisted.
To this end, investment in loan capital is therefore similar in a number of key respects to
investment in shares, on the basis that, both are ‘securities’ BUT the nature of the
risk and the returns on the investment will be different.
What is the key distinction between shareholders and investment creditors?
Shareholders have rights in the company, whereas, investment creditors acquire rights
against the company.
For e.g., as a general rule, creditors do not have a right to vote at general meetings: the
extent to which they can exercise control over the company depends upon the terms of the
debt contract.

ALSO
If creditors secure their lending, they will also have rights in the company’s property.
What if there is insolvency?
The claims of a loan creditor must be paid before the shareholders.

Secured Borrowing: Company Charges

Choo
Where a company borrows capital through loan, such as in the manner explained above,
such company is required to provide some form of security to the lender for the sum
borrowed.
Why is security for a loan important?
In the event of the company being in breach of the loan contract, (i.e., a loan can be secured
over the company’s land and in the event of the company defaulting on its repayments), the
creditor can enforce its security interest immediately and recover from the company.

Goode (2008)
Has described the nature of a security interest as, an agreement between the creditor and
debtor by which a specified asset or class of assets is appropriated to the satisfaction of the
loan. Title does not pass but rather an encumbrance on the property is created.

ALSO
National Provincial Bank v Charnley (1924)
Atkin LJ noted that, the principal feature of a charge was that the creditor acquired a present
right to have the charged property made available as security.
He said:

I think there can be no doubt that where in a transaction for value both parties evince an
intention that property, existing or future, shall be made available as security for the
payment of a debt, and that the creditor shall have a present right to have it made available,
there is a charge, even though the present legal right which is contemplated can only be
enforced at some future date, and though the creditor gets no legal right of property, either
absolute or special, or any legal right to possession, but only gets a right to have the security
made available by an order of the Court.

Charges encountered as security interests

MG
(2) types of loan securities
1. Fixed charges
2. Floating Charges

Fixed Charges
Usually attached by the creditor to some particular piece of property already owned by the
company (i.e., warehouse).
These types of charges operate analogous to a house mortgage, in that, the rights of the
creditors (chargee), attach immediately to the property and the company’s (chargor)
power to deal with the asset is restricted.

According to Lord Millett in Agnew v Commissioner of Inland Revenue [2001],

He said:
A fixed charge gives the holder of the charge an immediate proprietary interest in the assets
subject to the charge which binds all those into whose hands the assets may come with notice
of the charge.

Advantage of a fixed charge

From a creditors’ point of view, one of the most important advantages of a fixed charge is
that, it provides a much stronger security for a charge.
For e.g., when an asset covered by a fixed charge is sold, the chargee will have priority in
relation to all of the sale proceeds. Meaning, all the sale proceeds must be used to satisfy
the debt of the chargee.

HOWEVER
What about assets covered by a charge that was created as a floating charge?
The proceeds of sale of those assets can be taken by other people before the money is used
to repay the debts of the floating chargee.
So, the proceeds of sale may be used to pay for the costs of the winding up (such as the
liquidator’s charges) or to pay off preferential creditors (e.g., the company’s employees).

MOREOVER
A portion of the proceeds of the sale of floating charge assets must also be set aside for
unsecured creditors, under s.176A of the Insolvency Act 1986.
Purpose of s.176 IA 1986
Introduced to ensure that, when a company is wound up, unsecured creditors get more of
their money back, whereas anyone with a floating charge (typically, a bank) gets less.

Floating Charges
Floats over the whole or a part (class) of the chargor’s assets, which may fluctuate as a result
of acquisitions and disposals.
Simply, these are assets of the company that are constantly changing (i.e., corporate
property such as; stock in trade, plant (machinery) and book debts aka receivables- (sums
owed to a company in respect of goods or services supplied by it) Choo.
Operation of a floating charge
Choo
For e.g., stock in trade, when an item is sold the charge ceases to attach to it BUT when
something is subsequently added to the company’s stock the charge will automatically extend
over the new item.
Floats
In this sense, the idea of a charge that floats over changing property (attaching, de-attaching
when sold and re-attaching when something new is added).
A distinguishable feature of a floating charge?
Unlike a fixed charge (mortgage operation), the company can continue to deal with its
assets in the ordinary course of business, without having to obtain the chargee’s permission.

Re Yorkshire Woolcombers Association [1908], listed more distinguishable features of a

floating charge.
According to Romer LJ:
- It is a charge on a class of assets of a company present and future.

- That class is one which, in the ordinary course of the business of the company, would
be changing from time to time.
 - By the charge it is contemplated that, until some future step is taken by or on behalf
of those interested in the charge, the company may carry on its business in the
ordinary way as far as concerns the particular class [charged].

ALSO
Evans v Rival Granite Quarries Ltd (1910)
The COA recognised that, the holder of a floating charge acquires an immediate equity
Buckley LJ stressed that; a floating charge is not a future security but rather ‘it is a
present security which presently affects all the assets of the company expressed to be
included in it’.
Further, Buckley LJ went on:
it is not a specific security; the holder cannot affirm that the assets are specifically
mortgaged to him. The assets are mortgaged in such a way that the mortgagor can deal with
them without the concurrence of the mortgagee. A floating security is not a specific mortgage
of the assets, plus a licence to the mortgagor to dispose of them in the course of his business,
but is a floating mortgage applying to every item comprised in the security, but not
specifically affecting any item until some event occurs or some act on the part of the
mortgagee is done which causes it to crystallise into a fixed security.

ALSO
Re Bond Worth Ltd (1980)
Slade J in summarising Buckley LJ’s decision added that a floating charge:

‘remains unattached to any particular property and leaves the company with a licence to
deal with, and even sell, the assets falling within its ambit in the ordinary course of business,
as if the charge had not been given, until . . . it is said to ‘crystallise’ . . .

Disadvantage of a floating charge

It can sometimes be avoided under s.245 IA 1986.
What is the primary object of s.245 IA 1986?
To prevent a creditor who was initially unsecured, from obtaining a floating charge to secure
their existing loan at the expense of other unsecured creditors, especially when insolvency
is approaching.
Therefore, it (s.245) invalidates a floating charge created within 12 months (termed
‘the relevant time’) prior to the onset of insolvency.

HOWEVER
It cannot be invalidated if the charge was created in return for ‘new’ money borrowed by
the company at the time of, or after, the creation of the charge.
NOR, according to s.245(4), can the charge be invalidated if the company was able to pay
its debts when the charge was created.
What if the charge was given to a ‘connected person’?
Stricter rules apply.
For e.g., a director of the company – the relevant time is then extended to 2yrs, and the
exception in s.245(4) does not apply.
Would the type of charge being created be clear from the wording of the charge itself?
The courts have decided that the nature of the charge depends on its substance, not on the
label given adopted by the parties.
Royal Trust Bank v National Westminster Bank plc (1996)
Agnew v IRC (Re Brumark) (2001)
According to Lord Millett:

In deciding whether a charge is a fixed or a floating charge , the Court is engaged

in a two-stage process. At the first stage it must construe the instrument of charge and seek
to gather the intentions of the parties from the language they have used. But the object at this
stage of the process is not to discover whether the parties intended to create a fixed or a
floating charge. It is to ascertain the nature of the rights and obligations which the parties
intended to grant each other in respect of the charged assets. Once these have been
ascertained, the Court can then embark on the second stage of the process, which is one of
categorisation. This is a matter of law. It does not depend on the intention of the parties. If
their intention, properly gathered from the language of the instrument, is to grant the
company rights in respect of the charged assets which are inconsistent with the nature of a
fixed charge, then the charge cannot be a fixed charge however they may have chosen to
describe it.

Most important feature that distinguishes a fixed charge from a floating charge?
Under the latter (floating), the company will retain control over the asset charged,
including the right to dispose of it in the ordinary course of business. In National

Westminster Bank plc v Spectrum Plus Ltd [2005],

Lord Phillips MR explained that:

Initially it was not difficult to distinguish between a fixed and a floating charge. A fixed
charge arose where the chargor agreed that he would no longer have the right of free
disposal of the assets charged, but that they should stand as security for the discharge of
obligations owed to the chargee. A floating charge was normally granted by a company
which wished to be free to acquire and dispose of assets in the normal course of its business,
but nonetheless to make its assets available as security to the chargee in priority to other
creditors should it cease to trade. The hallmark of the floating charge was the agreement
that the chargor should be free to dispose of his assets in the normal course of business
unless and until the chargee intervened. Up to that moment the charge ‘floated’.

Floating Charges over Book Debts

What is a book debt?
Th e term ‘book debts’ has been defi ned by Lord Esher MR in Official Receiver v Tailby
(1886) as: ‘debts arising in a business in which it is the proper and usual course to keep
books, and which ought to be entered in such books’. (Choo).
MG
Essentially, the debts owed to the company by its own customers, say for the goods or
services that the company is supplying to those customers. The company obtains a loan that
is secured over its outstanding dets.
Benefit of a book debt?
Can be a valuable asset for the company, which it may well want to use as security, enabling
it to borrow more money from its own bank and probably at a lower rate of interest.
Are book debts fixed or floating charges?
The charge itself will probably have been drafted by the charge holder (the bank) and might
well say that it is a fixed charge, since this is clearly preferable for the bank, for all the
reasons set out above.
However, the charge will usually allow the company to retain ‘control’ over the charged
asset (the book debts) in the sense that, as each debt is paid to the company by a customer,
the company will be free to use that money for its own business.

CHOO
Siebe Gorman & Co Ltd v Barclays Bank Ltd (1979)
Considered the issue of whether or not a fixed charge could be created over a company’s
book debts
The company granted a debenture in favour of Barclays Bank which was expressed to be a
‘first fixed charge’ over all present and future book debts.
The debenture required the company to pay the proceeds of its book debts into an account
held with Barclays Bank and it prohibited the company from charging or assigning its book
debts without the bank’s consent.

In finding that a fixed charge had been created, Slade J held that the restrictions placed on
the company’s power to deal with the proceeds of the debts, including the bank’s right to stop
the company making withdrawals even when the account was temporarily in credit, gave the
bank a degree of control which was inconsistent with a floating charge.

ALSO
National Westminster Bank plc v Spectrum Plus Ltd [2005]
Resolved the nature of a charge over a book debt
Here, Spectrum (chargor), granted a fixed (specific) charge to the bank over its book debts,
to secure an overdraft of £250,000.
The charge stated that the security was a specific charge over ALL present and future book
debts and other debts.
It also prohibited Spectrum from charging or assigning debts and the company was required
to pay the proceeds of collection into an account held with the bank.
However, the debenture did not specify any restrictions on the company’s operation of the
account.
Spectrum’s account was always overdrawn and the proceeds from its book debts were paid
into the account which Spectrum drew on as and when necessary.

When Spectrum went into liquidation the bank sought a declaration that the debenture created
a fixed charge over the company’s book debts and their proceeds.

The HL held that, although it is possible to create a fixed charge over book debts and their
proceeds, the charge in the present case was a floating charge.

Lord Scott delivered the leading judgment. He stressed that, the ability of the chargor to
continue to deal with the charged assets characterised it as floating.
Thus, for a fixed charge to be created over book debts the proceeds must, therefore, be
paid into a ‘blocked’ account (i.e. an account that the company would not then be free
to draw monies out of).
NB- charges over book debts, that allow the company to retain control over those debts, will
usually be floating charges, rather than fixed ones.

The practical and important consequence of this

If a company becomes insolvent, the book debts due to the company will not be taken
entirely by, say, the company’s bank, under a fixed charge but instead will be subject
only to a floating charge and subject to the priorities noted above.
Some of the proceeds of these charges will be used for preferential creditors, OR for
the company’s unsecured creditors.

Re Harmony Care Homes Ltd [2009] EWHC 1961.

A case in which a lender did, unusually, have sufficient control over the book debts that
had been charged by a borrower for that charge to be a fixed one.

HOWEVER
Keenan Bros Ltd (1986)
A stricter approach was taken
The company was required to pay the proceeds of book debts into a special account, over
which the bank had an absolute discretion to permit the company to transfer moneys to its
working account.

The SC Ireland held that, the bank’s control over the special account was such as to deprive
the company of the free use of the proceeds.
A fixed charge had, therefore, been created.

Debentures
Choo
What is debenture?
This is a Latin term that means ‘money owed to me’.
In simple terms, indebtedness of a company to a creditor is generally acknowledged by way
of a debenture.

Salomon v Salomon (1897)

Where, upon incorporation, Mr Salomon changed from being a sole trader to a debenture
holder and shareholder.

Other definitions
 Statute
According to s.738 CA 2006: ‘“debenture” includes debenture stock, bonds and any other
securities of a company, whether constituting a charge on the assets of the company or not.’

ALSO
For the purposes of s.29(2) Insolvency Act 1986, a definition is adopted.
An obvious example of a debenture which falls within the statutory definition is,
a mortgage of freehold land by a company, it being a security of a company and
a charge on its assets.
Knightsbridge Estates Trust Ltd v Byrne (1940)
Lord Romer

 Common Law/ judges

Levy v Abercorris Slate and Slab Co (1887)
Chitty J stated that: ‘a debenture means a document which either creates a debt or
acknowledges it, and any document which fulfils either of these conditions is a “debenture”’.
Criticism of Chitty J’s definition
It is drawn too wide.
For e.g., it encompasses documents such as; a bank statement where the account in question
stands in credit (because it is an acknowledgement that the bank effectively owes its
client the amount of the credit balance).

Chitty J Definition endorsed

Lemon v Austin Friars

ALSO
Investment Trust Ltd (1926)

ALSO
British India Steam Navigation Co v IRC (1881)
Lindley J said:

Now, what the correct meaning of ‘debenture’ is I do not know. I do not find anywhere any
precise definition of it. We know that there are various kinds of instruments commonly called
debentures. You may have mortgage debentures, which are charges of some kind on
property. You may have debentures which are bonds; and, if this instrument were under seal,
it would be a debenture of that kind. You may have a debenture which is nothing more than
an acknowledgement of indebtedness. And you may have [as on the facts] . . . a statement by
two directors that the company will pay a certain sum of money on a given day, and will also
pay interest half-yearly at certain times and at a certain place, upon production of certain
coupons by the holder of the instrument. I think any of these things which I have referred to
may be debentures within the Act.

NB- Notwithstanding the breadth of these definitions, the commercial world generally
adopts a fairly restrictive view of the term, viewing ‘debentures’ as referring to secured loans.
Categories of Debentures?
Can be categorised as either;

- Irredeemable debentures – are permitted by CA, notwithstanding equity’s prohibition

of ‘clogs’ or fetters on the equity of redemption.

s.739 CA provides:
‘a condition contained in debentures, or in a deed for securing debentures,
is not invalid by reason only that the debentures are thereby made irredeemable
or redeemable only on the happening of a contingency (however remote), or on
the expiration of a period (however long), any rule of equity notwithstanding.
Knightsbridge Estates Trust Ltd v Byrne (1940)

- Redeemable debentures- are generally expressed to be payable either on demand or

on a fixed date.
Once redeemed, a debenture can be reissued by the company UNLESS there is an express
or
implied prohibition contained in the articles (s.194).

Debenture Stock
Choo
What is debenture stock?
Money borrowed from a number of different lenders all on the same terms.

In effect, the lenders become a ‘class’ of creditors, whose rights are usually set out in a trust
deed and trustees are appointed (usually a financial institution), to represent the interests of
the creditors, as a class, with the company.

NB- The modern practice is that, all the loans are aggregated and advanced to the company
by the trustees.
The contractual relationship?
Here, is between the trustees and the company.

Individual creditors (or ‘investors’) then subscribe for debenture stock in the fund.
Sealy and Worthington (2008)