BUSINESS LAW 2

LARGE GROUP 5a
Student Guide

Debt Finance and Security

Maintenance of Capital

Context

In Large Group 2, you saw that there were two main ways by which a company
raises finance, either by issuing shares (Equity Finance) or by borrowing (Debt
Finance), concentrating on Equity Finance. Today we cover Debt Finance. In this
Large Group, we are going to think about borrowing generally and thee various forms
of debt finance. Today we are going to concentrate on what are called debenture
loans.

Of course, no-one is going to lend money unless they are reasonably confident that
they will be repaid. Although some loans may be unsecured, in most cases, the
lender will require some form of security. We will concentrate on loans secured on
the assets of the company, the types of security that lenders require and the
measures necessary for lenders to take to protect themselves against the risk of
insolvency.

Well-managed borrowing is not a problem. However, problems do arise, and, in a

worst case scenario, if companies cannot pay their debts, the inevitable result is
insolvency. Often at the heart of the problem is the company’s borrowings. In an
insolvency situation, lenders will be keen to get as much of their money back as
possible. In this Large Group, we will consider how the various types of security
affect who gets paid, in what order (or priority) and how much. We will look at
insolvency in the Units 7 – 9, so what we are looking at today is also useful
background for these sessions.

We will also consider some important rules in the Companies Act 2006 in relation to
maintenance of share capital, which are also designed to protect creditors.

Outcomes

By the end of this Large Group you should be able to:

1. Explain what is meant by debt finance.

2. Identify the main sources of borrowing.

3. Describe the different types of company charge and the role of security in
protecting the interests of creditors in an insolvency.

4. Explain the rules governing priority of charges.

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5. Explain the statutory rules governing the maintenance of capital rule, and the
main exceptions to those rules.

6. Explain the procedure for an off-market buy-back of shares from distributable

profit.

7. Outline the commercial reasons why a company would want to purchase its own
shares.

INTRODUCTION

1. DEBT FINANCE

2. CORPORATE BORROWING

2.1 Types of borrowing

Activity 1

Below you will find the Balance Sheet from the latest accounts of Jumbo Gym
Ltd (‘Jumbo’).

1. Study Jumbo’s Balance Sheet and identify three types of borrowing.

2. How much does Jumbo owe to its various creditors?

3. Which of the loans which you have identified is likely to be a secured loan?

JUMBO GYM LIMITED

BALANCE SHEET AS AT 31 MARCH 20[ ]

£ £
ASSETS EMPLOYED

Fixed Assets
Tangible Assets (incl. premises) 350,000

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 Intangible Assets (incl. IP rights and
goodwill) 50,000
400,000

Current Assets
Stock 50,000
Debtors 10,000
Cash 10,000
70,000

Current Liabilities
Creditors 15,000
Tax 20,000
Wages (2 employees) 30,000
Overdraft 15,000
(80,000)
NET CURRENT ASSETS (10,000)

Less:
Bank Loan (secured on premises) (100,000)

NET ASSETS 290,000

CAPITAL EMPLOYED
Share Capital 100,000
Profit and Loss Reserve 90,000
290,000

2.1.1 Loans and loan facilities

2.1.2 Trade creditors

2.1.3 Debt securities

2.2 Debentures

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3. SECURITY AND CHARGES

3.1 Personal and proprietary rights

3.2 Types of security

3.2.1 Background – types of property

Activity 2

Look again at Jumbo’s Balance Sheet (see Activity 1). Make a list of all the
types of property which would be available as security for a loan.

3.2.2 Mortgages

3.2.3 Fixed charges

3.2.4 Floating charges

Re Yorkshire Woolcombers Association Ltd; sub nom Illingworth v Houldsworth

[1904] AC 335 (CA)

 Crystallisation

Re Brightlife [1986] 3 All ER 673

 Floating Charges over whole undertaking

 Advantages/Disadvantages

Activity 3
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 What do you think are the main advantages and disadvantages of a floating
charge. Fill in the grid below.

Advantages Disadvantages

3.3 What assets can be charged?

Activity 3

Look again at Jumbo’s Balance Sheet (see Activity 1). Make a list of all the
types of property which would be available to charge as security for a loan.

3.4 Registration of Charges (s.859A-Q CA 2006)

3.5 Priority of Charges

3.5.1 Order of Priority

3.5.2 Guarantees

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4 MAINTENANCE OF CAPITAL

4.1 The creditor relationship

4.1.1 Directors and creditors - s.172(3) CA 2006

Activity 4

This Activity is revision from your Business Law 2 Module.

ss.172(1)(a)-(f) of the Companies Act 2006 lists the stakeholders of a company

whose interests the directors must have regard to when considering their duty
to promote the success of the company.

The interests of which of the following are not included?

A. Shareholders
B. Employees
C. Customers and suppliers
D. Creditors
E. The community and environment

BTI 2014 LLC v Sequana SA & Ors [2019] EWCA Civ 112

4.1.2 Shareholders and creditors - limited liability

4.2 Maintenance of share capital

4.2.1 Increase of share capital (s.617(1)(a) CA 2006)

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 4.2.2 Reduction of share capital (s.641 CA 2006)

Circumstances in which a company may reduce its share capital

(1) A limited company having a share capital may reduce its share capital—

(a) in the case of a private company limited by shares, by special resolution

supported by a solvency statement (see sections 642 to 644);

(b) in any case, by special resolution confirmed by the court (see sections 645 to
651).
s.641 Companies Act 2006

4.2.3 Buy-back of shares (Chapter 4 CA 2006)

4.2.3.1 Why would a company want to buy back its shares?

 Private companies

Example

Assume that Jumbo Gym Ltd has four shareholders, Kai, Patrick and Ellie, (Kai’s now
ex-girlfriend), who all hold 30% of the shares (30,000 ordinary £1 shares), and Ria
who holds 10% of the shares (10,000 ordinary £1 shares). Unfortunately, Kai and
Ellie split up rather acrimoniously and Ellie wants to sell her shares. None of the
others can afford to buy the shares and Kai is worried that in view of the breakdown
in their relationship, Ellie might decide to cause trouble if she remains as a
shareholder.

 Public companies

4.2.3.2 The rules for a buy-back (ss.690 – 693 CA 2006)

4.2.3.3 Procedure (ss.694 – 695 CA 2006)

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 4.2.3.4 Effect of a buy-back

Activity 5

Re-read the example above. Assume that Jumbo Gym Ltd has now entered into the
contract with Ellie to buy back her shares for £30,000.

What do you think will be the effects of the buy-back?

4.2.3.5 Directors’ duties

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