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The authority on corporate borrowing
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"immensely practical ... it will be of great value not only to the practising lawyer but also to other professionals engaged in corporate finance"Journal of International Banking Law and Regulation
"A no-nonsense, legal, practical, lucid and concise approach to corporate borrowing and the vast number of issues involved ... making reading it an absolute pleasure"
"No serious corporate lawyer can afford to be without a copy of this essential book"
"clear and reasonably accessible to the non-specialist, while containing a great deal of practical and legal guidance"
"a practical and concise guide to this complex area of law and practice"Reviews of the previous editions
"a thorough and well-written overview of the relevant law"
"extremely helpful in explaining difficult concepts clearly"
‘Neither a borrower, nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.’
1.1 Whatever truth there may be in Polonius’s advice, it is a fact of life that the vast majority of people do, at some stage, borrow and/or lend money. In the case of companies, borrowing, whether by loans from banks or by the issue of debt securities, is an essential feature of responsible financial management: too little, and the company does not have as much money available for capital investment and working capital as it ought; too much, and the interest burden will cause financial problems.
1.2 The money borrowed by companies is often spoken of as ‘loan capital’. The word ‘capital’ is used in many senses in relation to companies: share capital, loan capital, working capital, issued capital, paid-up capital and so forth. The common idea underlying all these terms is that of ‘money obtained or to be obtained for the purpose of commencing or extending a company’s business as distinguished from money earned in carrying on its business’. Money earned in carrying on the business may, however, be turned into capital, or capitalised, in the sense that it may be used in some extension of the company’s business or in paying off or replacing existing capital, instead of being used to pay dividends.
1.3 Loan capital is simply capital that has been borrowed. It is sometimes spoken of as the opposite of working capital, but this is not a correct distinction. Working capital refers to the part of a company’s capital (whether loan capital or share capital) that is used in its day-to-day business operation tomeet current expenses, ie cash, debtors and other current assets.
1.4 So what is a loan? Its most important characteristic is that it is a form of debt, and therefore to be contrasted with share capital. There are many types of hybrid transactions which combine characteristics of both debt and share capital, but English law will generally treat a monetary obligation as either one or the other. The distinction is important for a number of reasons:
(a) creditors rank ahead of shareholders in a winding up of the company;
(b) creditors rarely, if ever, have any right to vote at general meetings of the company and can generally exercise control over the company only through covenants in the debt contract;
(c) interest paid by the company on a debt is usually a deductible expense for the company’s tax purposes, whereas dividends on shares are not;
(d) dividends are usually only payable if there are sufficient distributable profits, and thus will vary with the performance of the company’s business, whereas interest is usually payable irrespective of profits. If the interest does vary with profits or if the lender is to receive a share of profits, the lender’s claim in a winding up of the company in the UK is automatically subordinated to the claims of the company’s other creditors;
(e) the repayment or repurchase of share capital is subject to rules on the maintenance of capital, but the repayment of a debt is not;
(f) shares may not be issued at a discount, but debt securities may be. However, where debt securities are convertible into shares, the issue price of the debt securities must not, when taken in conjunction with the conversion price, be such as to enable conversion to result in the shares being issued at a discount;
(g) the value of a shareholder’s investment can increase with the net capital value of the company’s business, but the value of a creditor’s investment generally does not;
(h) debt securities and loan facilities usually provide for repayment on, or before, one or more specified dates, whereas shares usually have no specified repayment date;
(i) debt may, but need not, have the benefit of security interests, whereas shares cannot. A security interest, giving priority over unsecured creditors, is conceptually incompatible with the nature of equity, as equity is the entitlement to what remains after the other liabilities have been paid; and
(j) a creditor’s exposure to loss is limited to the extent of the debt. A shareholder in a limited liability company is in a similar position, but in the case of an unlimited liability company the shareholder’s exposure for the company’s liabilities is unlimited.
1.5 However, not every type of debt constitutes a loan. A purchase on credit, for example, is not a loan by the vendor, nor is an issue of loan stock as consideration for the acquisition of property. The essence of a loan is ‘a sum of money lent for a time to be returned in money or money’s worth’. There must be both an initial advance and an obligation to repay: ‘Borrowing necessarily implies repayment at some time and under some circumstances.’ The obligation to repay will usually be express, but need not be so: any payment, in the absence of circumstances indicating otherwise, imports a prima facie obligation to repay unless the payee can prove otherwise.
1.6 One difficult question is whether there is still a loan if the obligation to repay is only contingent. It is common for companies to borrow money through the issue of perpetual or irredeemable securities, expressed to be repayable only in the winding up of the company or at the company’s option. It is also common for loans to be subordinated by expressing repayment to be contingent
on the company’s solvency, or to be ‘limited recourse’ in nature, in that the lender is only entitled to be repaid out of a particular fund or asset. Funds raised in this way are invariably designated as loan capital in companies’ books, but it has been suggested that, if the repayment is conditional, the fund-raising only constitutes a loan if the event on which it is conditional is bound to happen. However, it is not inconsistent with an agreement being by way of loan that the money cannot be sued for, and that the creditor must look to a fund for payment, and securities which are expressed to be irredeemable are still loans if, on their true construction, they are irredeemable only so long as the company is in existence, and thus become repayable only on winding up. The correct test would seem to be whether, on the true construction of the agreement, there is a present obligation to repay the money in the future upon the happening of certain defined events, or whether the obligation to repay only arises in the future on the occurrence of a contingency. In the latter situation, a debt obligation does not arise unless and until the contingency occurs, but in the former situation the arrangement can constitute a loan (notwithstanding that there are circumstances in which a lesser amount, or indeed nothing, maybe repayable). Depending on the drafting, therefore, perpetual, subordinated and limited recourse debts are all capable of constituting loans. Further aspects of the repayment obligation are considered at 5.1–5.23.
1.7 Another difficult question is whether the initial advance must be made to the person who is to repay. In Potts’ Executors v IRC, the House of Lords held that payments by a company on behalf of a director, with the director being debited with the payments in his account with the company, did not amount to loans. However, certain of their Lordships made it clear that a payment by A to B at the request of C, on terms that it is to be repaid by C, can amount to a loan, and that whether it does depends upon the circumstances of the case. Thus money paid by a banker pursuant to a cheque drawn on an overdrawn account is a loan to the customer; money paid by an employer, pursuant to a facility agreement with an employee, to the trustee of a share incentive scheme in acquisition of shares for the employee is the making of a loan to the employee; and, whereas an issue of loan stock by way of acquisition consideration is not a borrowing, a contract pursuant to which the company purchases the property at a stated sum, borrows that sum from the vendor and issues loan stock to the vendor in satisfaction of the obligation to repay may well be a borrowing.
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