Distinguishing Share Capital and Loan Capital - Coursework Example

Topic: Distinguish between share capital and loan capital, paying particular attention to the way in which load capital may be secured Language Style: English UK Grade: 1st class Pages: 12 Introduction The fraction capital of a company's raised by the subscription, ordinary shares and preference shares is called Share capital. Particular proportion of a company's Capital gather by means of loan is called Loan Capital. Companies raise capital in a number of ways. They may have it provided by the founders savings in which case things are relatively Straightforward more usually a company will obtain its capital through a Loan from a bank or other institution or from the general public. Under Company Act-1985 section- 263 and under Company Act-2006 section - 540 to section 564 the UK companies have a wider variety of capital intensifying. This paper would go to investigate difference between share capital and loan capital, paying meticulous attention to the way in which loan capital may be secured1 Corporate borrowing where this is done by debentures or debenture Stock it also examines the types of charge that companies can issue to Creditors is floating and fixed charges. The priority of secured creditors is considered together with an examination of the registration requirements for charges. Share Capital: Membership of a company limited by shares is based on an undertaking to Contribute capital to the company in payment for shares issued by the company. The amount of capital to be contributed is a matter for agreement between each Member and the company but once the agreed amount has been contributed neither the company nor its creditors may demand a further contribution2. The contributed capital of a company is used by it to make profits, which may be shared among is members if the company is wound up when it is solvent, the contributed capital may be returned to members but if it has to be wound up when it is insolvent then all the assets acquired with the members contributed capital will have to be used to pay the company debts and nothing will be returned to the members. As well as sharing in profits the members of a company normally jointly control it by appointing directors to manage the company affairs. In many private companies, of course, the members are also the directors. A member of a company who contributes more capital than another will want a proportionally greater share in distribution of the company profits and also a greater influence on the company affairs (i.e., more votes at members meetings). The extent of a members undertaking to contribute capital, and of entitlement to share in distributions and vote at meetings, are all related to the number and class of shares of the company that the member holds a description of each member. Shareholding must be entered against the members name in the company register of members (CA 2006, s 113). A share is essentially a limit of account for measuring a member's interest in a company. Each share is required to have sum of capital assigned to it as its nominal value (s 542) and this is the size of the unit of account. The nominal value of a share is the minimum value that a company must demand to receive as contributed capital in exchange for the share so if Textbook Examples Co plc, has only one class of members and the nominal value of each of its shares is 50p, and I undertake to contribute 5000 worth of capital to the company I Cannot expect to be allotted more than 10,000 of its shares. Moreover, the company must not offer to allot me more than 10,000 of its 50p shares as an incentive to me to contribute only 5,000 worth of capital because to do so would distort the way in which the shares allotted to me measure my interest in the company (s 580) it is however permissible for a shareholder to undertake to contribute more for shares than their nominal value -the excess is called share premium Capital contributed in exchange for shares, apart from share premium, is called share capital. Having undertaken to contribute capital to a limited company and thereby become a member, a person may transfer that membership to someone else either by gift or sale. In most private companies, however the members give the directors power to Control admission to membership and an attempted transfer by an existing member may fail because the directors refuse to accept he transferee as a new member. The called up share capital of a company is the amount actually contributed to its share capital plus amounts presently due to be contributed by members (section 547)3 such amount may arise either because the company has called for further contributed from holders of partly paid shares or because members agreed to pay for their shares in instalments and the instalments are due on fired dates. Structures of Share Capital: A company may have different classes of members with differing rights of membership if there is a provision to that effect in its articles of associations (Andrews v Gas metre Co4) The draft model articles for private Companies Act 21 (1) and the draft model articles for public companies act 42 (1) provide that shares may be issued with such rights or restriction as may be Determined by ordinary resolution. Shares in different classes may have different nominal values. Nominal values of different shares may be in different currencies (Re Shaulinavian Bank Group plc.5). Normally in a company limited by shares, every member is a shareholder, so that the terms members and shareholder are synonymous where a company limited by shares his uncertficated shares, there is legislative provision that only shareholders can be members SI200/3755, Reg. 24(3). In principle, a company limited by shares which had no uncertificated shares could have a class of members (perhaps called honorary members) who are not required to contribute any capital and who each have one vote, and then no shares would be needed to measure the interests any particular member of that class. The nominal value of the shares held by a member of a company measures the member's liability to contribute capital to the company. In return for this liability Membership confers benefits, of which the main ones are; (a) The right to influence the way the company affairs are conducted by voting at meetings of members. (b) The right to a return of contributed capital when the company is wound up (provided there is any property after paying the company creditors) sometimes a Company returns part of its contributed capital though continuing in business, but this is subject to rules which attempt to ensure that creditors are not jeopardised. (c) The right to participate when the company makes distribution of its profits to its Members if on winding up company there is a surplus after paying all its creditors and repaying its contributed capital then the surplus is divided among the members, while a company is in existence it may anticipate an ultimate share out of surplus by an annual (or more frequent) distribution of profits. A distribution of surplus or annual profits is called a dividend. The default position at common law for entitlement to return of contributed capital or to dividends is that payments are proportional to the nominal values of shares held in Oakbank oil Co v Crum6; Birch v Cropper7; Re Anglo Continental Corporation of western Australia8). However, AC 2006, s 581 permits a company articles to authorise dividends Proportion to amounts paid up on shares, and this is done by art 71 of the draft model articles for public companies, Bonus shares are issued on the same basis (art 78 (2) (b). So under these articles, dividends and bonus shares are proportional to capital contributed rather than capital, which it has been undertaken to contribute and nothing is distributed on totally unpaid shares. Parliament has insisted that members of a registered company must be liable to contribute to its assets, but a holder of shares in a company limited by shares has only a limited liability, which is to contribute the nominal value of the shares held in the 19th century some companies tried to make membership more attractive by devising ways in which members did not have to be liable for the full nominal value of their shares. The courts slowly ruled each attempt to be unlawful. In one of the most important cases, Ooregum Gold Mining Co of India ltd v Roper9, Lord Halsbury LC said at p 134: What Ooregum Gold Mining co of India Ltd had run into temporary difficulties and The market value of its 1 shares was only 121-2p It members adopted a special resolution that it should issue further 1 shares, which would be treated as having had 75p paid up on them though the company had not in fact received that 75p. This is called issuing shares at a discount. Although the Ooregum discounted shares were issued for 5p each the company register of members recorded that they had been issued at 80p each Holders of the discounted Ooregum shares thought they were liable to contribute only a further 20p each for them. The company was successful but a holder of ordinary shares on which the full 1 had been paid took proceedings to have the company register of members rectified to show that only 5p had been paid on the discounted shares instead of 80p. The House of Lords affirming the decisions of the courts below ordered the rectification asked for. Lord Halsbury LC said at p 134, that law... from doing that, which is compendiously described as issuing shares at a discount, prohibited the company. It follows that a company Cannot give away its shares, treating shares as fully paid up though it has not received Anything for them (Re Eddystone Marine Insurance co10). Statutory provisions have superseded the decisions of the courts. AC 2006, s 580(1) prohibits the allotment of shares at a discount if a share is allotted at a discount the allottee is liable to pay the company the amount of the discount plus interest at 5per cent per year (ss 580 (2) and 609). Loan Capital: Borrowing is an important method of financing the activities of companies in Britain Nowadays by far the most important form of borrowing is an overdraft at a bank. But this is quite a recent phenomenon and much of the law on borrowing by companies was developed to deal with loans from private individuals. A lender of capital to a company usually insists on being granted a right of recourse against property of the company if the loan is not repaid on time. The right of recourse is security for the repayment of the loan. Among business people the word debenture usually denotes a document by which a company gives security for the repayment of a loan however the courts have ways held that debenture means any document issued by a company acknowledging indebtedness and this is the sense in which the word is used in CA 1985 (Lemon v Austin friars Investment Trust ltd11). In the second half of the 19th century small companies often took loans from private investors in units of, say 100 For each 100 (say) lent an investor was given a certificates specifying entitlement to interest and repayment of principal, and the holders of these certificates would all given an equal right of recourse against the company, and the holders of these certificates would all be given an equal right of recourse against the company property if there was default in paying interest or repaying principal A set of identical certificates like this issued by company is called a series of debentures in series feature in many court cases but are now virtually extinct. Until about 1970 it was common for listed companies to raise very large loan if it is marketable-that is if There are facilities for him to sell him own rights to interest and to repayment of capital, should he find himself in need of case special arrangements can be made so that large loans are marketable through the London stock exchange. Marketable loans will be considered separately. If a company is registered as a public company on its initial incorporation it is an offence for it to exercise any borrowing powers unless the registrar has issued it a certificate to comment business or it has re registered as a private company (CA 2006, s 761(i). Company Charges Creditors will often require security from a borrower before lending money, so that in the event of a default on repayment the creditor can enforce the security interest.12 By requiring security from a debtor company the creditor seeks to ensure priority over the general body of the creditors should the company be wounding up. The granting of security by a company does not mean that the title to the secured asset passes to the creditor but rather it creates an encumbrance on the property. In National Provincial Bank v Charnley13, Atkin L J mentioned that the creditor gets a right to have the security made available by an order of the court. For companies, the most common species of charges given as security interest are fixed and floating charges14. Fixed Charges A company may grant a fixed charge to a creditor over certain property such as a warehouse. Such a charge is similar to a mortgage in that the rights of the creditor attach immediately to the property and the company's power to deal with the asset is restricted. Lord Millett stated in Agnew V Commissioner of Inland Revenue15 that: 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. Floating Charges: As its name suggests, a Floating charge floats over the whole or a part of the charger's assets, which may fluctuate as a result of acquisitions and disposals. Corporate property that can be made subject to a floating charge includes stock in trade, plant, and book debts. The distinguishing features of a floating charge are that the company can continue to deal with the assets in the ordinary course of business without having to obtain the chargee's permission. A floating charge converts to a fixed charge over the assets within its scope upon the occurrence of a 'crystallizing' event such as a default on repayment or the winding up of the company. The Impact of Liquidation: The distinction between a fixed and floating charge assumes critical importance if the company goes into liquidation because of the ranking of the chargees against the general body of creditors. In Re Yorkshire Woolcombers Association16, Romer LJ listed the following distinguishing features of a floating charge: 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 class17. In determining whether a charge is fixed or floating the courts will look to the substance of the matter irrespective of what description the parties use to categorize it. In this regard Lord Millett explained in Agnew V Commissioner of Inland Revenue, that: 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. In Arthur D Little v Ableco Finance LLC18 the charger, Arthur D Little, guaranteed the liabilities of its two parent companies to Ableco by creating a charge, described as a first fixed charge, over its shareholding in a subsidiary company, CCL. The charger company retained both its voting and dividend rights with respect to the shares until default. The company's administrator argued that it is floating charge. It was held, Appling Lord Millett reasoning in Agnew that whether or not the charge was fixed or floating is a question of law and the particular charge in issue was fixed. It did not float over a body fluctuating assets and, not withstanding the company's voting and divided rights, it could not deal with the asset in the ordinary course of business: the company could not dispose of, or otherwise deal with, the shares. The asset was therefore under the control of the chargee. Crystallisation: In NW Robbie & Co Ltd v Witney Warehouse Co Ltd19 held that Crystallisation converts the floating Charge in to an equitable fixed Charge over the assets of the company owned by it at that time. This will also include future acquired assets if within the scope of the charge. Upon Crystallisation the Chargee loses the right to deal with the assets in the ordinary course of business. Since a charge is created by contract, the parties can agree the events, which will trigger Crystallisation. A floating Charge will also crystallize when a debenture holder or the trustees take possession or appoint a receiver or realize the security as a result of the occurrence of an event specified in debenture. In Re Panama, New Zealand and Australian Royal Mail Co20 default in the repayment of principle or payment of interest. Priority of Charges: The governing principle is that security interests rank according to the order of their creation: qui Prior est tempore, potior est jure. This is subject to number of exceptions. A legal mortgage will take Priority over a prior equitable security if it purchased without notice of the prior equitable interest and for value (Coleman v London County and Westminister Bank Ltd21) Avoidance of floating Charges: Section 245 of the Insolvency Act 1986 invalidates a floating Charges created within twelve months (termed the relevant time) prior to the onset of insolvency unless it was created in consideration for money paid, or goods and services supplied, at the same time or as or subsequent to the creation of the Charge. The relevant time is extended to two years where the charge is created in favour of a connected person. However, s.245 (4) provides that a floating Charge created of a non-connected person within the relevant time will not be invalidated if the company was able to pay its debts at the time the charge was created and did not become unable to do so as a result of creating the charge22. Conclusion: In the light of above discussion, the distinction between Share capital and Loan capital might be concluded that Loan Capital would be obliged to be repaid or refinanced, when share capital can be set aside permanently. Loan Capital entailed customary interest payments; the company has to generate cash flow to pay. But for Share Capital there are no requirements of payment, it might obtain dividends out of retained earnings. Certificate or Collateral assets are essential to avail Loan Capital, but for Share Capital no collateral assets are essential. Loan Capital providers are conventional. They cannot share any advantage or profits. Therefore, they want to eradicate all likely loss or disadvantage risks. On the contrary, Share Capital providers are antagonistic. They can agree to downside risks for the reason that they fully share the benefit as well. For Loan Capital all payments of interest are tax deductible but the dividend payments are not at all taxes deductible. Loan Capital has a little or even no impact on control of the company. Share Capital necessitates shared control of the company and may compel restrictions as needed. Loan Capital consent to leverage of company profits, when Shareholders divide up the company profits. The British Government has indicated that key themes underpinning the Company Act -2006 aimed to enhance shareholder engagement and a long-term investment culture. The new Act stand for a thorough renovated of company law and also combines existing law, generating a complete code of company law in one place for capital rising. Under all consideration the formalities and facilities under Company Act 1985 and Company Act-2006 relating to the company charges, loan capital is more preferred and secured. Bibliography: Arsalidou, D, (2007), Shareholder primacy in cl.173 of the Company Law Bill 2006, Company Lawyer, 28 (3) 67-69 ISSN 0144-1027 Brigham, E. F., & Houseton, J. F. 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