Company Law - Black Books - Essay Example

i) There are more disadvantages than advantages for Black Books to raise its capital through loan or borrowing from lenders. Some of these disadvantages include but are not limited to: (i) repaying the loan exactly with the previously agreed upon contractual relationship—in other words, whether Black Books is doing well or not businesswise, the loan has to be paid back without any new concession for re-contracting; (ii) supplying a collateral security before the lenders could agree to grant the loans. In the case of Black Books, the securities offered to the lenders are the company’s land and some monetary securities. Hence, sometimes, the lenders could place some restrictions on the use of these collateral securities; in this case, Black Books would be denied of optimally utilizing its assets to maximize its profit potential. And when this problem occurs, Black Books may find itself enmeshed in huge debts owing to corporate inactivity; (iii) loss of control on the company—this means that in the event of incurring huge debts due to poor performance, the lenders may request that the current management at Black Books be replaced by receivership or administration that are external and has little knowledge of how Black Books has been run (Mead and Sagar, 2006). The major problem associated with incurring huge debts or going insolvent is that it may destroy a company’s brand image that had been developed for years. And if this condition occurs or left to persist, it would be difficult for Black Books to regain the loyalty of its long- 2 time customers who may have begun to boycott the company’s books for another one (Omar, 2004). However, the main advantage of sourcing operating capital through loan or borrowing from lenders is that Black Books could claim tax relief on the interests payable to service the loan (Mead and Sagar, 2006). But if Black Books had chosen to raise its capital through share capital, it would have been able to dodge the requirements to provide collateral securities necessary for securing the loans. And it would have faced no restriction on the use of its assets which had been used as the collateral securities (Mead and Sagar, 2006). However, Black Books could not claim tax relief on the dividends from share capital, unlike the one from loan capital (Mead and Sagar, 2006). But using share capital appears safe for Black Books (if the company has chosen this method earlier on) because there would be no fear of going bankrupt owing to the restrictions on the utilization of Black Books’ assets placed under the lenders as collateral securities. Hence, Black Books can continue to operate and protect its brand image from being sullied due to insolvency and the take-over of the company’s administration by a new set of managers, who may lack adequate information about the true state of the company (Omar, 2004). 3 (ii) Black Books is expected to create debentures, which are the documents detailing the terms of borrowing capital loan from the lenders. Black Books has also indicated in the debentures some floating charges on some or all of its assets so as to fulfill the requirements stipulated by the lenders. However, some formalities must be strictly followed in order to draw up the appropriate debentures necessary for Black Books to get the loan. And each of the formalities has legal consequences as explained in the series of processes below: (a) Black Books approaches Lender to borrow ?500,000; the formality here is offering a legal mortgage of the company’s land as a security for the loan in favour of the Lender. This entails that the Lender has powers on the property—it could either restrict Black Books’ access to the land or sell it off when the company failed to pay the loan interests (Dakin et al., 2002). (b) Black Books wants to issue a first floating charge over the company's assets to the extent of ?100,000 in favour of the company's major trade creditor, Supplier, and include a "negative pledge" clause—the essence of a negative clause is to give the company’s major Creditor priority when it comes to settling the company’s creditors. (c) Black Books also intends issuing a second floating charge over the company's assets to the extent of ?50,000 in favour of another trade creditor, Pressing, and including an "automatic crystallisation" clause in the event of the England 4 Cricket Team losing the One Day test series in Australia in January 2011—this kind of document gives power to the creditor, Pressing, to claim ?50,000 due to automatic crystallisation, since the condition or term of the agreement did not materialize according to the contractual agreement between the two parties (Goode, 2003). Why these formalities are important is that they help to define the status of agreement between Black Books, the Lender, the major creditor—Supplier, and the other trade creditor—Pressing. The debentures confirm the power of each party in the process of granting capital loan to Black Books. Although they do not have similar power on the assets Black Books used as collateral securities, but the documents are clear enough to explain the legal consequences of each contractual agreement (Goode, 2003). These formalities are necessary to protect the creditors in case Black Books eventually goes bankrupt. And the documents are also helpful in knowing the priority of each creditor when it comes to repaying the loans the company had received from them. 5 (iii) There are some legal consequences for both creditors, Supplier and Pressing if Black Books falls short of its expectations in paying up the interests on the loan capital. The first issue to iron out in this circumstance is that which creditor will be enjoying priority in financial settlement in case Black Books eventually ends up in the hands of receivership? And how could the creditors recover their loans from the company’s accounts? Both Supplier and Pressing have secured by floating charges debentures with Black Books: which means that they could place some charges on a class of the company’s assets. Supplier has a floating charge of ?100,000 on Black Books’ assets, meaning that it could claim up to that amount of the company’s assets if Black Books defaults on paying its loan (Kothari, 2006). The good news is that the terms in the debenture explain how Supplier could recoup its loan to Black Books, which may include selling the assets under its charge or appointing a receiver that would manage the company (Kothari, 2006). Since Black Books gave Supplier a debenture that includes a “negative pledge clause”, this shows that supplier will receive a priority over Pressing when it comes to settling the financial obligations of Black Books to these creditors (Tyagi and Kumar, 2003). On the other hand, Pressing has a contractual agreement with Black Books with a debenture that stipulates that in the event of the England Cricket Team losing the One Day test series in Australia in January 2011, which it did, floating charge floating charge over the company's assets to the tune of ?50,000 that was given to Pressing will 6 automatically crystallized. In other words, the floating charge will become a fixed charge, which Pressing could apply on Black Books’ assets to recover its loan to the company. (Kothari, 2006). Pressing could decide to request court to set up a receiver for Black Books so as to change the management at the company. Or it could sell off the charge it has on the property of Black Books to offset the debt the company has owed it. However, the only issue that may be hard for both Supplier and Pressing is that the two creditors have to wait until the court has recovered the cost of winding-up Black Books before they could receive any repayment. This indicates that if the cost of liquidating Black Books appears to be too much, it may take a long time for both Supplier and Pressing to receive any repayment Kothari, 2006). To better understand how these two creditors would handle their legal concerns, it is helpful to look at Agnew v Commissioner of Inland Revenue [2001], where it was ruled that liquidated company (for example, like Black Books) must respect the terms of its debentures with its creditors, no matter what the conditions of things look like (Kothari, 2006). So, this observation supports the expectations of the creditors as described in the debentures, and which neither court nor the new receiver (in case Black Books becomes insolvent) can change (Kothari, 2006). (iv) If Black Books defaults on paying the loan interest as described in the debentures, Lender can enjoy the following remedies to recover its loan given to Black Books: 7 (a) Lender can claim the ownership of the Black Books’ land which was used as the collateral security for borrowing the loan to the tune of ?500,000—although some procedures have to be followed before the transfer of ownership of the land to Lender could be authenticated. According to Company Act 1989, Lender should register the land as its property so that it would not be forfeited against subsequent purchaser. It is also necessary that the land is registered with Her Majesty Land Registry. Once these important registrations are concluded, Lender could claim legal ownership of the land and can sell it to any subsequent mortgagee without fear of being forfeited (Leece, 2004). In case Black Books refuses to give up the land, Lender could seek a legal assistance by asking the court to prevail on Black Books and honor its previous agreement on the issue, which is to yield its landed property to Lender if it defaults in paying its quarterly loan repayments (Leece, 2004). There are similar cases like in recent years; in Barrymores v Harris Scarfe [2001], the Supreme Court of Western Australia held that s440C of the Corporations Act protects receivers from conversion claims by the owner of goods subject to retention of title where the company is under administration at the time. What this indicates is that if Black Books has been placed under the receivership owing to the actions of the other two creditors—Supplier and Pressing—it is impossible for Black Books to refuse 8 ceding the ownership of the land to Lender. This is completely against the law. However, if there is a clause in the debenture or contractual agreement which claims that Black Books could offset its debt to Lender through alternative payment and not ceding the landed property, then Lender could ask the court to compel Black Books to raise money from its assets to pay its debt as arranged (Leece, 2004). But it is rare for creditors to accept such a clause. The main reason for requesting for a tangible collateral security before issuing a loan is to have something to recover the money from in case the borrower (Black Books) defaults in its loan repayment. Another interesting point to consider in this issue is that even though the price of the land has risen more than initial ?500,000 borrowed from Lender, Black Books or its new managers cannot decide to sell the land on their own with the hope of making profits after settling the company’s debt with the Lender (Leece, 2004). The most important thing to consider in this scenario is the content of the contractual agreement that was agreed upon by both parties. Sometimes there could be changes in the agreement as permitted by the first contracts signed by the two parties. But for the purpose of this case study, no such agreement was stated to be in effect; therefore, Lender could utilize the current debentures that requires for the transfer of land ownership in case Black Books could not fulfill its previous promise of paying its loan 9 from Lender on quarterly basis; since this action gives Lender the right to act. It is not clear if the initial agreement between Lender and Black Books support outright transfer of ownership of the land or transfer of a part of the land (Leece, 2004). It is helpful to clarify this clause in the event the value of the increases unexpectedly, and Black Books wishing to keep a part of the land to itself. However, it is evident that no matter what the case is, Lender has the benefit of converting Black Books’ land to pay off the loan the company owns it, as stipulated in the contractual agreement both parties have agreed on—This is an undeniable fact, as far as the relationship between the two parties are concerned. 10 References Agnew v Commissioner of Inland Revenue [2001] UK PC 28 (5 June 2001) Barrymores v Harris Scarfe [2001] WASC 210 Dakin, J. Rabinowitz, G. and Beattie-Jones., 2002. Loan and security documents:a negotiating handbook. Amman: Jordan. Goode, R.M., 2003. Legal problem of credit and security. London: Sweet & Maxwell. Kothari, V., 2006. Securitization: the financial instrument of the future. London: John Wiley and Sons. Leece, D., 2004. Economics of the mortgage market: perspectives on household decision making. London: Wiley-Blackwell. Mead, L. and Sagar, D., 2006. CIMA learning system fundamentals of ethics, corporate governance and business law: new syllabus. London: Butterworth-Heinemann. Omar, J. Paul., 2004. European insolvency law. London: Ashgate Publishing Ltd. Tyagi, M. and Kumar, A., 2003. Company law. Kolkata: Atlantic Publishers & Distributors Ltd. Read More