Company & Insolvency Law - Assignment Example

?Assignment The difference between the fixed charge and the floating charge granted to the bank and Loanshark; There are two types of charges thatKhalid and Mahmood may consider which is a fixed and a floating charge. Before and at the onset of insolvency, fixed charge holders enjoy an unfettered right to enforce their debt repayments by dragging their debtors to court upon default by the latter. Fixed and floating charges are used in order for the company to secure borrowings under debentures which may be issued by the company as a source of long term loan. The difference between a fixed and a floating charge is that a fixed charge refers to the mortgage that may be secured on a fixed asset for example a piece of property, land, machinery, buildings, intellectual property etc. whereas a floating charge is that which allows a company to undertake borrowings despite non possession of assets which may be specific in nature and the charges are placed on the company’s assets like its machinery, stock in trade etc. Before and at the onset of insolvency, fixed charge holders enjoy an unfettered right to enforce their debt repayments by dragging their debtors to court upon default by the latter.1 A debenture holder, whose debt is secured by a floating charge over the assets of a company such as its book debts and trading stock, is likely to enjoy boundless benefits should such a charge crystallize preferably before the onset of insolvency. In Khalid and Mahmood’s business, the bank charges a fixed charge on the company’s assets meaning it secures via mortgaging the assets of the company in case of debts and further affixes a floating charge on the rest of the undertaking of the company. At the onset of liquidation of the insolvent, the fixed charge holder may sell the fixed assets and use the money regained in order to cover his personal debts, repay himself and then prove for the outstanding balance or may give up his security to the liquidator and then claim the full amount of the debt as an unsecured creditor. Economic duress cannot be totally ruled out in circumstances where a company’s directors desperately seek a loan from an institutionalized lender in order to keep the company’s business afloat. The borrower is often the weaker party owing to the weight of his needs, leaving room for the stronger party to make collateral demands whose fairness may be of little relevance, given the freedom of contract doctrine at the heart of contract law. However, when the sum realized from the fixed assets is not enough to pay the debt owed to the creditors, the holder is then relegated to the undesirable general league of unsecured creditors for the remaining balance, subject to pari passu regime. The fixed charge of 75,000 that has been granted by the bank is an automatic security clause, and is the first priority and thus needs to be paid before anything else. According to the facts of the case, the bank got the 75,000 pounds of loan as a fixed charge interest. This loan was undertaken to be a floating charge loan with a negative pledge on the floating assets of the company. It can be demarcated to a floating charge loan only when the loan is given on collateral which is not fixed in nature. Loanshark granted a 20000 Pounds worth of floating charge on the company’s undertaking. Adopting from the theory, we can assume that such charge was given on the floating assets of the company. Taking case laws into account, the case of Agnew v Commissioners of Inland Revenue2 involved the security interest of the company’s assets and the priority of the creditors in the winding up of the business. Other cases like Leyland Daf Ltd3 involve floating charges depicting how crystallization on time can help save the company. Under all the circumstances, if a company has taken loan on a fixed charge interest and floating charge interest, the loan which has been taken on the fixed charge interest has to be paid at the earliest time possible. This is done so that the loan on the fixed security which is more vulnerable in nature can be settles off quickly. The answer to the question whether the company can grant floating charge lies in negative. The company cannot grant a floating charge to Loanshark Ltd because of the fact that the restriction clause in the agreement shall prevent Loanshark’s arrangement to attain a floating charge loan from the company. The next question which needs to be answered is to ascertain the fact as to which floating charge has more priority under the present set of the circumstances which the company has faced itself according the to the situation at hand. The answer to the question as to which floating charge has more priority lies in the fact that the one which has been registered shall have the first priority to be paid off by the company. Under the set of rules, a loan on floating charge allows you to deal with the assets at hand, however, if you are under a fixed interest then such conditions do not take place and one cannot deal with the assets under any circumstances. The fixed charge under the present set of the circumstances is a secured loan. Every secured loan which has been taken from the money lenders has to be recovered and therefore such a loan in these circumstances shall be recovered easily. However, the floating charge loan stands not to be recovered since this is a loan which is not secured in any way as things go by. The second floating charge by Loanshark shall be made void when they try to register it due to the security clause that the bank has inserted. If it is not registered then Loanshark stands a very minute chance of recovering its loan since it would be considered to be an unsecured creditor. . It also overruled Re New Bullas Trading Ltd4 on whether a fixed and floating charge could be combined in a single security document. Lord Scott warned that such combination has the potential to create immense confusion in the business world. For instance, classifying a charge by a bank as a floating rather than a fixed charge meant that the holder would mean that the bank would have to endure the limitations cast on the floating charge by the Enterprise Act 2002 The insolvency pecking order from China works Ltd to the liquidator should go according to the parri passu rule. In order to understand the process in which the entire transaction is going to take place, it is pertinent to understand the legal definition of Parri Passu. “On an equal footing or proportionately. A phrase used especially of the creditors of an insolvent estate who (with certain exceptions) are entitled to payment of their debts in shares proportioned to their respective claims.” Understanding this definition, we can ascertain the fact that the entire payment of debts should be distributed among the creditors in the correct proportion, since that is the correct way of distributing the money to the creditors. All the stock holders and shareholders have to be distributed money in the manner in which the debtors owed them money. In order to conclude, it must be understood that pari passu regime has largely been feeding preferential creditors out of the floating charge’s assets and the floating charge is largely metaphoric in nature and function given its inability to secure the assets of its holders. The company thus cannot grant Loanshark a floating charge because the directors would not want the bank’s floating charge to crystallize due to the lack of finances which would lead to the end of the company. Despite this, the floating charge as compared to the fixed charge allows one to deal with the assets but cannot be recovered as it is unsecured by nature. The second floating charge by Loansharks will be made void when they try to register it due to the security clause the bank inserted. If it is not registered then Loansharks will be just another unsecured creditor who is likely to get nothing during liquidation. Answer 2 Explain to Khalid the legitimacy of the 200,000 order he takes for himself. The 200,000 pounds contract is presented to the company requiring that all the directors pass it and does not require only a single director’s opinion. Every director has a fiduciary duty towards the company which is a separate legal entity and to pass any order as per personal interest would amount to breach of this duty on part of the director. It is pertinent to understand the corporate opportunity doctrine to understand the legitimacy of the order Khalid has taken for himself; The corporate opportunity doctrine is the legal principle providing that directors, officers, and controlling shareholders of a corporation must not take for themselves any business opportunity that could benefit the corporation.5 As per Section 175(1) of the Companies Act 2006, a director must avoid any kind of situation by way of which he receives direct or indirect interest that conflicts with the interests of the company. According to Lord Herschell’s speech in Bray v Ford, “it is an inflexible rule of a court of equity that a person in a fiduciary position…is not, unless otherwise expressly provided…allowed to put himself in a position where his interest and duty conflict. It does not appear to me that this rule is… founded upon principles of morality. I regard it rather as based on the consideration that, human nature being what it is, there is a danger, in such circumstances, of the person holding a fiduciary position being swayed by interest rather than by duty, and thus prejudicing those whom he was bound to protect.”6 Khalid, being the fiduciary of the company cannot in any way exercise the rights of his position in a manner that affects the interests of the company; in other words, he must act in a bona fide manner by not taking undue advantage of his position or make profits out of his trust. The contract that was passed was of 200,000 which is a substantial amount needed to be passed by all the directors of the company and not just a single one. Khalid passing the contract to himself would be in breach of the fiduciary duty or responsibility that he owes to the company and it would amount to him taking advantage of such an opportunity because it would amount to his personal benefit or gain, as was observed in Chan v Zacharia.7 Khalid’s first priority would be to protect the interest of the company as the company is a legal entity on its own, and not to use any undue influence in order to gain profit from or misappropriate the assets of the company. Khalid being the director of the company got the opportunity to pass the contract however because he has not been required to account he would have ended up making a large amount of profits deliberately, as a result of which the interests of the company would have conflicted. An incident of the duty to avoid a conflict of interests is the so-called corporate opportunity doctrine. This ‘makes it a breach of fiduciary duty by a director to appropriate for his own benefit an economic opportunity which is considered to belong rightly to the company which he serves’.8   Lord Cranworth LC stated that ‘no-one, having [fiduciary] duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound to protect’, went on to stress that “his duty to the company imposed on him the obligation of obtaining these iron chairs at the lowest possible price. His personal interest would lead him in an entirely opposite direction, would induce him to fix the price as high as possible. This is the very evil against which the rule in question is directed.”9 If the requirement of authorization is complied with or if the director has declared to the other directors his interest in a proposed transaction with the company, these processes replace the equitable rule that required the members to authorize such breaches of duty. This is made subject to any enactment or any provision in the company’s articles which require the authorization or approval of members.10 However, since Khalid is a self-dealing director, he would be deemed to be under conflict of interest and thus the order of 200,000 passed personally by him would not be considered to be legitimate in the eyes of the law, a case in example being observed in Rly Co v Blaikie Bros.11 Since the transaction is a long term one, it would require the approval of all the members and not Khalid alone. Since Khalid was the director of the company, he had the opportunity of taking into account his personal interest however that goes against the interest of the company at large. In order for the 200,000 contract to remain legitimate, he must adhere to the corporate opportunity doctrine and avoid this conflict which creates his personal interest. A corporation has an interest or expectancy in a business opportunity if the opportunity would further an established business policy of the corporation.12 Question 3: The directors should take the business into insolvency from September 2010. This is the perfect time for the business to venture into complete liquidation since the accountant told them about the non-viability of the business at that time. The Directors of the Company are liable for the debts of the company according to the facts of the case and the law lay down. The directors are liable for the debts from September to February 2012 and this is where their responsibility strikes in. According to the rule of pari passu the creditors shall get their due at the last, since the stake holders and shareholders are given priority at the top most hierarchy of the liquidation. The directors are in a difficult situation under the present circumstances. They are unlikely to get anything since they were responsible for the debts which the company has received over the period mentioned above. There will not be any share to pay off the directors since there is a paucity of funds. Overall it is an established fact that the directors are responsible for the debt and they shall not get the share to the extent which the company lost. “The liquidation process is carried out on the basis of the priorities rule which in turn hinges on the concept of collateralization. One key flaw in the concept of collateralization is that it fails to take into account the economic and social factors affecting the various creditors and the manner of their decision making.”13 The liquidation process begins with the approval and authority of the Court. That is the first step in the scheme of liquidation. The shareholders in the present scenario are in a fixed situation. Khalid and Mahmood are the directors of the company who were at the fault for not having paid the loans back to the creditors, and therefore according to the rule of pari passu the creditors should be paid before the shareholders to compensate for the loss which has been caused. In the present case, there is a loss of 20000 Pounds which Loanshark had paid them. This money has to be recovered by the Creditors after the company is liquidated, since this is the decision which has been taken by the shareholders of the company. And in doing such liquidation it is imperative to understand that the creditors Loanshark should be given the first priority. Since the creditors in this scenario are secured creditors it is important to give them their share of money once the company is getting liquidated. In the first scenario when the loan of 75000 Pounds was approved, it was approved in the fashion of a floating charge interest, which basically concludes that the creditors acted unsecured creditors over the entire floating asset of the company. The order of the company is the order of priorities in which the company will be liquidated. The directors of the company will be liable and not entitled to any repayment as the shareholders because there will not be enough finances to pay them off. The court needs to be paid its fees or expenses first because of it will give the sanction for the company to begin its process of liquidation. Next, the fixed charge holders will be paid unless there is not enough money in which case they will be relegated to the group of other unsecured creditors. The preferential creditors or the employees will be paid next as the Insolvency Act places them ahead of the floating charge holders and the expenses of the liquidation in the hierarchy, with the order of priority within that class laid out in the sixth schedule to the Act. Following them, the liquidation expenses that the company has indulged in would need to be accounted for. The liquidator’s pay will be made according to whatever amount has been fixed at the company’s general meeting and the expenses in liquidation include expenses of conducting litigation which the liquidator is empowered to defend in his name and on the company’s behalf.14 The assets that remain within the company’s hold after all these payments have been made will have to then cover the floating charge of the company after which the unsecured creditors and then the shareholders are paid with whatever else can be realized by the company. The term “creditors” refers to the institutions, persons and/or corporate entities to whom the insolvent entity is indebted and they may be either adjusting or non-adjusting in nature.15 It is crucial to adopt the summary of Section 176(1) to get a better understanding: “an Insolvency Practitioner shall a prescribed part of the company’s net property available for the satisfaction of unsecured debts, and shall not distribute that part to floating charge holders except in so far as it exceeds the amount required for the satisfaction of unsecured debts.” From this text we can ascertain the fact that in the first loan of 75000 the loan was given as an unsecured loan. Therefore, the creditors shall not be given higher priority once the company is liquidated as the creditors are unsecured creditors and the rule of pari passu allows that such loan shall be settled right in the end. The fixed charge holders calculatingly advance credit finance to debtor companies to aid their operating cash flow, or finance a specific fixed asset investment at rates that are commensurate with the risk assumed. In return, they take collateral to secure the prompt repayment of what is owed to them. They are not only relatively insulated from potential default but are also saved from the battle of priority by the well demarcated assets to which their charges attach. In a case where a secured creditor is moved to a group of unsecured creditors, it is recommended that the fixed charge holder’s outstanding balance be given first priority before the claims of other creditors in the general pool are satisfied pari passu. Loanshark for the loan it gave as 20000 Pounds is an unsecured loan since any loan given on a floating charge of interest and which is not registered shall be an unsecured loan. Under the present case scenario we can safely ascertain that Loanshark is an unsecured creditor and therefore once the company is liquidated they will not get any share. Unsecured creditors lay nearly at the bottom of the priority pyramid, only a step above the shareholders, and are subjected to the pari passu regime for the recovery of a dividend if any. This rule essentially provides that if debts rank equally, so shall they abate among themselves if there should be a shortfall in the assets designated for the satisfaction of such debts.16 Debts differed by statutory virtue also fall into the exceptions to the pari passu and a potential encroachment to unsatisfied floating charge holders. They are inclusive of sums due from the insolvent company to a director(s) who unfortunately satisfied the test for fraudulent and wrongful trading, with the result that court ordered their debt(s) to be differed. The category also plays host to claims of the insolvent’s shareholders and other members such as claims for dividends and profits.17 The loan of Loanshark of 20000 lies at the bottom of Pari passu rule. Bibliography and Appendix Milan, D., “Company Charges and Security: An Overview of the Present Position”, Co. L.N. 2006, 9, 1-4 Financial-dictionary.thefreedictionary.com (2012) Absolute Priority Rule financial definition of Absolute Priority Rule. Absolute Priority Rule finance term by the Free Online Dictionary.. [online] Available at: http://financial-dictionary.thefreedictionary.com/Absolute+Priority+Rule [Accessed: 28 Jun 2012]. Chrispas Nyombi (2012): Unfairness and confusion: inherent features of floating charge security, The Law Teacher, 46:2, 197-203 J. Armour, ‘ Legal Capital: An Outdated Concept’, (EBOR, Vol. 7, 2006) p.5 at 11 R. Mokal, citing IA 1986, s. 74(2) f 18B Am. Jur. 2d Corporations § 1536 (1964). [2001] UKPC 28 [2004] UKHL 9 [1994] 1 BCLC 845 [1896] AC 44 at 51-52 [1894] 1 Ch 616; See, Official Report, 9/2/2006; coll GC337 18B Am. Jur. 2d Corporations § 1542 (1964). IA 1986, s. 175(2) Read More