Unit 3 - Raising Capital (incl Going Public SIPPA) 2014+ PDF

UNIVERSITY OF TECHNOLOGY, JAMAICA COMPANY LAW - UNIT 3 (Revised) RAISING CAPITAL SHARES Definition and Nature of Shares “A share is the interest of a shareholder in the company measured by a sum of money, for the purpose of liability...

UNIVERSITY OF TECHNOLOGY, JAMAICA COMPANY LAW - UNIT 3 (Revised) RAISING CAPITAL SHARES Definition and Nature of Shares “A share is the interest of a shareholder in the company measured by a sum of money, for the purpose of liability in the first place, and of interest in the second and also consisting of a series of mutual covenants entered into by all the shareholders”.1 A share is a form of intangible property classified as a chose in action carrying rights and obligation and which is transferable. Types of Shares: 1. Ordinary Shares- these are the commonest types of shares. Dividends are not fixed and are declared according to the profit of the company. The holders have right to vote at all meetings of the company. 2. Non Voting Ordinary shares- The purpose of issuing this type of share is to enable the company to raise money and at the same time retain control. Non voting ordinary shares must be designated as such. 3. Deferred Shares- these are shares allotted to a person who first founded the company (also known as founder’s share). The holder of such a share is usually entitled to a proportion of the profits if the dividends on the ordinary shares have been paid up to a specified amount. The issue of such is now rare. 4. Redeemable shares- a company with a share capital may, if authorized by its articles issue shares which are redeemable. Such shares may be redeemable after the expiration of a period, on the occurrence of a specified event or at the option of the company or shareholder. Shares to be redeemed must have been issued as redeemable and must be fully paid up at the point of redemption. Section 56(2) states that redeemable shares may only be issued when there are other types of shares being issued (non redeemable shares).2 5. Preference shares- these shares are issued with the authority of the articles and which are entitled to some priority over other shares. They usually carry a right to preference in payment of dividend at a fixed rate (i.e. if dividend is declared) and a right to preference in the repayment of capital in a winding up. Holders of preference shares right to vote at general meetings is usually restricted to where their special rights are being varied or their dividend is in arrear except the articles provide otherwise. The rights attached to the preference shares must be clearly stated and there may be several classes of preference shares (first, second and third) ranking one after the other. 1 Borland’s Trustee v. Steel 1 Ch. 279 @ 288 2 The 2004 Act now allows the issuance of redeemable shares whether or not they’re preference shares. 1 Types of Preference Shares: 1. Cumulative preference shares- if no preference dividend is declared in any year, the arrears of dividend are carried forward and must be paid before a dividend is paid on the other shares. 2. Non- cumulative preference shares- if shares are declared to be non-cumulative preference shares, then the preferential dividend is to be paid out of the yearly profits or out of the net profits of each year and the dividend will not be cumulative i.e. any year in which the company does not make a profit, no dividend will be paid out for that year in any subsequent year the company makes profit. 3. Non- participating preference shares-They do not confer any right to a participation in the surplus profits of the company, after payment of a specified rate of dividend on the ordinary shares. 4. Participating preference shares- these confers right to participate in surplus profits up to a fixed percentage. E.g. right to preference dividend of five percent may be given together with a further right to participate in the surplus profits (after the ordinary shares have been paid) equally with the ordinary shares until another five percent has been paid, but no more. Legal effect of issuing of shares: Previously, a company having a share capital and limited by shares was required to have its authorized capital stated in its memorandum of association with a nominal value attached to those shares. The nominal or par value of the shares was fixed by the company’s constitution. However, in most cases this value was unrealistic and an artificial figure bearing no relation to the actual value of the share at the time of their issue. Hence, the Act provided for the issuance of shares at a discount or at a premium. Under the 2004 Companies Act the par regime is no longer in existence and therefore, companies can no longer issue shares either at a discount or at a premium. There is no requirement now for companies to state their share capital or the value of their shares on the articles of incorporation. The requirement is that companies must state the maximum number of shares the company is authorized to issue and the type/class of shares. The process of issuing shares to an interested party is called allotment of Shares.3 This is the appropriation to a person of a certain number of shares. The allotment remains merely a contract until the allotee’s name is registered in the register of members and thus becomes a member of the company. Allotment of shares of a private company is simple and immediate but for listed companies, offers may be made through stockbrokers. The company may make a call on the members demanding payment of money due in respect of the amount remaining unpaid on their shares. If a shareholder refuses to pay on the shares he would either forfeit the shares or surrender the shares back to the company. If this occurs, the shareholder is released from liability and he forfeits whatever payments that has been made on the shares. 3 Sections 48-52 2 Transfer of shares: A share is a transferable property but to obtain transfer of the legal ownership of the shares, to conditions must be satisfied: 1. A proper instrument must have been delivered to the company 4and 2. The directors must not have exercised their power of refusal given in the articles of incorporation. The power of refusal is usually provided in the articles of private companies limited by shares and public companies not listed on the stock exchange (shares of listed companies ought to be freely transferred). Shares should be transferred using a proper instrument of transfer. The articles usually provide that the instrument must be in the usual or common form and the transferor’s share certificate must accompany the proper instrument when presented for registration. The word ‘proper’ simply means the prescribed from of the company. Re. Greene,5 The articles provided that on the death of a named shareholder his shares should be registered in his widow’s name. It was held that the articleswas not an instrument of transfer. In private companies and companies not listed on the stock exchange. The procedure for transfer usually is as follows: 1. The transferor completes and signs the proper instrument of transfer, attaches his share certificate to it and sends it to the transferee. 2. The transferee signs the instrument and sends it and the share certificate to the company for registration. Stamp duty must be paid and transfer tax by transferor. 3. If the directors are not exercising their power of refusal, they will register the transfer, strike out the transferor’s name from the register and insert the name of the transferee as a member of the company. For public listed companies, transfer of the shares is done through stockbrokers and trading is done on the stock exchange. Pre- emption rights of shareholders and directors right of refusal in private companies: The articles of a private company usually has a pre-emption clause giving the existing members of the company a right of first refusal of shares which other members wish to transfer. The effect of this is the shares for sale must first be offered to existing shareholders and if they refuse or are not interested, the shares may then be offered to outsiders. In addition, directors have power to refuse transfer to outsiders. The directors power is subject to the following conditions; 1. The directors must consider the transfer and take an active decision to refuse to register it. In Re Hackney Pavilion Ltd6 it was held that there was no positive act of refusal and the transfer was ordered to be registered. 4 Section 75- it is unlawful for a company to register a transfer of shares unless proper instrument of transfer has been delivered to the company. 5 Ch.333 6 1 Ch. 276 3  2. The directors in reaching their decision to refuse registration must have acted bona fide in the interest of the company. 3. The directors are not obliged to disclose detailed reasons for their refusal unless the articles so provides but if they do, the court will consider their reasons to decide whether they acted bona fide or not. 4. Power of refusal must be exercised within a reasonable time. In Re Swaledale Cleaners Ltd.7 it was held that the attempt by directors to exercise power of refusal 4½ months after submission of instrument of transfer was invalid. Financial Assistance8 Where circumstances prejudicial to the company exist, a company cannot directly or indirectly give financial assistance by means of loan, guarantee or otherwise to any person for the purchase of shares or in connection with purchase or subscription of shares in that company or any of its affiliates. This means that where there are reasonable grounds for believing that the company is unable or would be, after giving financial assistance, be unable to pay its liabilities as they become due or the company’s assets would be less than its liabilities, the company is prohibited from giving financial assistance to individuals purchasing its shares or shares of affiliated companies. Subject to the provisions of the Act and the company’s articles, a company may give financial assistance in the following situations: a. Where the lending of money is part of the ordinary business of the company. b. To employees of the company to enable them to purchase shares in an employee share ownership plan approved under the Employee Share Ownership Plan Act. c. On account of expenditure incurred or to be incurred on behalf of the company. Power of company to purchase own shares: Under section 58 of the Companies Act, a company can purchase its own shares provided it is authorized by its articles. However a company shall not make any payment to purchase or otherwise acquire shares issued by it unless a statutory declaration is made by the company’s directors and lodged with the Registrar, to the effect that there are no reasonable grounds for believing that; a. The company is or would after the payment be unable to pay its liabilities as they become due or b. The company’s assets would be less than its liabilities. The declaration must be based on the company’s audited accounts made up no more than 12 months before the date of declaration and unaudited accounts made up no more than 45 days before the date of the statutory declaration. Directors of the company who willfully or recklessly make a declaration are liable to imprisonment or a fine. 7 1 WLR 295 8 Section 184-185 4 SHARE CAPITAL9 Maintenance of share capital It is a fundamental principal of company law that the share capital of a company must be maintained. This means that paid up share capital must not be returned to members and members liability on capital not paid up must not be reduced. An authorized return of capital to shareholders is ultra vires and cannot be validated or ratified by shareholders in general meeting. The share capital must be maintained because it is from this fund that the creditors of the company are paid. Maintenance of share capital means: 1. Dividend may only be paid out of distributable profits. 2. Capital may only be distributed to members under the formal procedure of reduction of share capital or winding up. 3. There are restrictions on the purchase by a company of its own shares and on giving financial assistance for purchasing of shares of the company or of its holding company. 4. A public company which no longer have net assets equal to half the amount of its share capital is required to convene a general meeting so that members may consider whether it should go into liquidation or not. Exceptions to the rule that share capital must be maintained: 1. A company may reduce its share capital in accordance with the provisions of the Companies Act. 2. Capital may be returned to the members after the company’s debts have been paid in winding up. 3. By the provisions of the Companies Act, a company may purchase its own shares under a court order to relieve an unfairly prejudiced minority. 4. On forfeiture of shares and surrender of shares to avoid forfeiture. Alteration of Capital The Companies Act allows a limited company with share capital if authorized by its articles to alter its share capital in any of the following ways10: 1. Increasing its share capital by issuing new shares; 2. Consolidation and dividing all or any of its share capital into shares of larger amount than its existing shares; 3. Converting all or any of its paid-up shares into stocks or reconverting stock into paid-up shares of any denomination; 4. Subdividing all or any of its shares into shares of smaller amount; 5. Canceling shares otherwise than in connection with a reduction of share capital under section 68. The company is required to give notice to the Registrar within one month of any alteration. 9 Sections 34 – 39; 63-72 10 Section 66 5 Increase of capital11 Every increase of nominal capital must be made by the company in general meeting. If the articles authorize the increase of capital, whether an ordinary or special resolution is required depends on the articles. If the articles do not give authority to increase capital, the articles must be altered by special resolution so that they do give authority but the one special resolution can both authorize the increase and effect the increase. The notice convening the meeting must specify the amount of the proposed increase and notice must be given to the registrar within the specified period of passing the resolution. Consolidation of shares This takes place when several shares are consolidated into one e.g. when ten $1 shares are consolidated into one $10 share. The articles must authorize consolidation and the resolution specified in the articles must be passed. If the articles is silent, a special resolution to give authority and to effect the consolidation is necessary. Notice must be given to the registrar within the specified period. Conversion of shares Stock is a set of shares put together in a bundle. The difference between stock and shares is that you can subdivide a stock into small fractions but you cannot subdivide a share. Conversion of shares to stock can only be made if the shares are fully paid. The articles must authorize the conversion or reconversion and the resolution specified in the articles must be passed. Notice of conversion or reconversion must be given to the registrar within the specified period. When shares are converted into stock, the register of members must show the amount of stock held by each member and a certificate is issued for the stock. Subdivision of shares This is the division of shares into shares of smaller amount e.g. division of one $10 share into $5 shares. This is often done for the purpose of improving the marketability of expensive shares. The articles must authorize the subdivision and the specified resolution in the articles must be passed and notice of the subdivision must be given to the registrar within the specified period. Cancellation of unissued shares A company may cancel shares, which have not been taken or agreed to be taken by any person and ‘diminish’ the amount of its share capital by the amount of the shares to cancelled. The articles must authorize cancellation and the required resolution must be passed and notice of cancellation must be given to the registrar within the specified period. The cancellation of shares must not have the effect of reduction of share capital. 11 Section 67 6 Reduction of share capital12 Subject to the confirmation by the court, a limited company with share capital may, if authorized by its articles, pass a special resolution to reduce its share capital. Section 71 gives a company the power to do any of the following: (a) Extinguish or reduce the liability on any of its shares in respect to share capital not paid up; (b) Reduce its stated capital by an amount that is not represented by realizable assets or; (c) Pay off any paid up share capital which is in excess of the wants of the company. In Trevor V Withworth,13 it was held that the company could not purchase its own shares even though there was an express power to do so in its memorandum since this would amount to a reduction of capital. DIVIDENDS Definition and nature: Dividend is the shareholder’s share of company’s profit legally available for distribution as such. Under the Companies Act, companies that have been issued with license of the minister to dispense with ‘limited’ in their names are prohibited from distributing profit to their members. These companies limited by guarantee usually not having share capital cannot declare dividend. Dividends can only be paid out of the distributable profit of the company. Payment of Dividends The following rules apply to payment of dividend: i. Dividends are paid in the manner laid down by the articles. Usually, the articles provide that the board of directors must first recommend payment of dividends after considering a complete and detailed list of the company’s assets and investments. The company in general meeting will then declare the amount recommended as dividend by the board. In the absence of anything to the contrary in the articles, a company in general meeting cannot be compelled to declare dividend and no action can be brought for its recovery until it has been declared, but once it is declared, it becomes a debt which the company must pay. ii. Dividends are paid out of the distributable profit of the company which is the accumulated realized14 profits that has not been utilized by distribution or 12 Section 71 13 12 App Cases 40a 14 ‘accumulated’ – requires that losses of previous years must be included in determining the current distributable surplus. ‘realised’ – means reduced to actual cash. It does not include increase in the value of retained asset as a result of revaluation. 7  capitalization and which has not been written off in a reduction or reorganization of capital. iii. The board of directors may declare interim dividends if the articles give them such power. iv. Dividends are payable in cash except the articles provide for payment otherwise than in cash. v. Articles may provide for forfeiture of unclaimed dividends after a certain number of years. In Bond V Barrow Haematite Steel Co,15The company suffered a realized loss of £200,000 and the directors decided that the remaining £50,000 otherwise available for payment of dividends should be held back to cover general depreciation in value of assets (an unrealized capital loss). Preference shareholders sued to compel company to declare dividends. It was held that the directors are the judge of what should be distributed as dividends and the court cannot overrule their opinion. In Wood V Odessa Waterworks Co,16Articles of the company authorized company to declare dividends to be paid. A resolution was passed for a declaration of dividend in form of debentures on which the company would pay interest pending redemption. A shareholder sued the company claiming that the articles were a contract and that the effect of the contract ‘to be paid’ meant immediate cash payment. It was held that the claim was correct and an injunction was issued to prevent the company from paying the dividend otherwise than in cash. Unlawful payment of dividend: i. If dividends are paid out of non-distributable profit or out of capital, the directors and shareholders may have to return the money to the company. ii. Any member of the company may apply to court for an injunction to restrain the company from paying unlawful dividend even where a resolution was passed in general meeting to approve such payment. iii. The company may recover an unlawful distribution from its members if at the time of payment they knew or ought to have known that dividend were being paid out of capital. iv. Directors are liable if without preparing accounts they recommend dividends or declare interim dividends which are paid out of capital because they have a duty to ensure that distributable profits are available. v. The directors are liable if they make some mistake of law or interpretation of the company constitution which leads them to recommend or declare unlawful dividend. In Re Exchange Banking Co,17 The directors for several years laid before the general meeting accounts which showed as assets, debts of the company which the directors knew to be bad debts. Relying on these accounts, the shareholders passed resolutions to declare dividends out of the profits shown in the accounts when in actual fact, the company had 15 1 Ch. 353 16 42 Ch.D 636 17 8 made losses. On liquidation, the liquidator claimed that the directors must make good to the company dividend which they knew was paid out of capital. It was held that the shareholders even if they had known the true position could not by resolution passed in general meeting sanction payments prohibited by law. The directors as trustees of the company’s assets must refund the sums improperly paid out of those assets. In Re Oxford Benefit Building and Investment Society,18 articles of the company provided that dividends may be paid out of ‘realized profits’. The directors never attempted to in any report or balance sheet distinguish realized profit from estimated profit or ascertain out of what fund the dividend were actually paid. It was held that they must make good the dividends improperly paid. Capitalization Capitalization of a company’s profit is either creating bonus shares or transferring profits to capital redemption reserve. Companies may create distributable or undistributable reserves. Bonus shares are paid out of distributable reserve. When a company capitalizes its distributable reserve, it reduces its accumulated realized profits available for dividend and may issue in its place to existing ordinary shareholders bonus shares fully or partially paid proportion to their holdings. Companies may capitalize undistributable reserve if authorized by its articles. Funds in this reserve usually results from revaluation in the value of fixed assets made in good faith by competent valuators which are unlikely to fluctuate in the short term. Creation of reserve and of bonus shares must be provided for in the articles of incorporation. Bonus Shares Requirement of bonus shares: i. There must be authority in the articles. ii. The company’s nominal share capital must be sufficient. iii. The members must have passed an ordinary resolution for issuing the bonus shares. iv. The shares must be allotted by the board in the proportions specified in the articles. v. Return of allotments in accordance with the companies act must be delivered to the registrar. GOING PUBLIC – PUBLIC COMPANIES AND PROSPECTUS Where a company decides that it intends to access capital from the public through equity financing rather than debt, it must be registered as a public company. The first time that a company offers its shares to the public is called an initial public offering (IPO). These shares are traded through the country’s securities exchange. In Jamaica, shares of public companies are traded on the Jamaica Stock Exchange, either on its main board or on the 18 3 Ch.D. 502 9 Junior Stock Exchange. Companies have different reasons for using equity to raise capital. Unlike debt financing, by selling shares to the public the company has access to cheap money that it does not have to repay which is often used for expansion of the business. Equity financing is also used to repay debts of the company. PROSPECTUS In addition to the relevant documents of incorporation, if the company proposes to be registered as a public company, then its prospectus must be delivered to the Registrar and when the Registrar sees that the content of the prospectus has been fully complied with, it is registered. A prospectus is a book/statement issued by a public company or intending public company inviting the public to subscribe to shares or purchase debenture stocks of the company setting out the advantages to accrue from such investment. It is issued either by the company or the promoter or by an issuing house or a share broker/stockbroker. The purpose of the prospectus is to provide the necessary information to enable the potential investor to decide whether or not to subscribe for the company’s shares or debentures.19 Procedure for issuing prospectus: 1. The prospectus is prepared, printed, dated and signed by every person named as a director or proposed director of the company or by their individual agent authorized in writing.20 2. A copy of the prospectus is delivered to the COJ and to the Financial Services Commission for registration. 3. The Registrar will refuse registration if he considers that on the face of it the prospectus is misleading21 but if he finds that it is in order, he will register it and inform the company or the person who delivered the copy for registration of the fact of registration and the date of registration. 4. On receipt of the letter from the Registrar, the company will include the date of registration on the prospectus and issue it to the public. Content: Information to be provided in the prospectus includes: 1. Who the directors are, and what benefit they will get from their directorships. 2. What profit is being made by the promoters. 3. The amount of capital required by the company to be subscribed, the amount actually received or to be received in cash and the precise nature of consideration given for the remaining capital. 4. Company’s past financial record. 5. Company’s obligations under contracts for commission and preliminary expenses. 19 O.H. Akinladejo, Company Law Manual 20 Section 40(2a) 21 Sec. 40 (4a) - “…within fourteen days or (longer as he sees necessary), the registrar must inform in writing the company or any other person who delivered the copy of prospectus of his opinion”. 10  6. Voting and dividend rights of each class of shares. 7. The number of qualification shares of the directors (if any). 8. The number of founder shares (if any). 9. Names, descriptions and addresses of directors. 10. The minimum subscription. 11. The time of opening the subscription list. 12. The amount payable on application and allotment of each share. 13. The names and addresses of the vendors of any property purchased or to be purchased by the company and the amount payable in cash, shares or debentures or such property. 14. The amount paid or payable as commission for subscribing or procuring subscription for shares or debentures. 15. Estimated amount of the preliminary expenses. 16. Names and addresses of the auditors. 17. Length of time for which the business of the company has been carried on. The prospectus must contain the following: 1. Reports of the auditors of the company specifying the profit, losses, assets and liabilities of the company 2. Report by accountants named in the prospectus specifying the profits, and losses of the business of the company for three financial years immediately preceding the issue of the prospectus. 3. Any material contract referred to in the prospectus. A prospectus may also include a statement by an expert. The expert must have given and not withdrawn a written consent to the inclusion of the statement in the prospectus and the prospectus must state that the expert gave a written consent. Remedies for false statement in prospectus: We have remedies at common law and from the Companies Act. Common law: 1. Rescission -The Company is liable for misrepresentations made by its agent while the agent was acting within the scope of his authority or as an alter ego of the company. Rescission is available for fraudulent, innocent or negligent misrepresentation of statements in the prospectus. Rescission enables the allotee to recover what he paid for the shares or debentures plus interest. For rescission of the contract of allotment to be possible, the allotee must prove; a. That there was a material false statement of fact not opinion and b. That he was induced to subscribe because of the false statement. City of Edinburgh Brewery Co. Ltd. v. Gibson’s Trustee22 A prospectus stated that a large number of gentlemen in the trade and others have become shareholders. When the register of members was made up, there were 55 shareholders of whom 10 or 12 were connected with the trade. It was held that there was not a 22 7 M. 886 11 sufficiently material misrepresentation to warrant a rescission of the contract of allotment. Re Pacaya Rubber and Produce Co ltd.23 A company issued a prospectus inviting subscriptions for the purpose of buying a rubber estate in Peru. The prospectus contained extracts from the report of an expert on the spot. The report was false. It was held that the accuracy of the report was prima facie the basis of the contract and if the company did not intend to contract on that basis, it should have disassociated itself from the report in clear terms and warned that it did not vouch for the accuracy of the report. Court allowed rescission of the contract. The right to rescission is lost if: a) After discovering the misrepresentation, the alottee does an act which shows that he wants to retain the shares e.g. attends and votes at general meeting or receives dividends or attempts to sell the shares. b) The alottee fails to act within a reasonable time of discovering the truth c) Restitution is impossible e.g. he has sold the shares d) The company goes into liquidation. 2. Damages for fraud- an action for damages may be brought against the company or the individuals responsible in addition to rescission or in lieu of rescission if the misrepresentation is negligent or fraudulent. A prospectus may be fraudulent if it contained false statements or if it has true statements but omissions give a false impression as a whole. The measure of damages for fraud is prima facie the difference between the actual value of the shares at the time of allotment and the sum paid for them. 3. Both civil and criminal sanctions can be invoked if the prospectus requirements are not complied with and if the information in the prospectus is inaccurate or misleading. Sec. 44- Civil Liability The following persons are required to pay compensation to all persons who subscribe for any shares or debenture on the faith of the prospectus and sustained loss or damage; a) Every person who is a director of the company at the time of the issue of the prospectus b) Every person who has authorized himself to be named and is named in the prospectus as a director either immediately or after an interval of time. c) Promoters of the company d) Person who authorized the issue of the prospectus. Sec. 45- Criminal Liability The Act provides that any person who authorizes the issue of a prospectus containing an untrue statement is liable upon conviction to two years or a fine or both or upon summary 23 1 Ch. 542 12 conviction by a resident magistrate to three months imprisonment or a fine not exceeding $100,000 or both. Sec. 42 - A $100,000 fine is levied against anyone who is knowingly a party to the issue of a prospectus with an expert’s statement without consent by the expert that the statement should be included in the prospectus. Sec. 40 (7) - If a prospectus is issued without having been registered as required by this section, the company, and every person who is knowingly a party to the issue of the prospectus, shall be liable to a fine not exceeding five thousand dollars for every day from the date of the issue of the prospectus until it is withdrawn in a manner. Statement in lieu of Prospectus: This is submitted for registration by a private company converting to a public company and does not yet have a prospectus in place (Section. 26). LOAN CAPITAL AND DEBENTURES Definition and Nature24 This is the term used to describe borrowed money obtained usually by the issue of debentures or financial assistance from financial institutions. Loan capital is a liability owed to creditors and is different from share capital which represents the interests of members as owners of the company. The Companies Act25 provides that a public company will be unable to conduct business or exercise any borrowing powers without first receiving the Registrar’s certificate that the company’s allotted share capital is not less than the authorized minimum. The current minimum is set at $500,000. The Act allows the Minister the discretion to adjust the authorized minimum share capital requirement for public companies. A debenture is a written acknowledgement of a debt by the company. It is a document which states the terms on which a company has borrowed money. It may also create a charge over the company’s assets as security for the loan. In essence, a debenture is a long term loan made at a fixed rate of interest. Types of debentures: 1. Single debenture- This takes the form of a simple loan or overdraft facility from a bank. 2. Debenture issued as a series- This is when a company raises loan capital from different persons and different lenders provide different amounts on different dates. Each lender receives a debenture in identical form and even though the transactions are separate, they all rank equally having same right to repayment and security for the loan. 24 Section 84- 92 25 Section 34 13  3. Debenture stock- this is used by public companies to raise loan capital from large number of lenders. Each lender has a right to be repaid his capital and interest at the stated time but for convenience, the separate loans are treated as a single global loan stock in which each stockholder has a specified fraction contributed when the stock was issued. The terms of the debenture stock are expressed in a trust deed and a trustee is appointed for the stock holders to represent their interests and enforce their rights. Each stockholder receives a stock certificate which states that he is a registered holder of a certain amount of debenture stock subject to terms and conditions of the trust deed. Debentures may be further classified as: a. Registered debentures-This is when debenture or debenture stock is made payable to the registered holder. Most debentures are registered debentures. They are not negotiable instruments. b. Bearer debentures-These are debentures made payable to bearer. They are negotiable instruments therefore; a transferee in good faith for value takes them free from any defects in the title of a prior holder. They are transferred by mere delivery. c. Redeemable debentures- These are issued on the terms that the company is bound to redeem a certain number of the debentures each year or that the company may repurchase them or that the company is bound to set aside a sinking fund for redemption purposes on a specified date. d. Perpetual/ Irredeemable debentures-These debentures are not repaid until the company either defaults in payment of interests or goes into liquidation. e. Convertible debentures- These debentures may be converted into shares at a fixed date at holders’ option. f. Secured debentures- The Company’s assets are used as security for the loan. This is a form of mortgage. Nature and advantages of Trust Deed: The three types of debentures described in the proceeding paragraphs are usually secured by trust deed. A trustee is appointed over the company’s property (usually a trust corporation) and in the event that interest or principal cannot be paid on specified date, the trustee exercises the rights specified in the trust deed. A trust deed will usually contain the following covenants and clauses; i. Covenant by company to pay debenture holders principal on specified date and interest. ii. Covenant giving the trustee a legal mortgage on specified freehold and leasehold interests and floating charge over the rest of the company’s undertakings and properties. iii. A clause specifying the events in which the security will become enforceable and giving power to trustee to appoint a receiver when the event occurs. iv. Covenant by company to keep properties charged in good repair and to insure them. v. Covenant by company to keep a register of debenture holders. 14 Charges: 26 A charge will give the debenture holder, as creditor, a legal right to receive repayment of all sums he is owed out of a specified fund or more commonly, out of the proceeds following the sale of a specific property. A charge over a company’s asset gives the creditor a prior claim to payment of his debt out of those assets. They are two types of charges: 1. Fixed charge 2. Floating charge Fixed charge- is suitable for fixed assets of the company which the company is likely to retain for a long time. The charge attaches to the relevant specific asset at the time of the creation of the charge. If the company disposes of the asset charged, it will either repay the secured debt out of the proceeds of sale to discharge the debt or transfer the asset subject to the charge to the transferee/purchaser. Floating charge- A floating charge was defined in Re Yorkshire Wool Combers Association Ltd.27 as a charge: i. on a class of assets of a company, present or future ii. which class is, in the ordinary course of the company’s business, changing from time to time and iii. until the holders enforce the charge, the company may carry on business and deal with the assets charged. A floating charge does not attach to the relevant assets until the charge crystallizes and it is not restricted to current assets such as stock in trade or book debts only. It may apply to fixed, current and future assets of a company. A floating charge is usually created by expressed words e.g. ‘a floating charge over the undertakings and assets’, but no special form of words is necessary. NB. Once the company has freedom to deal with the assets in the ordinary course of business until the charge crystallizes, it is a floating charge. It is sufficient to relate a floating charge to a class of assets which may not be identified until crystallization. It is not always obvious whether a charge is fixed or floating, in fact most charges often express the charge to be fixed or floating so that if a receiver is appointed, the assets may be realized without reference to preferential creditors. However, whether a charge will be regarded as fixed or floating is not conclusively dependent on the words used in creating the charge but rather whether the charge envisages that the company will still be able to deal with the charged assets in the ordinary course of business without reference to the charge. Crystallization: 26 Section 93-104 27 2 Ch. 284 15 This is the process by which a floating charge is converted to a fixed equitable charge. The floating charge crystallizes into a fixed charge on the assets of the company i.e. it becomes attached on the assets of the company. The events that will cause crystallization of a floating charge may or may not be stated in the charge. The occurrence of the following events will cause crystallization whether stated or not as a condition for crystallization of a floating charge: 1. liquidation of a company 2. cessation of business 3. active intervention by a chargee by appointing a receiver over the assets of the company charged or exercising a power of sale 4. Crystallization of another floating charge if it causes the company to cease business. If a floating charge contains a provision that the charge is to crystallize on the occurrence of a specified event whether or not the chargee learns of the event and whether or not the chargee wants to enforce the charge as a result of the event, the occurrence of such an event could cause the automatic crystallization of the charge. Registration of charges:28 Every charge created unless registered is void. A void charge is not a charge and has no priority over a valid charge but the debt which it secured is still in existence and will be regarded as an unsecured debt. A charge duly registered within twenty one days of its creation shall rank in priority to any charge after it. A charge created but not registered until after the twenty one days of its creation shall for the purposes of priority deemed to have been created on the date of registration. NB. Registration of a charge constitutes notice to the world of the existence of that charge. Section 94 provides that it is the duty of the company to register the charge but registration may also be done by any interested party in the event that the company neglects or defaults in registering the charge.29 Section 103 mandates that a Register of charges is to be kept by the company.30 Priority of charges: When there are many charges over the assets of the company by different persons, it is important to determine in what order of priority the chargees will be paid. A fixed charge can be either legal or equitable while a floating charge is an equitable charge. There are two types of priority which applies to secured creditors: Horizontal priority- the order of distribution within a particular class of secured creditors. Vertical priority- the order of distribution between different classes of secured creditors. 28 Section 93-95 29 section 94 30 Section 103 16 Remedies open to unsecured creditors: 1. Sue for principal or interest and after obtaining judgment, he may levy execution against the company. 2. Petition the court for winding up of the company by the court on the ground that the company is unable to pay its debts. Remedies open to the secured creditors: 1. Sue for principal or interest 2. Present a petition for the winding up of the company 3. Exercise any power conferred by the debenture or trust deed e.g. appointing a receiver of assets charged 4. Apply to the court for either the appointment of a receiver or a receiver and manager (administrative receiver) or an order for sale or foreclosure (an order for foreclosure will only be made if all the debenture holders of the same class as plaintiffs are before the court). Receivers:31 A debenture or trust deed usually gives power to the debenture holders to appoint a receiver in the event of default by the company. A receiver takes possession of the company’s property over which he is appointed, manages and realizes it for the benefit of the debenture holders. He takes possession of only the specific asset charged. The receiver is regarded as an agent of the company and not of the debenture holders in order to safe guards the debenture holders against liability for wrongful acts. A receiver may be appointed under a fixed or floating charge but usually, he is appointed under a floating charge because the holder the holder of a fixed charge can simply sell the property himself without appointing a receiver. Administrative Receivers/ Receiver Managers: This is a receiver appointed under a floating charge over the whole or substantially the whole of the company’s assets. He also manages the company’s business. The debenture would usually stipulate the conditions for appointment of the administrative receiver. The directors’ powers over the assets are suspended and every letter head, invoice and other company documents must state that the company is in receivership. Official receiver: An official receiver is appointed by applying to the court for such an appointment if the debenture does not give adequate power for the appointment of a receiver. The official receiver is an officer of the court not an agent of the company or an agent of the debenture holders. The court will appoint an official receiver if the principal or interest is due and unpaid, or if the company has begun to wind up, or if the security is in jeopardy. I. Basics of the Security Interests in Personal Property Act, 2013 31 Section 341-350 17 A. Who is interested in a secured transaction? 1. The debtor “Debtor” is defined in section 2. Usually we think of the debtor as someone who owes money. Maybe so, but not necessarily so under SIPPA. A secured transaction creates two obligations: (1) a personal obligation, such as a promise to pay money, and (2) a supporting or collateral obligation, such as the transfer of rights in property that secures the personal obligation (the “secured property”). A debtor under SIPPA is a person whose property supports a personal obligation. That person may be the person who owes the debt, or that person may be somebody else. Anyone may be a debtor under SIPPA. That is, the debtor may be an individual or an entity of any nature that has the legal capacity to enter into a contract. There may be more than one debtor to a single secured transaction. 2. The secured creditor “Secured creditor” is defined in section 2. The secured creditor is the person who takes from a debtor the rights in the property that secures an obligation. Any person or entity that has capacity to make a contract may be a secured creditor. An obligation to multiple secured creditors may be secured by one security agreement. 3. Third parties The debtor and the secured creditor are parties to the “security contract” – the agreement in which property rights are transferred to secure the obligation. Others, however, may be interested in the secured property, either because they, too, have rights in the property or because at some time in the future they acquire rights in the property. a. Other secured creditors A debtor may secure obligations to multiple secured creditors, using the same property as security. Sometimes this is desirable to all involved, and sometimes it is not desirable. We must keep in mind, however, that there may be competing claims to collateral, asserted by multiple secured creditors. b. Execution creditors “Execution creditor” is defined in section 32. An execution creditor is someone who acquires property rights in secured property without the consent of the debtor. (By contrast, the debtor agrees to transfer rights in secured property to the secured creditor.) An execution creditor may be a person who holds a judgment against a person and has rights to execute on the debtor’s property to satisfy the judgment. An execution creditor may be a taxing authority that has a right to seize property of a delinquent taxpayer. An execution creditor may be a liquidator or bankruptcy administrator. c. Buyers and lessees of secured property The debtor may sell or lease secured property to a buyer or lessee. Depending on the circumstance, this may be desirable for all concerned, or it may violate an agreement between the debtor and the secured creditor. In any event, a buyer or lessee of secured property acquires rights that compete with the rights of secured creditors. 18 B. The elements of a secured transaction 1. The security interest “Security interest” is defined in section 2. A security interest is a property right. Courts interpret the security interest as a “legal” right, rather than an “equitable” right in property. Usually the debtor owns the secured property, but this is not necessarily so. If the debtor merely has power to transfer rights in property, the debtor can give a security interest in whatever rights the debtor has. So, if the debtor owns property, the debtor may transfer a security interest in that ownership. If the debtor leases property, the debtor may only transfer a security interest only in rights held under the lease. 2. The security contract “Security contract” is defined in section 2. The security contract is the agreement in that describes the collateral (the “secured property”) and in which the debtor transfers rights in the property to the secured creditor. 3. The secured obligation The secured obligation is a promise that is secured by the secured property. The secured obligation may be created in the security contract, or in another contract, such as a promissory note. An obligation may be secured by multiple security contracts. Multiple obligations may be secured by a single security contract. A secured obligation need not be a monetary obligation. The secured obligation may be of any nature, such as a promise to perform or not to perform. 4. The secured property The secured property must be personal property. (“Personal property” may be thought of as property other than land and buildings.) Personal property may be tangible, such as business equipment, stock in trade, or consumer goods. Personal property may be quasi- tangible, such as documents of title, checks and other financial instruments, or documents of title. Personal property may be intangible, such as intellectual property rights or bank accounts. The secured property may exist at the time that the security contract is concluded. The secured property may also be property in which the debtor acquires rights at a future time. C. The essential legal concepts 1. Attachment of the security interest to secured property A security interest is enforceable against a debtor when the security interest “attaches” to the secured property. Registration is not a requirement for the enforcement of a security interest against a debtor. Attachment of a security interest is governed by section 5. A security interest attaches when three conditions are met: (1) the secured creditor gives value to the debtor 19 (2) the debtor has rights in the secured property (3) there is a security contract that describes the property or the secured property is (in certain cases) in the possession or control of the secured creditor. The three conditions may be met in any order. Example #1. Debtor owns a truck; Debtor signs security contract covering the truck; Creditor signs loan agreement promising to disburse funds secured by the truck. The security interest attaches to the truck and is enforceable when the Creditor signs the agreement. Example #2. Debtor signs a security contract covering future equipment and inventory; Creditor makes periodic advances of cash under an agreement secured by the equipment and inventory; months later, debtor purchases stock-in-trade and a delivery vehicle. The security interests in the stock-in-trade and the delivery vehicle attach instantly when the debtor acquires rights in them. 2. Perfection of the security interest against third parties A security interest is enforceable against third parties if it is “perfected”. Perfection is governed by sections 8 and 9. There are three methods of perfection of a security interest. (1) Registration. A security interest may be perfected by registration of a notice in accordance with the rules on registration. Registration is the most common method of perfection. (2) Possession. A security interest may be perfect if the secured creditor takes possession of the collateral. For example, the secured creditor might perfect a security interest by taking possession of goods, or a financial instrument, or a document of title. With perfection by possession, registration is not necessary for perfection. (3) Control. A security interest may be perfected in a deposit account or a securities account if secured creditor has control of the account. The methods for taking control are found in section 9(2). If a security is perfected by control, registration is not necessary. 3. Priority of competing security interests It is possible that multiple security interests will apply to the same secured property. Where there are competing security interests in the same secured property, the general priority rules are found in section 22, but there are exceptions for special circumstances and special types of property. Simply stated, the general priority rule is that the first creditor to register or perfect a security interest has priority over the claims of creditors who register or perfect later (or who do not register or perfect at all). Note that the essence of the priority rule is “first to register or perfect”. In most cases, the earliest registration date will have priority. Note that the security interest might attach to the secured property long after registration, but the priority date upon attachment will relate back to the registration date, if there should be competing claims. Example. (1) In January, Creditor ABC registers a notice covering future inventory of Borrower; (2) in February, Creditor DEF registers a notice covering future inventory of 20 the same Borrower; (3) in March, Borrower acquires stock in trade and defaults on his loan to Creditor DEF. Under the common law governing floating charges, Creditor DEF’s charge crystallizes upon Borrower’s default and Creditor DEF has priority. On the contrary, under SIPPA, DEF’s claim is subordinate to ABC’s claim because ABC registered first. 4. Purchase money security interests “Purchase money security interest” is defined in section 2. In essence, a purchase money security interest is a security interest in specific goods given by a debtor to secure financing for the purpose of buying those specific goods. An auto loan secured by the auto creates a purchase money security interest. The traditional hire-purchase agreement creates a purchase money security interest. Special priority rules in section 23 apply to purchase money security interests (PMSIs). A PMSI in goods other than inventory is perfected from the date of delivery of the goods to the debtor, if registration occurs within 15 working days. This gives PMSI creditors (such as consumer finance companies and auto finance companies) a grace period during which to complete registration. The PMSI has priority over prior security interests that are not PMSIs, even if the prior security interest is perfected. This priority for PMSIs is often called a “super-priority” because it is an exception to the “first to register or perfect” rule. Example. Bank ABC has a security interest in all the present and future personal property of Borrower, perfected in January. Borrower gives a PMSI in a new printing press acquired with a loan from Finance Company, which registers in June. Finance Company’s PMSI has priority over Bank ABC’s security interest, even though Bank ABC registered first. Bank ABC will have first priority in the printing press when the PMSI is discharged. A PMSI in inventory has a super-priority over general security interests if the conditions in section 23(2) are met. The PMSI creditor must give notice to prior secured creditors who have registered. A PMSI in intangible property has super-priority over non-PMSIs, if the PMSI is perfected within 15 working days from the date of attachment. A PMSI in accounts receivable that are bought by the secured creditor has superpriority over non-PMSIs. The purpose of the super-priority, in every case, is to promote commerce by facilitating purchase money financing. The super-priority gives an incentive to the PMSI financier. Without the super-priority, PMSI financiers might decline to extend credit where a general security interest has already been perfected. In each case, the economic advantage gained by the super-priority is deemed to outweigh the temporary harm, if any, to the holder of the non-PMSI, even though that security interest was perfected first. The super-priority rule for PMSIs has its roots in the unpaid vendor lien, and in the advantages previously enjoyed by title-retaining sellers, such as hire-purchase sellers. 7. Default SIPPA does not define default. The definition of “default” is left to the parties to agree upon. Otherwise, the definition is left to common law. 21 Default should not be understood as limited to the failure to pay a monetary obligation. Default may be defined by the parties as failure to perform any obligation, such as an obligation not to sell the property, an obligation to care for, or to insure the property, etc. Upon any event of default, the secured creditor has: (1) Rights under SIPPA (2) Any rights agreed upon in the security contract. (3) Any rights granted under any other law. Under SIPPA, upon default the secured creditor has a right to take possession of the secured property and to dispose of the property in any commercially reasonable manner. Under certain circumstances, the secured creditor may retain the property in full or partial satisfaction of the secured debt. Under certain circumstances prior to the disposition of the property, the debtor may redeem the property. If the secured creditor has possession or control of secured property, the secured creditor may dispose of the property without judicial process. D. The scope of SIPPA 1. Transactions covered by the Act – sec. 3(1) SIPPA applies to all transactions where the effect of an agreement is that personal property secures an obligation. SIPPA applies no matter what form or terminology is used by the parties and regardless of their intent. SIPPA applies whether title to secured property is held by the debtor or by the secured creditor. SIPPA applies to existing security devices known as, or formerly known as company charges, pledges and chattel mortgages such as the registered bill of sale. SIPPA applies to some transactions and property interests that do not create security in personal property but which are included for purposes of registration and priority to avoid confusion among prospective secured creditors. These transactions include (1) leasing (2) consignments (3) the sale of accounts (factoring, or in bulk) (4) the interests of execution creditors 2. Transactions not covered by the Act – sec. 3(2) See section 3(2) for an important list of transactions that are not covered by the scope of SIPPA. Notably, the list includes: A right to a life insurance claim or a superannuation fund. A real estate transaction. An assignment for the benefit of creditors. Securities in a depository licensed under the Securities Act. Mortgages on ships and maritime liens. An assignment of employee wages. The assignment of accounts receivable for the mere purpose of debt collection. VIII. Registration A. Basics of the Registry. 22 A Security Interests Registry is established in section 47. The purpose is to provide for an electronic notice registry. The Security Interests Registry receives notices and maintains them for public search. The notices alert prospective creditors and buyers of secured property of the possible existence of a security interest. The registration date of a notice may establish the date by which priority of competing claims is measured under the priority provisions. The Security Interests Registry is the key to successful implementation of SIPPA. In conjunction with the priority rules, the Security Interests Registry helps secured parties to know their rights in advance of disputes. Greater legal certainty means less risk, which is the key to increased credit. The duties of the Security Interests Registry are purely administrative. The Security Interests Registry exercises no regulatory function over the granting, taking, attachment, perfection, or enforcement of security interests. The Security Interests Registry is required to accept registration notices of security interests, including amendments, continuations, and terminations of the notices, if they meet the minimal standards set for in the Act. The Security Interests Registry also registers notices of the claims of execution creditors. Notices are only intended (1) to alert prospective creditors and buyers of collateral of the possible existence of a security interest, and (2) establish a priority date in appropriate cases. Notices do not create security interests and therefore the acceptance or refusal of a notice at the Security Interests Registry does not constitute the creation or the failure to create a security interest in any personal property. Consequently, it is unnecessary for the registrar to examine documents or judge their authenticity. In general, the public is free to search for notices on the Security Interests Registry without charge. Notices, amendments, continuations statements and termination statements are effective from the time they are assigned (electronically and online) an identification number and registration date. B. Who registers? Secured creditors, or their agents, register notices, including amendments, continuations, and terminations. There may be multiple secured creditors on a notice. C. What to register? A notice contains (1) identification of the debtor, (2) identification of the secured creditor, (3) the amount (if any) of the principal indebtedness, and (4) a description of the secured property. [Section 49(1).] D. When to register? A notice may be registered before a security agreement has been concluded and before a security interest attaches to collateral [section 49(3)]. This is important because a secured creditor may want to assure that its priority will be maximized before incurring the expense of negotiating a security agreement. Pre-registration is also important because a notice may relate to multiple security contracts made during the business relationship between debtor and secured creditor. E. Authorization to register. 23 The debtor must authorize the registration of a notice, but the authorization is not disclosed to or maintained by the registry. A debtor who signs a security contract automatically authorizes registration of a notice. The authorization may also be in another document. The debtor’s authorization may occur after the notice is registered. [Section 49.] F. Duration of notice. A notice is effective for ten years, after which it lapses unless it has been continued or terminated. [Section 53.] G. Amendment of notice. A notice may be amended by the secured creditor at any time to change any of the information in the notice [section 51]. If the collateral description is changed to add collateral, the debtor must authorise the amendment in the same manner as for an initial notice. The amendment is effective as to the added collateral only from the date of the amendment. H. Continuation of duration of notice. A secured creditor may register a continuation statement that will extend the duration of the notice by an additional ten years [section 53(2) and (3)]. I. Termination of notice. The secured creditor may terminate a notice at any time. The process is simple and is contained in section 54. J. Registrar’s refusal to register. The Security Interests Registry may only refuse to register a notice on strictly limited grounds (section 56). The primary grounds for refusal are failure to pay the registration fee, failure to name a debtor or a secured creditor, and failure to identify a notice by number on an amendment, continuation or termination. SIPPA grants the registrar has no discretion to impose other conditions on registration. K. Registration caveats and traps for the unwary. A notice is effective even if it contains errors. The notice is ineffective only if it is found to be materially misleading [section 52]. The primary grounds upon which a notice may be found to be materially misleading are failure to properly name the debtor, and failure to identify a motor vehicle correctly by serial number (if the serial number is required). 24